Comparative Advantage and the Gains from International Trade

Effect of a Tariff on Economic Surplus

area of t (length * width) tells you

Opportunity Cost formula

give up/gain

How to: Determine who has the comparative advantage in the production of each good by calculating opportunity costs.

In order for the United States to produce 1 bushel of wheat, it must give up 5 shirts, while China has to give up 8 shirts for the same bushel of wheat. The United States gives up less to produce wheat, so it has the comparative advantage in the production of wheat. To produce 1 shirt, the United States must give up 1/5 of a bushel of wheat, while China only gives up 1/8 bushel of wheat. Therefore, China has the comparative advantage in the production of shirts.

Autarky

a situation where a country does not trade with other countries

ABSOLUTE Advantage

the ability of an individual, firm, or country to produce more of a good or service than competitors when using the same amount of resources

How to Determine who has the absolute advantage in the production of each good.

begin by looking at each good individually and ask yourself the question "Who can produce more of the good?"

Determine specialization by looking at the comparative advantage.

To receive gains from trade, countries should specialize in the good in which they have a comparative advantage and then trade that good for goods from other countries

External Economy

reductions in a firm's costs that result from an expansion in the size of an industry

Comparative advantage

shows that individuals, firms, and countries will be made better off by producing goods and services for which they have a lower opportunity cost than competitors and trading for those goods and services for which they have a higher opportunity cost **Nations develop comparative advantages for different reasons including a favorable climate, the availability of natural resources, an abundance of labor or capital, and access to superior production technologies. (tl;dr comp. adv. means being able to produce something at a lower opportunity cost than someone else)

In reality, countries do not completely specialize because

some goods are not traded internationally, opportunity costs increase as production increases, consumers in different countries have different preferences for products

terms of trade

the ratio at which a country can trade its exports for imports from other countries **No country would accept terms of trade worse than its opportunity cost—it would be better off producing by itself the goods that it was importing.

Trade Restrictions

usually in the form of tariffs, quotas, voluntary export restraints, and other non- tariff barriers Although tariffs and quotas save jobs in the countries that impose them, the employment gains often are achieved at a high cost The United States government has extended protection to some domestic industries due to allegations of dumping by foreign companies. (Dumping) refers to selling a product for a price below its cost of production.

reasons why a country may have a comparative advantage in producing a particular good

A firm in one country may have a relatively low opportunity cost in the production of a good because of favorable climate, abundant supplies of certain natural resources, or relatively abundant supplies of labor or capital. -superior technology in one country. -may also result from external economies

difference between comparative advantage and absolute advantage in international trade

Absolute advantage is the ability of a country to produce more of a good than other countries using the same amount of resources. comparative advantage is the key to determining specialization and trade. Countries have a comparative advantage in production when they can produce a good or service at a lower opportunity cost than other producers. Countries are better off if they specialize in producing the goods for which they have a comparative advantage. They can then trade for the goods for which other countries have a comparative advantage.

Question: Countries gain from specializing in producing goods in which they have a ___________ advantage and trading for goods in which other countries have a _____________ advantage.

Comparative; absolute Why?

Economic Impact of Quota

Consumer surplus falls by A+C+B+D (lower consumption, higher price)