Although all countries can increase their consumption through trade, not everyone in those countries will be happy with the result. In Roadway, an additional truck costs 0.5 boats. Through exchange, however, both countries are likely to end up consuming more of both goods. In the case of Roadway and Seaside, for example, some boat producers in Roadway will be displaced as cheaper boats arrive from Seaside. Trade is the concept of exchanging goods and services between two people or entities. Suppose two countries each produce two goods and their opportunity costs differ. An Emerging Consensus: Macroeconomics for the Twenty-First Century, 33.1 The Nature and Challenge of Economic Development, 33.2 Population Growth and Economic Development, Chapter 34: Socialist Economies in Transition, 34.1 The Theory and Practice of Socialism, 34.3 Economies in Transition: China and Russia, Appendix A.1: How to Construct and Interpret Graphs, Appendix A.2: Nonlinear Relationships and Graphs without Numbers, Appendix A.3: Using Graphs and Charts to Show Values of Variables, Appendix B: Extensions of the Aggregate Expenditures Model, Appendix B.2: The Aggregate Expenditures Model and Fiscal Policy. Before the 1980s, China did not trade internationally: It was self-sufficient. Imagine for a moment how your household would fare if it had to produce every good or service it consumed. prices in the future, it could use policies which encourage the accumulation of oil inventories and minimize the potential for future adverse shocks. Other private services include such areas as education, financial services, and business and professional services. By specializing in the activity in which each individual has a comparative advantage, people are able to consume far more than they could produce themselves. It will export that good to a country, or countries, that has a comparative advantage in something else. Data on America’s import and export components show that goods and services purchased by the nation outweigh those which it sells on the global marketplace. increased employment in the domestic import sector Once trade opens between the two countries, truck producers in Roadway will rush to export trucks to Seaside. The precise amounts of each good shipped will depend on demand an supply. These points lie outside the production possibilities curves of both countries. If Roadway concentrated all of its resources on the production of trucks, it could produce 10,000 trucks per year. How many computers exchange for a washing machine in Alpha? Seaside moves along its production possibilities curve to point B′, at which the slope equals −1. This stimulates a country to go for international trade. The United States developed its comparative advantage in these services as the share of services in the U.S. economy grew over time. Basis of International Trade A country specializes in a specific commodity due to mobility, productivity and other endowments of economic resources. We can determine opportunity costs in the two countries by comparing the slopes of their respective production possibilities curves at the points where they are producing. American Enterprise Institute 1789 Massachusetts Avenue, NW Washington, DC 20036 Main telephone: 202.862.5800 Main fax: 202.862.7177 According to the Ricardian model of trade, the demand side conditions come in handy in determining the trade compositions and gains from trade, after trade opens up. There are three principal differences. Roadway’s truck producers will now get one boat per truck—a far better exchange than was available to them before trade. The key lies in the opportunity costs of the two goods in the two countries. d) A country may export a good or import it, but not both. Notice that the opportunity cost of an additional boat in Roadway is two trucks, while the opportunity cost of an additional boat in Seaside is 0.2 trucks. Figure 17.1 “Roadway’s Production Possibilities Curve” shows a production possibilities curve for Roadway. In simple words, gain from trade refers to extra production and consumption effects that countries can achieve through international trade. Trade leads each country in the direction of producing more of the good in which it has a comparative advantage. Figure 17.1 “Roadway’s Production Possibilities Curve”, Figure 17.2 “Measuring Opportunity Cost in Roadway”, Figure 17.3 “Comparative Advantage in Roadway and Seaside”, Figure 17.4 “A Picture of Comparative Advantage in Roadway and Seaside”, Figure 17.5 “International Trade Induces Greater Specialization”, Figure 17.6 “The Mutual Benefits of Trade”, Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License. They may need or want the goods or services. She predicts that, as the economies of our trading partners grow, their demand for services will also increase. Figure 17.6 “The Mutual Benefits of Trade” shows one such possibility. Each household specializes in an activity in which it has a comparative advantage. Here, the terms of trade are one truck in exchange for one boat. As shown in Panel (b) of Figure 17.5 “International Trade Induces Greater Specialization”, producers will shift resources out of truck production and into boat production until they reach the point on their production possibilities curve at which the terms of trade equal the opportunity cost of producing boats. (You only have numbers for the end points of the production possibilities curves. Now suppose trade occurs, and the terms of trade are two washing machines for one computer. In Seaside, however, a truck could be exchanged for five boats. Figure 17.2 Measuring Opportunity Cost in Roadway. An economy with a comparative advantage in a particular good will expand its production of that good only up to the point where its opportunity cost equals the terms of trade. The production possibilities curve for a second hypothetical country, Seaside, is given in Panel (b). Surely agricultural goods represent an important comparative advantage for the United States. Similarly, Seaside will specialize more in boat production. We shall use the production possibilities model to analyze Roadway’s ability to produce goods and services. Suppose the world consists of two countries, Alpha and Beta. A production possibilities curve illustrates the production choices available to an economy. Assume the computers and washing machines produced in the two countries are identical. Figure 17.1 Roadway’s Production Possibilities Curve. If no trade occurs between the two countries, suppose that Roadway is at Point A and that Seaside is at Point A′. Trade allows both countries to consume more than they are capable of producing. At point A in Panel (a) of Figure 17.3 “Comparative Advantage in Roadway and Seaside”, one additional boat costs two trucks in Roadway; that is its opportunity cost. The terms of trade determine the extent to which each country will specialize. Explain and illustrate the conditions under which two countries can mutually benefit from trading with each other. Sources: Catherine L. Mann, “Is the U.S. Trade Deficit Sustainable?” Washington, D.C: Brookings Institution, 1999; Catherine L. Mann, “The U.S. Current Account, New Economy Services, and Implications for Sustainability,” Review of International Economics 12:2 (May 2004): 262–76. What developed countries trade with each other look very It sends 2,500 of those boats to Roadway, so it ends up with 3,500 boats per year. We will assume that the two countries have chosen to operate at these points through the workings of demand and supply. Roadway thus emerges with 4,500 trucks (the 7,000 it produces at B minus the 2,500 it ships) and 9,500 boats. International trade allows countries to expand their markets and access goods and services that otherwise may not have been available domestically. Which of the following is one of the conclusions of New Trade Theory? These developed countries also are the ones who seem to gain the most from international trade. The terms of trade determine the extent to which each country will specialize. We have chosen points R3 and S3 at specific points, but any point along the tangent line that is up to the right from R1 and S1 would suffice to illustrate the fact that both countries can end up consuming more of both goods. Each country produces two goods, boats and trucks. How will the production of the two goods be affected in each economy? Some truck producers in Seaside will be displaced as cheaper trucks arrive from Roadway. On the topic of international trade, the views of economists tend to differ from those of the general public. These gains are, thus, of two types gain from exchange and gain from specialisation in production. Clearly, Seaside has a comparative advantage in the production of boats. The terms of trade are one, meaning that one boat exchanges for one truck. That is, resources have been guided to their current uses as producers have responded to the demands of consumers in the two countries. The members of such a household would work very hard, but it is inconceivable that the household could survive if it relied on itself for everything it consumed. In Seaside, it costs five boats. Start studying chapter 33: the gains from international trade. Chapter 1: Economics: The Study of Choice, Chapter 2: Confronting Scarcity: Choices in Production, 2.3 Applications of the Production Possibilities Model, Chapter 4: Applications of Demand and Supply, 4.2 Government Intervention in Market Prices: Price Floors and Price Ceilings, Chapter 5: Elasticity: A Measure of Response, 5.2 Responsiveness of Demand to Other Factors, Chapter 6: Markets, Maximizers, and Efficiency, Chapter 7: The Analysis of Consumer Choice, 7.3 Indifference Curve Analysis: An Alternative Approach to Understanding Consumer Choice, 8.1 Production Choices and Costs: The Short Run, 8.2 Production Choices and Costs: The Long Run, Chapter 9: Competitive Markets for Goods and Services, 9.2 Output Determination in the Short Run, Chapter 11: The World of Imperfect Competition, 11.1 Monopolistic Competition: Competition Among Many, 11.2 Oligopoly: Competition Among the Few, 11.3 Extensions of Imperfect Competition: Advertising and Price Discrimination, Chapter 12: Wages and Employment in Perfect Competition, Chapter 13: Interest Rates and the Markets for Capital and Natural Resources, Chapter 14: Imperfectly Competitive Markets for Factors of Production, 14.1 Price-Setting Buyers: The Case of Monopsony, Chapter 15: Public Finance and Public Choice, 15.1 The Role of Government in a Market Economy, Chapter 16: Antitrust Policy and Business Regulation, 16.1 Antitrust Laws and Their Interpretation, 16.2 Antitrust and Competitiveness in a Global Economy, 16.3 Regulation: Protecting People from the Market, Chapter 18: The Economics of the Environment, 18.1 Maximizing the Net Benefits of Pollution, Chapter 19: Inequality, Poverty, and Discrimination, Chapter 20: Macroeconomics: The Big Picture, 20.1 Growth of Real GDP and Business Cycles, Chapter 21: Measuring Total Output and Income, Chapter 22: Aggregate Demand and Aggregate Supply, 22.2 Aggregate Demand and Aggregate Supply: The Long Run and the Short Run, 22.3 Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium, 23.2 Growth and the Long-Run Aggregate Supply Curve, Chapter 24: The Nature and Creation of Money, 24.2 The Banking System and Money Creation, Chapter 25: Financial Markets and the Economy, 25.1 The Bond and Foreign Exchange Markets, 25.2 Demand, Supply, and Equilibrium in the Money Market, 26.1 Monetary Policy in the United States, 26.2 Problems and Controversies of Monetary Policy, 26.3 Monetary Policy and the Equation of Exchange, 27.2 The Use of Fiscal Policy to Stabilize the Economy, Chapter 28: Consumption and the Aggregate Expenditures Model, 28.1 Determining the Level of Consumption, 28.3 Aggregate Expenditures and Aggregate Demand, Chapter 29: Investment and Economic Activity, Chapter 30: Net Exports and International Finance, 30.1 The International Sector: An Introduction, 31.2 Explaining Inflation–Unemployment Relationships, 31.3 Inflation and Unemployment in the Long Run, Chapter 32: A Brief History of Macroeconomic Thought and Policy, 32.1 The Great Depression and Keynesian Economics, 32.2 Keynesian Economics in the 1960s and 1970s, 32.3. One important motivation for international trade is the efficiency improvements that can arise because of the presence of economies of scale in production. The opportunity cost of producing one more boat is thus one truck. 2/ b. People participate in international trade because they make themselves better off by doing so. gains from trade the extra production and consumption benefits that countries can achieve through INTERNATIONAL TRADE.Countries trade with one another basically for the same reasons as individuals, firms and regions engaged in the exchange of goods and services - to obtain the benefits of SPECIALIZATION.By exchanging some of its own products for those of other nations, a country can … (How the specific terms of trade are actually determined is not important for this discussion. According to the U.S. International Trade Commission, for example, the U.S. gain from removing trade restrictions on textiles and apparel would have been almost twelve billion dollars in 2002 alone. 5-23 What Is New Trade Theory? The world price of a pair of shoes is $20. most trade is between countries at similar stages of de-velopment - countries with similar factor endowments and similar technologies. Today, however, agricultural goods make up a small percentage of U.S. exports, though the amount of agricultural goods that the United States does export continues to grow. Different countries have different factor endowments eg climate, skilled labour force, and natural resources vary between nations. Sketch typical, bowed-out production possibilities curves for the two countries. Nowadays, international trade is a significant proportion of GDP, and it is the sign of a prosperous country. The essential point is that Roadway will produce more of the good—trucks—in which it has a comparative advantage. If we allow for market imperfections and for dynamic considerations, trade may yield other gains. Trade improves consumer choice and total welfare. Both produce only two goods, computers and washing machines. Alternatively, we can ask about the opportunity cost of an additional truck. Learn vocabulary, terms, and more with flashcards, games, and other study tools. 12/22/2020 Instruments + Political economy of Trade policy Flashcards | Quizlet small country can import,is D %3D 400 - 5P. Before trade, truck producers in Roadway could exchange a truck for half a boat. As a result of trade, Roadway now produces more trucks and fewer boats. The slope of a line tangent to the production possibilities curve at point B, for example, is −1. Seaside could produce only 5,000. We have learned that the absolute value of the slope of a production possibilities curve at any point gives the quantity of the good on the vertical axis that must be given up to produce an additional unit of the good on the horizontal axis. Roadside will produce more trucks (and fewer boats). International trade promotes efficiency in production as countries will try to adopt better methods of production to keep costs down in order to remain competitive. If this is the case, there is an opportunity for trade between the two countries that will leave both better off. In Alpha, 1 computer trades for 2 washing machines; in Beta, 3.5 computers trade for one washing machine. We have so far assumed that no trade occurs between Roadway and Seaside. Suppose the hypothetical country of Roadway is completely isolated from the rest of the world. As we can see by looking at the intersection of the production possibilities curves with the vertical axes in Figure 17.3 “Comparative Advantage in Roadway and Seaside”, Roadway is able to produce more trucks than Seaside. Beta? International trade is then the concept of this exchange between people or entities in two different countries. In spite of people's apprehension about trade, both imports and exports are at all-time highs (see the figure). The specialization is not, however, complete. Now let us assume that trade opens up. The law of increasing opportunity cost means that, as an economy moves along its production possibilities curve, the cost of additional units rises. The world price of coal was less than China's domestic price and increases by area A + B; decreases by area B. Roadway and Seaside each consume more of both goods when there is trade between them. increases by area C + D; decreases by area C. At point A′ in Panel (b), 1 additional boat in Seaside costs only 0.2 truck. We assume that it produces only two goods—trucks and boats. Suppose the equivalent amounts for Beta are 8,000 computers and 8,000 washing machines per month. They will produce trucks in Roadway and boats in Seaside. Thus, the worker does not gain if the capitalist keeps the market price above the natural price by virtue of some manufacturing or trading secret, or by virtue of monopoly or the favorable situation of his land. Boat producers in Seaside will rush to export boats to Roadway. b. the goods they can produce at the lowest opportunity cost. Contact. Read Eye on Globalization. Demand plays a crucial role in the determination of international terms of trade in the Ricardian model only after opening up of trade. Doing business in other countries can boost your company's reputation. This forecast makes for good jokes, but it hardly squares with the facts. It neither exports nor imports goods and services. First, many noneconomists believe that it is more advantageous to trade with other members of one’s nation or ethnic group than with outsiders. Notice that each country produces on its production possibilities curve, but international trade allows both countries to consume a combination of goods they would be incapable of producing! Here are sketches of possible production possibilities curves. Full employment will be restored, which means both countries will be back at the same level of employment they had before trade. The two countries differ in their respective abilities to produce trucks and boats. One of the advantages of international trade is that you may have an outlet to dispose of surplus goods that you're unable to sell in your home market. Roadway thus has a comparative advantage in producing trucks; Seaside has a comparative advantage in producing boats. The graph shows the U.S. demand for and U.S. supply of shoes. Suppose that Beta is much more populous than Alpha, but because workers in Alpha have more physical and human capital, Alpha is able to produce more of both goods than Beta. Seaside tripled its production of boats—from 2,000 per year to 6,000 per year. Enhanced reputation. Suppose no trade occurs between the two countries and that they are each currently operating on their production possibilities curves at points A and A′ in Figure 17.3 “Comparative Advantage in Roadway and Seaside”. All countries are endowed by nature with the same productive The governments of such nations may then finance their activity by resorting to tariffs on imported goods, since such levies are relatively easy to administer. Jakub T. Jankiewicz – Microprocessor – CC BY-SA 2.0. Gains from trade are commonly described as resulting from: specialization in production from division of labor, economies of scale, scope, and agglomeration and relative availability of factor resources in types of output by farms, businesses, location and economies. Before trade, Roadway is producing at point A in Panel (a) and Seaside is producing at point A′ in Panel (b). Roadway produces more trucks, and Seaside produces more boats. Then China began to trade internationally in, among other items, coal and shoes. As the law of increasing opportunity costs predicts, in order to produce more boats, Roadway must give up more and more trucks for each additional boat. The economic case has been a powerful force in moving the world toward freer trade. International Trade: International trade is the exchange of products across the borders. The United States has a trade deficit. Politics of International Trade. Roadway must be operating somewhere on its production possibilities curve or it will be wasting resources or engaging in inefficient production. By shipping their boats to Roadway, they can get two trucks for each boat. The graph shows the demand for shoes in Brazil, DB, the supply of shoes produced in Brazil, SB, and the market equilibrium in Brazil when it does not trade internationally. That transition will be completed when the two countries are back on their respective production possibilities curves. Now look at the intersection of the production possibilities curves with the horizontal axes. A flight across the United States almost gives a birds-eye view of an apparent comparative advantage for the United States. So, from a policy perspective, it is important for the U.S. to promote trading policies that will keep this sector open. If trade opens between the two economies and the terms of trade are 1.5, then Alpha will produce more washing machines and fewer computers (moving to a point such as R2), while Beta will produce more computers and fewer washing machines (moving to a point such as S2). Chapter 6 Economies of Scale and International Trade. This is a net economic gain after deducting the losses to firms and workers in the domestic industry. Roadway’s production possibilities curve is given in Panel (a); it is the same one we saw in Figure 17.1 “Roadway’s Production Possibilities Curve” and Figure 17.2 “Measuring Opportunity Cost in Roadway”. Suppose Roadway ships 2,500 trucks per year to Seaside in exchange for 2,500 boats, as shown in the table in Figure 17.6 “The Mutual Benefits of Trade”. Gains from international trade Define trade International trade is the exchange of goods and services between countries. It reduces its production of trucks to 3,000 per year, but receives 2,500 more from Roadway. The country with a lower opportunity cost for a particular good or service has a comparative advantage in producing it and will export it to the other country.