SAYRE // MORRIS

Ninth Edition

CHAPTER 10

International Trade
Jason Dean, Wilfrid Laurier University

© 2018 McGraw-Hill Ryerson Limited 13-1

 CHAPTER 10

International Trade

Learning Objectives:
1. Explain the importance of international trade and
why nations trade with each other
2. Explain why nations import certain goods, even
though they can be made more cheaply at home
3. Explain how the gains from trade are divided
between trading partners

© 2018 McGraw-Hill Ryerson Limited 13-2

 CHAPTER 13

International Trade

4. Describe why some groups win and others lose as a

result of freer trade, and explore trade restrictions
5. Identify some arguments against free trade

© 2018 McGraw-Hill Ryerson Limited 13-3

Trends in World Trade and GDP
1970-2011

Source: World Trade Organization, International Trade Statistics 2012.

© 2018 McGraw-Hill Ryerson Limited 13-4
 Specialization and Trade
• Factor endowment

– An advantage in production that comes from better skills,

equipment, or other resources

• Theory of absolute advantage

– Nations, like firms and individuals, should specialize in

producing goods and services for which they have an
advantage

– They should trade for goods and services for which they
do not enjoy an advantage
© 2018 McGraw-Hill Ryerson Limited 13-5
 Test Your Understanding
Beer Wine
Freedonia 4 1
Libraland 3 4

• Which country should specialize in which product?

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 Test Your Understanding
Beer Wine
Freedonia 4 1
Libraland 3 4

• Which country should specialize in which product?

Freedonia should specialize in beer and Libraland

should specialize in wine

© 2018 McGraw-Hill Ryerson Limited 13-7

 Test Your Understanding
Beer Wine
Freedonia 4 1
Libraland 3 4
• Suppose that initially the working population of each country
is 20 million, with 10 million working in each industry. What is
the total output of the two countries?

© 2018 McGraw-Hill Ryerson Limited 13-8

 Test Your Understanding
Beer Wine
Freedonia 4 1
Libraland 3 4
• Suppose that initially the working population of each country
is 20 million, with 10 million working in each industry. What is
the total output of the two countries?

Beer Wine
Freedonia 40 10
Libraland 30 40
Totals 70 50
© 2018 McGraw-Hill Ryerson Limited 13-9
 Test Your Understanding
Beer Wine
Freedonia 4 1
Libraland 3 4
• Suppose that each country decides to specialize in the
product in which it has an advantage. What will be the total
output of each product, and what are the gains from trade?

© 2018 McGraw-Hill Ryerson Limited 13-10

 Test Your Understanding
Beer Wine
Freedonia 4 1
Libraland 3 4
• Suppose that each country decides to specialize in the
product in which it has an advantage. What will be the total
output of each product, and what are the gains from trade?
Beer Wine
Freedonia 80 0
Libraland 0 80
Totals 80 80
Gains are 10 beer, 30 wine
© 2018 McGraw-Hill Ryerson Limited 13-11
 Specialization and Trade
• Theory of Comparative Advantage

– The advantage that comes from producing something at a

lower opportunity cost than others are able to do

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 Comparative Advantage
Table 10.4. Output per Worker by Country and Industry
Number of Bushels per Day
Wheat Beans
United States 4 or 4
Philippines 1 or 3

• Each country has a trade-off (opportunity cost) for each item

it produces
Table 10.5. Opportunity costs of Production
Cost of Producing One Unit
Wheat Beans
United States 1 bean or 1 wheat
Philippines 3 beans or 1/3 wheat
© 2018 McGraw-Hill Ryerson Limited 13-13
 Comparative Advantage
• The U.S. is comparatively better at making wheat
– It gives up 1 beans, while Philippines gives up 3
Table 10.5. Opportunity costs of Production
Cost of Producing One Unit
Wheat Beans
United States 1 bean or 1 wheat
Philippines 3 beans or 1/3 wheat

• The Philippines is comparatively better at beans

– It gives up 1/3 of wheat, while the U.S. gives up 1
– Both can be better off specializing, with trade
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 Production Without Trade
• Suppose the United States produces at C, while the
Philippines produces at B (no trade)

Table 13.6 Production Possibilities

United States: Output (millions of bushels per day)
A B C D E F
Wheat 400 320 240 160 80 0
Beans 0 80 160 240 320 400
Philippines: Output (millions of bushels per day)
A B C D E F
Wheat 100 80 60 40 20 0
Beans 0 60 120 180 240 300

© 2018 McGraw-Hill Ryerson Limited 13-15

 Production Without Trade
• Suppose the United States produces at C, while the
Philippines produces at B (no trade)

Table 13.6 Production Possibilities

United States: Output (millions of bushels per day)
A B C D E F
Wheat 400 320 240 160 80 0
Beans 0 80 160 240 320 400
Philippines: Output (millions of bushels per day)
A B C D E F
Wheat 100 80 60 40 20 0
Beans 0 60 120 180 240 300

© 2018 McGraw-Hill Ryerson Limited 13-16

 Production Without Trade
• Suppose the United States produces at C, while the
Philippines produces at B (no trade)

Table 13.6 Production Possibilities

United States: Output (millions of bushels per day)
A B C D E F
Wheat 240
400 + 80320 = 240 160 80 0
Beans 320
0 Wheat 80 160 240 320 400
Philippines: Output (millions of bushels per day)
A B C D E F
Wheat 100 80 60 160 + 6020=
40 0
Beans 0 60 120 180 240 300
220 Beans
© 2018 McGraw-Hill Ryerson Limited 13-17
 Specialization With Trade
• Suppose the United States specializes at A, while the
Philippines specializes at F, and they trade

Table 13.6 Production Possibilities

United States: Output (millions of bushels per day)
A B C D E F
Wheat 400 320 240 160 80 0
Beans 0 80 160 240 320 400
Philippines: Output (millions of bushels per day)
A B C D E F
Wheat 100 80 60 40 20 0
Beans 0 60 120 180 240 300

© 2018 McGraw-Hill Ryerson Limited 13-18

 Specialization With Trade
• Suppose the United States specializes at A, while the
Philippines specializes at F, and they trade

Table 13.6 Production Possibilities

United States: Output (millions of bushels per day)
A
400 B
WheatC D E F
Wheat 400 320 240 160 80 0
Beans 0 80 160 240 320 400
Philippines: Output (millions of bushels per day)
A B C D E F
Wheat80 more 100Wheat80and 60 40 20 0
Beans 0
80 more Beans, total 60 120 300
180 Beans 240 300

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 Terms of Trade
• The average price of a country’s exports compared with the
price of its imports

Terms of trade = Average price of exports × 100

Average price of imports

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Terms of Trade

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Table 13.10 Output per Worker by Country and Industry
Philippines
Before Trade After Trade
Beans produced
Beans exported
Beans consumed
Wheat produced
Wheat imported
Wheat consumed

United States
Before Trade After Trade
Beans produced
Beans exported
Beans consumed
Wheat produced
Wheat imported
Wheat consumed

© 2018 McGraw-Hill Ryerson Limited 13-22

Table 13.10 Output per Worker by Country and Industry
Philippines
Before Trade After Trade
Beans produced 60
Beans exported 0
Beans consumed 60
Wheat produced 80
Wheat imported 0
Wheat consumed 80

United States
Before Trade After Trade
Beans produced
Beans exported
Beans consumed
Wheat produced
Wheat imported
Wheat consumed

© 2018 McGraw-Hill Ryerson Limited 13-23

Table 13.10 Output per Worker by Country and Industry
Philippines
Before Trade After Trade
Beans produced 60
Beans exported 0
Beans consumed 60
Wheat produced 80
Wheat imported 0
Wheat consumed 80

United States
Before Trade After Trade
Beans produced 160
Beans exported 0
Beans consumed 160
Wheat produced 240
Wheat imported 0
Wheat consumed 240

© 2018 McGraw-Hill Ryerson Limited 13-24

Table 13.10 Output per Worker by Country and Industry
Philippines
Before Trade After Trade
Beans produced 60 300
Beans exported 0 -240
Beans consumed 60 60
Wheat produced 80 0
Wheat imported 0 120
Wheat consumed 80 120
Gain = 40 Wheat
United States
Before Trade After Trade
Beans produced 160
Beans exported 0
Beans consumed 160
Wheat produced 240
Wheat imported 0
Wheat consumed 240

© 2018 McGraw-Hill Ryerson Limited 13-25

Table 13.10 Output per Worker by Country and Industry
Philippines
Before Trade After Trade
Beans produced 60 300
Beans exported 0 -240
Beans consumed 60 60
Wheat produced 80 0
Wheat imported 0 120
Wheat consumed 80 120
Gain = 40 Wheat
United States
Before Trade After Trade
Beans produced 160 0
Beans imported 0 240
Beans consumed 160 240
Wheat produced 240 400
Wheat exported 0 -120
Wheat consumed 240 280
Gain = 80 Beans and 40 Wheat

© 2018 McGraw-Hill Ryerson Limited 13-26

 U.S. Production and Trading
Possibilities Curves
• The slope before trade is 1 (1 wheat for 1 beans)

• If the terms of trade are 2 beans for 1 wheat, the maximum

quantity of
beans
available
to the U.S.
increases

© 2018 McGraw-Hill Ryerson Limited 13-27

 Philippines Production and Trading
Possibilities Curves
• The slope before trade is 1/3 (1 wheat for 3 beans)

• If the terms of trade are 2 beans for 1 wheat, the maximum

quantity of
wheat
available
to the
Philippines
increases

© 2018 McGraw-Hill Ryerson Limited 13-28

 Test Your Understanding
Output/worker Apples Pears
Freedonia 6 3
Libraland 3 2
– Assuming the two countries above wish to trade, would
terms of trade of 1 bushel of pears = 2.5 bushels of apples
be feasible?
– What about 1 bushel of pears = 1 bushel of apples?
– 1 bushel of pears = 1.75 bushels of apples?

© 2018 McGraw-Hill Ryerson Limited 13-29

 Test Your Understanding
Output/worker Apples Pears
Freedonia 6 3
Libraland 3 2
– Assuming the two countries above wish to trade, would
terms of trade of 1 bushel of pears = 2.5 bushels of apples
be feasible?
– What about 1 bushel of pears = 1 bushel of apples?
– 1 bushel of pears = 1.75 bushels of apples?
Only the last one is feasible. In Freedonia 1 pear costs 2
apples. In Libraland 1 pear costs 1.5 apples. Therefore, the
terms of trade must be between 1 pear = 1.5 to 2 apples.

© 2018 McGraw-Hill Ryerson Limited 13-30

 Advantages of Free Trade
• Lower prices as the result of lower costs of production

• Higher incomes

• A greater variety and quality of products

• Increased competition

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 Demand and Supply
Without Free Trade
• Demand and supply are higher in France

• Thus in France the quantity is higher and the price is lower

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 Demand and Supply
With Free Trade
– The world price lies between France and Germany
– France’s surplus (exports) = Germany’s shortage (imports)

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 Winners and Losers
from Free Trade
Winners Losers

Domestic (German) Consumers

Foreign (French) Consumers
• More product choices
• Pay higher prices
• Pay lower prices

Foreign (French) Producers Domestic (German) Producers

• Bigger market • Get lower prices
• Get higher prices • More competition

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 Trade Protection
• Types:

– Import quotas

– Tariffs

– Currency-exchange controls

– Bureaucratic regulations

– Voluntary export restrictions

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 Trade Restrictions
• Quota

– A limit imposed on the production or sale of a product

• Protectionism

– The economic policy of protecting domestic producers by

restricting the importation of foreign products

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 Import Quotas
• Import quotas raise the price, lower imports,
and increase
domestic
production

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 Trade Restrictions
• Tariff

– A tax (or duty) levied on imports

• Currency exchange controls

– Government restrictions limiting the amount of foreign

currencies that can be obtained

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 Effects of a Tariff
• Tariffs raise the price, lower imports,
increase
domestic
production,
and raise tax
revenue

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 Trade Restrictions
• Bureaucratic regulations

– Rules that make it hard for foreign products to enter the

country, or require them to be modified before entering

• Voluntary export restriction (VER)

– An agreement by an exporting country to restrict the

amount of its exports to another country

© 2018 McGraw-Hill Ryerson Limited 13-40

 Arguments Against Free Trade
• Strategy industry argument

– A country’s strategic industries may be offered protection

so the country does not become dependent on foreign
manufacturers

• Infant industry argument

– Certain “infant” industries may be protected until they are

sufficiently mature to take on foreign competition

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 Arguments Against Free Trade
• Cultural identity argument

– Free trade brings mass production and standardization,

which may harm the importing country’s sense of identity

• Environmental and labour standards

– May be eroded to compete with countries whose

standards are lower and have a cost advantage as a result

© 2018 McGraw-Hill Ryerson Limited 13-42

 CHAPTER 10

Key Concepts to Remember:

1. Theories of absolute and comparative advantage

2. Gains from trade stem from differences in the
opportunity costs of production
3. How the gains from trade are divided
4. There are winners and losers when free trade is
introduced
5. Trade restrictions and the arguments against free
trade
© 2018 McGraw-Hill Ryerson Limited 13-43