econ test

Study Guide for Chapter 7

Chapter 7: Comparative advantage and gains from trade

Learning Objective:

1. Explain the difference between comparative advantage and absolute advantage in international trade.

2. Explain how countries gain from international trade: i) gain as a whole nation; 2) potential winners and losers within a country.

3. Analyze the economic effects of tariffs or quotas.

4. Evaluate the debate over trade policies and globalization.

Section 7.1

Understand Figure 7.1:

a. Both exports and imports have tended to increase as a fraction of U.S. gross domestic product (GDP) since 1970.

b. Trade deficits (=imports-exports) has also increased as well.

Section 7.2 : Comparative advantage

Absolute vs. comparative advantage:

a. Absolute advantage: focus on which country can produce more with the same amount of resources. From table 7.1, you can easily see that Japan has an absolute advantage in both Cell & Tablet.

b. Comparative advantage: focus on which country has a lower (marginal) opportunity cost. From table 7.2, Japan has a comparative advantage in Cell, while the U.S. in Tablet.

*** practice how to compute the marginal opportunity cost.

Section 7.3: Gain from international trade

Introduction: you must know differences between gains from trade as a whole nation(see slide 11) and gains from trade within a country as individuals (see slide 14).

Terms of trade (TOT): understand what determines the limits of TOT (see Slide 10). For example, Seller’s opportunity cost (=exporting country) (TOT of 1C( Buyer’s opportunity cost (=importing country).

From Slide 5( table 7.2), ½T (Japan)(TOT of 1C( 2T (U.S.)

Production in Autarky (=no trade): See Slide 9. Understand which country should specialize in which good and produce how much it can produce.

Gains from trade as a whole nation:

-Understand table 7.4 (See Slide 11): produce more and consume more through trade. Understand how much each country gains from trade as a whole nation. Where do these gains come from? Change in amount of resources or benefits from specialization (more efficient use of resources)?

Why don’t we see complete specialization? (slide 12)

Where does comparative advantage come from? (slide 13)

Gains from trade within a country as individuals (Slide 14)

Examine who are potential winners and losers from trade within a country and why.

Exporting industries (tablets in the U.S.)---where a country has a comparative advantage; import-competing industries (cell phones in the U.S.)---where a country doesn’t.

Section 7.4

Government policies restricting international trade (Slide 16, 17 & 18):

a. Tariffs

b. Quotas and voluntary export restraints (VER)

c. Economic effects of tariff or quota (focus on my lecture note: Slide 17 & 18)

-Slide 17: From all the assumptions, you should know that the U.S. will import ethanol from foreign countries, and the price of domestic ethanol will be the same as the world price of ethanol (=$1.00).

From Figure 7.6 (slide 18), you should know why the US consumers will be winners from trade (answer: enjoy more at a lower price) and the U.S. ethanol makers will become losers (answer: sell less at a lower price) after trade, but without tariff.

-Slide 18: After a tariff, you should know that winners (=us consumers) become losers, while losers (=us ethanol makers) become winners.

Government policies promoting trade (slide 20):

a. Bilateral approach: promote trade between two countries.

b. Multilateral approach: more than 2 countries. For example, NAFTA, EU, AND WTO..

Section 7.5

Understand why some people oppose free trade (see slide 21-24).

Key Terms

Absolute advantage: The ability to produce more of a good or service than competitors when using the same amount of resources.

Autarky: A situation in which a country does not trade with other countries.

Comparative advantage: The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.

Dumping: Selling a product for a price below its cost of production.

Exports: Goods and services produced domestically but sold in other countries.

External economies: Reductions in a firm’s costs that result from an increase in the size of an industry.

Free trade: Trade between countries that is without government restrictions.

Globalization: The process of countries becoming more open to foreign trade and investment.

Imports: Goods and services bought domestically but produced in other countries.

Opportunity cost: The highest-valued alternative that must be given up to engage in an activity.

Protectionism: The use of trade barriers to shield domestic firms from foreign competition.

Quota, p. 218. A numeric limit a government imposes on the quantity of a good that can be imported into the country.

Tariff: A tax imposed by a government on imports.

Terms of trade: The ratio at which a country can trade its exports for imports from other countries.

Voluntary export restraint (VER): An agreement negotiated between two countries that places a numerical limit on the quantity of a good that can be imported by one country from the other country.

World Trade Organization (WTO): An international organization that oversees international trade agreements.