Subject:
Economics
Material Type:
Module
Level:
Community College / Lower Division, College / Upper Division
Provider:
Ohio Open Ed Collaborative
Tags:
Comparative Advantage, Gains From Trade, International Trade, Oss0042
License:
Creative Commons Attribution Non-Commercial
Language:
English
Media Formats:
eBook

Education Standards (6)

International Trade Resources

International Trade Resources

Overview

In this topic, students will be introduced to the elements of international trade. They’ll learn about the gains from trade and how they arise. They’ll learn the difference between absolute and comparative advantage and why comparative advantage is the key to profitable trade. They’ll also be exposed to the types of trade restrictions imposed by governments and the usual justifications for those restrictions.            

Learning Objectives

  1. Identify arguments for and against free trade (1,2,15,16)
  2. Explain the law of comparative advantage and the concept of absolute advantage (2)
  3. Identify government policies that can affect international trade (2,6)
  4. State and explain the justifications for government restrictions on trade (2,6)
  5. Analyze the economic impact of trade restrictions such as tariffs or quotas with the supply/demand model (5,6)
  6. Discuss reasons for trends in international trade over time (2,15)

NOTE: This module meets Ohio TAGs 1, 2, 5, 6, 15 & 16 for an Intro to Microeconomics course

Supplemental Content/Alternative Resources

Alternative Textbook Resource

Principles of Economics: International Trade

Full Citation: University of Minnesota Libraries, Minneapolis, MN. Principles of Economics, Publishing Ed. 2016. University of Minnesota, (CC BY-NC-SA 4.0), 2016.

This material in this chapter is similar to that in the primary recommended text.  The introduction to the chapter gives a good summary of gains from trade and a short history of trade liberalization in recent decades.  The coverage of restrictions on international trade in section 17.3 is a little more complete and may be useful to instructors.  Likewise, the section on justifications for trade restrictions offers some additional insights.   

Alternative Video Resources

The following videos are produced by George Mason University.  The selected videos are part of an extensive collection of videos that cover most topics in microeconomics.   

Active Learning Exercise

Trade Restrictions and Local Economic Activities

This is a timely topic given the recent controversy over trade deals, tariffs and trade wars.  Students will be asked to assume the role of a consultant to a regional economic development association for an area that has steel producers but also many steel and aluminum users.  The association wants to make a statement to their legislative representative regarding foreign competition.  Students will choose from four ready-made responses but they’ll be required to explain and defend their choice.  

This exercise is included in Starting Point: Teaching and Learning Economics

Questions and Problems

International Trade

Questions and Problems

Instructors can add a Google Doc of the International Trade Questions and Problems to their Google Drive or download a Word File of the International Trade Questions and Problems.

Questions:

  1. Jack and Jill are carpenters.  The table below shows how many cabinets each can install and how many closet doors each can hang in one hour. 

    Door Hanging Table for Jack and Jill

     
    1. Who has the absolute advantage in installing cabinets and who has the absolute advantage in hanging closet doors?  Explain.
    2. Who has the comparative advantage in installing cabinets and who has the comparative advantage in hanging closet doors?  Explain.
       
  2. The countries of Utopia and Metopia produce bread and cheese.  The table below shows their respective production possibilities frontiers (PPF). 

    Respective Production Possibilities Frontiers Graph

     
    1. Which country has the comparative advantage in bread and which in making cheese?  Explain.
    2. Utopia is initially producing and consuming at point B on its PPF and Metopia is initially producing and consuming at point C on its PPF.  Explain why both countries would be better off if they both specialize completely in the good in which they have the comparative advantage (ans. b) and trade. 
    3. Draw both countries’ PPFs and show how both can benefit by specializing trading assuming Utopia trades 50 loaves to Metopia for 50 pounds of cheese.
  3. Gains from trade aren’t confined to trade among nations but also occur in transactions among individuals.  Give an example of gains from trade that accrue to a typical individual or household.

  4. Intra-industry trade has become an increasingly large percentage of total trade in recent decades.  What is intra-industry trade and what factors motivate its growth?  

  5. Assume the U.S. imposes a tariff on imported aluminum.  Use supply/demand analysis to explain the effects of the tariff.  Who benefits from the tariff and who suffers?  Explain.  
     
  6. Briefly discuss the usual arguments for protectionism and why many economists are skeptical of their effectiveness. 
     
  7. One of the most-voiced objections to free trade is that is costs domestic jobs.  Taking a broad view of the effects of tariffs or other trade restrictions, discuss the validity of this objection.  
     
  8. Discuss the role of the World Trade Organization in lowering barriers to trade.

Answers:

  1. …  
    1. Jill has the absolute advantage in both tasks.  She can install one more cabinet and hang one more closet door in an hour than Jack. 
    2. The opportunity cost of installing a cabinet (in terms of closet doors not hung) is 0.5 for Jack and 0.6 for Jill.  Therefore, because Jack’s opportunity cost is lower, Jack has a comparative advantage in installing cabinets.  The opportunity cost of hanging a closet door (in terms of cabinets not installed) is 2 for Jack and 1.67 for Jill.  Therefore, because Jill’s opportunity cost is lower, Jill has a comparative advantage in hanging closet doors. 
  2. …  
    1. In Utopia, the opportunity cost of producing one loaf of bread is ½ pound of cheese. In Metopia, the opportunity cost of producing one loaf of bread is 2 pounds of cheese.  In Utopia, the opportunity cost of producing one pound of cheese is two loaves of bread.  In Metopia, the opportunity cost of producing one pound of cheese is one half a loaf of bread.  Thus, Utopia has the comparative advantage in cheese and Metopia has the comparative advantage in bread. 
    2. At their initial production (and consumption) levels, total production is 130 loaves of bread and 145 pounds of cheese.  If both countries specialize completely in their comparative advantage, total production rises to 150 loaves of bread and 180 pounds of cheese.  Specialization increases world production.
    3. Without trade (and at initial points on their PPFs), Utopia produces and consumes 100 loaves of bread and 25 pounds of cheese, and Metopia produces and consumes 30 loaves of bread and 120 pounds of cheese.  With specialization and with a trade of 50 loaves of bread from Utopia in exchange for 50 pounds of cheese from Metopia both countries are better off.  Utopia produces 150 loaves, trades 50 loaves for 50 pounds of cheese for a net gain of 25 pounds of cheese.  Metopia produces 180 pounds, trades 50 pounds for 50 loaves for a net gain of 20 loaves and 10 pounds. 
       
  3. Students should appreciate the gains from trade occur when they specialize in a profession (accountant, teacher) and use their income to buy goods and services that would be costly to produce themselves. 
     
  4. Intra-industry trade (sometimes called two-way trade) refers to trade in goods that are similar.  Some intra-industry trade is the result of seasonality or transportation costs (trade in fresh produce may reverse with the growing season and buyers may find it cheaper to buy from sellers who despite being on the other side of the border, are still closer).  Much of intra-industry trade arises from product differentiation and the ensuing specialization and economies of scale that create a comparative advantage.  
     
  5. The effect of a tariff on imported aluminum would be to shift the supply curve of aluminum available domestically to the left, causing the domestic price to rise and demand to decline.    Domestic aluminum companies would benefit by gaining market share.  Domestic aluminum workers might also benefit.  Foreign aluminum producers would lose market share.  All downstream users of aluminum would face higher costs.  
     
  6. The infant industry argument to protect fledgling industries until they can compete.  Skepticism arises because the process of picking candidates can be corrupted and that protection, once granted, may be hard to end.  2) The anti-dumping argument which proposes restrictions as a way to fix the unfair trade practice of selling below cost of production.  The skepticism is that it’s difficult to determine cost of production and it may be normal competition that pushes world prices down. 3) The environmental protection argument which contends that all countries should abide by certain environmental standards.  Environment standards are only one of many factors that are considered in location.  In addition, it’s hypocritical for first-world nations, who have dumped their share of pollution, to lecture developing countries. 4) The unsafe consumer products argument that contends that domestic consumers be kept safe.  Not a bad argument but can lead special interests to insist on unnecessarily strict standard.   5) The national interest (security) argument that contends that it is dangerous to rely on foreign sources for strategic materials.  The argument is not bad but there are other ways to achieve desired results and the designation of strategic materials is subject to special interest.    
     
  7. Taking a narrow view, tariffs or other restrictions on trade can save jobs in the protected industry.  Make that view slightly broader and you’ll realize that those jobs are saved due to a subsidy from domestic consumers in the form of higher prices.  Broaden the view even more and you’ll have to consider the downstream effects on industries that use the protected good as an input.  Those effects include higher prices, lower output and reduced employment.  Finally, it’s likely that countries whose goods are subject to import restrictions will retaliate by restricting access to their markets.  
  8. The World Trade Organization was established in 1995 to help trade flow smoothly, freely, fairly and predictably among member nations.  It currently has 164 members including the U.S.  The WTO provides a framework for negotiating trade agreements and for settling trade disputes between member nations.