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Lecture 17

ECONO-2202 Lecture Notes - Lecture 17: Trade Adjustment Assistance, International Trade, Eurozone


Department
Economics
Course Code
ECONO-2202
Professor
Iqbal
Lecture
17

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Chapter 26 Outline LECTURE NOTES
I. Learning Objectives After reading this chapter, students should be able to:
A. List and discuss several key facts about international trade.
B. Define comparative advantage, and demonstrate how specialization and trade add to a nation’s
output.
C. Describe how differences between world prices and domestic prices prompt exports and imports.
D. Analyze the economic effects of tariffs and quotas.
E. Analyze the validity of the most frequently presented arguments for protectionism.
F. Identify and explain the objectives of GATT, WTO, EU, eurozone, and NAFTA, and discuss
offshoring and trade adjustment assistance.
II. Some Key Trade Facts
A. The United States has a trade deficit in goods (exports exceed imports); in 2015 the trade deficit
in goods was $529 billion.
B. The United States has a trade surplus in services ($220 billion in 2015).
C. The principal exports of the United States include chemicals, semiconductors, consumer durables,
aircraft, and agricultural products. Its main imports are petroleum, automobiles, computers,
household appliances, and metals.
D. The United States exports many of the “same” goods it imports (intra-industry trade).
E. Canada is the United States’ quantitatively most important trading partner (19 percent of U.S.
exports; 13 percent of U.S. imports).
F. The United States had a $366 billion trade deficit with China in 2015.
G. The shale oil boom greatly reduced U.S. dependence on foreign oil. By 2105, U.S. imports from
OPEC fell to $66.2 billion while exporting $72.8 billion of good to those countries.
H. The United States leads the world in the volume of exports and imports. China, Germany, the
United States, Japan, and the Netherlands are the world’s top five exporters; U.S. exports of
goods make up about 8.5 percent of the world’s exports.
I. U.S. exports of goods and services (on a national income account basis) comprise 13 percent of
total U.S. output.
J. China is now a major trading country with $2.2 trillion in exports in 2015. South Korea, Taiwan,
and Singapore are also large traders.
K. International trade and finance link economies. Economic change in one part of the world has
repercussions for countries around the globe.
L. International trade and finance is often at the center of debates of U.S. economic policy.

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III. The Economic Basis for Trade
A. International trade is a way nations can specialize, increase the productivity of their resources,
and realize a larger total output than they otherwise would.
B. Two points amplify the rationale for trade.
1. The distribution of economic resources among nations is uneven.
2. Efficient production of various goods requires different technologies or combinations of
resources.
3. Products are differentiated among nations and some people prefer imports.
C. Interaction of these points can be illustrated.
1. China has a large labor force and can specialize in labor-intensive goods.
2. Australia has an abundance of land relative to human and capital resources and can cheaply
produce land intensive agricultural products. Mexico’s climate and unskilled labor force
means they can produce vegetables at a low cost.
3. Industrially advanced nations like the United States and Germany are in a position to produce
capital-intensive goods.
D. As national economies evolve, the resource base may be altered affecting the relative efficiency
with which nations can produce various goods and services.
IV. Comparative Advantage
A. With trade, a country allocates more resources and produces a larger output in exporting
industries with fewer resources and output in the importing industries.
B. The basic principle of comparative advantage rests on differing opportunity costs of producing
various goods and services allows countries to specialize, increasing productivity of resources
and increasing output.
C. An example of comparative advantage is developed in Figure 40.1 and Table 40.1 comparing an
imaginary example using the United States and Mexico, where the labor forces of the two
countries are assumed to be of equal size.
1. Before trade, both nations are self-sufficient in beef and vegetables and produce at the levels
shown in Figure 40.1 on their PPCs. There are three important points to realize with regard to
their production possibilities curves:
a. Constant costs: The linear production possibilities “curves” assume constant
opportunity costs (implying resources are perfectly substitutable).
b. Different costs: Different resource mixes and technology generates different
opportunity costs between the two nations.
c. U.S. absolute advantage in both goods: Given the assumption of equal-sized labor
forces, Figure 40.1 illustrates a case where the United States is more productive (can
produce at lower cost) in producing both of the goods.
2. The principle of comparative advantage says that total output will be greatest when each good
is produced by the nation that has the lower opportunity cost. The United States has a
comparative advantage in beef production and should specialize in beef, and Mexico should
specialize in vegetables as one would expect.
3. Note in Table 40.1 that after specialization there will be more beef and more vegetables in
total than the totals before specialization. Total beef production rose from 26 units of beef to
30 units of beef; vegetable production rose from 16 to 20.
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4. Since each nation would like some of both goods, they will now have to trade. The terms of
trade will be limited by the original cost conditions in each country. For example, in the
United States 1 beef = 1 vegetable, so the United States will not give up more than 1 beef for
each vegetable. Similarly, in Mexico 1 beef = 2 vegetables, so Mexico will not trade more
than 2 vegetables for 1 beef. These two facts set the limits to the terms of trade. The rate of
exchange will be somewhere between 1 and 2 vegetables for each beef (Key Graph 40.2
illustrates these possibilities graphically). The actual terms of trade within these limits will
depend on each country’s negotiating power and world demand and supply conditions for
these products.
5. The gains from trade can be shown by selecting any trade ratio within the limits. The text
selects 1B = 1-1/2V. If the United States chooses to trade 10 tons of beef for 15 tons of
vegetables, both nations will be better off than they were when they were self-sufficient.
Specialization and trade have improved the productivity of their resources.
6. As a result of specialization and trade, both countries can have more of both products.
7. The above example assumes constant-cost industries, which would not be the case in the real
world. Rather, as the United States begins to expand beef production, its relative costs will
rise and likewise with costs of vegetable production in Mexico. The effect of increasing costs
is that complete specialization will probably not occur with many products.
D. Consider This . . . A CPA and a House Painter
1. In this example, the CPA is absolutely more productive than the house painter but has a
higher opportunity cost for painting the house because of the wages sacrificed by painting
instead of accounting.
2. The best allocation of resources is for the CPA to hire a painter because the opportunity cost
is lower, similar to how countries determine the goods they will produce and the ones that
they will import.
E. The case for free trade is restated in the text: through free trade, based on the principle of
comparative advantage, the world economy can achieve a more efficient allocation of resources
and a higher level of material well-being. Both countries gain more of both goods (see Key Graph
Figure 40.2).
1. One side benefit from free trade is that it promotes competition and deters monopoly power.
2. Another side benefit may occur as specialization increases the production possibility curve by
raising the productivity of the resources devoted to producing certain goods.
3. Free trade links national interests, potentially breaking down national animosities.
F. Consider This . . . Misunderstanding the Gains from Trade
1. Contrary to common myths, the true gain from international trade is not an increase in
employment in the export sector but an increase in total output.
2. International trade enables a country to have a total output that is greater than its PPC.
V. Supply and Demand Analysis of Exports and Imports
A. This analysis helps us understand how prices and quantities of exports and imports are
determined in world markets.
1. The equilibrium world price derives from the interaction of world supply and demand.
2. The equilibrium domestic price is determined by domestic supply and demand. It is the price
that would prevail in a closed economy with no international trade.
3. When economies are open to trade, differences between world and domestic prices form the
basis for exports or imports.
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