Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

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Only available with supplementary resources at additional cost

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All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

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Chapter 16: Why International Trade?

Figure 16.1: The process of some globalization has accelerated in recent decades, resulting in the world economy to become vastly interdependent. [1]
“The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon their doorstep. [...] The ‘internationalization’ of [economic life] was nearly complete.”  - John Maynard Keynes, 1914 [1]
“I am in favor of helping the prosperity of all countries because, when we are all prosperous, the trade of each becomes more valuable to the other.”  - William Howard Taft, 27th President of the United States, 1909 [2]
“This is the moment when we must build on the wealth that open markets have created, and share its benefits more equitably. Trade has been a cornerstone of our growth and global development. But we will not be able to sustain this growth if it favors the few, and not the many.”  – Barack Obama, 44th President of the United States (2008) [3]

16.1 Objectives

After working through this chapter, you will be able to:

  • discuss the advantages and disadvantages of trade among individuals and businesses in the same town or country and among individuals and businesses in different countries. 
  • define the concepts of absolute and comparative advantage and explain their significance in determining the patterns of trade.
  • explain the consequences of establishing tariffs and quotas.

Question 16.01

Question 16.01

Why do individuals, businesses and countries trade with one another? Make a list of the benefits of trade.

Hover here to see the hint for Question 16.01.
Click here to see the answer to Question 16.01.

16.2 Why Trade?

Suppose two individuals decide to trade with each other. Bill gives his bicycle to Sarah in return for Sarah’s computer. Each has full knowledge of the condition and value of both items. Who wins in this trade? Maybe Sarah took advantage of Bill – why would she want to get rid of her computer? On the other hand, maybe Bill is taking advantage of Sarah; he obviously values the computer more than the bicycle.

What about trade between businesses? Or between individuals and businesses? Who is better off when you buy something from Radio Shack – you or the store? Who is better off, the employee who is paid wages, or the employer who receives labor? When GM orders parts from a supplier, is there a winner and a loser in the trade?

Trade among individuals and businesses is almost always carried on because the participants believe that they will be better off as a result of the trade. When you choose to eat dinner at Chili’s, you do so because you are hungry and prefer Chili’s tonight over other choices. The owners of Chili’s are providing you a meal in return for the profit the owner expects to earn. Unless either you or the owners are surprised, you both will be better off as a result of the transaction.

Trade occurs between rational people because everyone benefits. If one party in a trade felt that they would be worse off as a result of the transaction, then they would choose not to engage in the trade. It may seem intuitive that if someone wins in a trade, then someone must also lose. But trade is not a zero-sum game, that is, a game where the total benefit is fixed. Under certain circumstances, there can always be two winners in a trade between rational participants who have full information about the trade.

Trade is buying and selling of goods and services on the parts of individuals and businesses. It occurs among individuals and companies just down the block, across town, in New York, in California, and in Brazil, France, Japan, Russia, England, China, among many, many others.

Why do people trade? Why do you say thank you when a store clerk sells you something? Why does the clerk say “thank you”? Why do you both say “thank you”? The reason is that you are both better off; you both benefit.

Figure 16.2: Individuals buy and businesses sell goods and services because all participants believe that they will be better off as a result of trade. [2]

What about international trade? Is it the same as trade between individuals and businesses in the United States? When Japan ships cars to the US, is this trade better for Japan or for the U.S.? Do Japanese automakers or American consumers benefit? What about Japanese consumers and American automakers – how are they affected by this trade? International trade is an issue that inspires passionate debate, swings voters in elections, and can result in legislation that has a real impact on the wallets of real people. In order to form an intelligent opinion on the wide variety of issues associated with international trade, it is important to understand international trade, whom it affects, what sort of barriers exist, and how those barriers affect different groups of people.

But aren’t there costs? Yes, there are costs, and they can be significant.

Someone who loses his or her job or business as a result of competition from someone else pays significant costs. We should be just as aware of those costs as we are of the benefits. The essential first question becomes: do the benefits outweigh the costs? The second is whether the people who benefit are different from those who pay the costs. Finally, should we help those individuals who bear the costs by giving them some of the gains?

16.3 Specialization

People could produce everything they consume. Some families in the less developed economies of the world today produce everything they consume. Some in the U.S. try to function in that manner as well because of their own preferences for a simple lifestyle. But most of us, working on our own, could not come close to producing the quantity and quality of the goods and services we currently consume.

By learning to do something well and specializing in that occupation, most of us spend much of our time in that activity. We (or an employer) sell the good or service we produce, and we use the income to buy the other goods and services we want. That is trade. That is the way our economy functions.

Can you imagine what would happen if we passed laws that prevented trade from happening? Let’s not go so far as to say we prevent all trade (that is, you and I would have to produce all that we want to consume). Consider just preventing interstate trade. That is, all we consume in Tennessee must be produced in Tennessee.

Think about it. No bananas. No oranges. Expensive greenhouse lettuce and tomatoes in the winter. Only country music and only the Nashville Network. Why would we want to do something like that to ourselves? (It is not too absurd. Until the 1980s, we prohibited banks from selling their services across state lines. Some states prevented banks from selling outside of their own cities.)

The primary reason the state of Tennessee might want to restrict outside music from being imported is to help the country music industry. If we all had no choice but to listen to music produced in Tennessee, more Nashville musicians, songwriters, and studio personnel would be employed. And we would all be better off, right? Of course not! But the Nashville musicians might be, at least until other states prevented their consumers from listening to country music in response to the Tennessee legislation.

Specialization takes place when an individual, business, or country focuses on the production of a limited number of goods or services in order to make more efficient use of its resources. Individuals often specialize in producing certain goods or services and then trade those goods or services for other goods. If we specialize, we can produce more. If we can all produce more and then trade, we will all be better off. However, it does require that we specialize in the production of goods and services in which we are particularly productive.

16.4 Absolute Advantage

There are many reasons why specialization is beneficial. One is geography. We use fewer resources if we grow artichokes in California than if we try to grow artichokes in Nebraska since the climate in California is more favorable for growing artichokes compared to the seasonal temperature and precipitation conditions in Nebraska. However, cattle can be raised in Nebraska much more efficiently than in California because of the relatively cheaper cost of land in Nebraska.

Table 16.1: Number of artichokes or cattle one worker can grow in each state.

In Table 16.1, we show how many artichokes and cattle can be grown in each state. To make the example clearer, let’s assume that it takes the same amount of land and capital in California and Nebraska to grow artichokes and cattle. The only resource that varies is labor. One worker in California, working full-time for one year, can produce 10,000 bushels of artichokes or 100 head of cattle. One worker in Nebraska can produce 1,000 bushels of artichokes or 1,000 head of cattle.

To keep the numbers simple, suppose California and Nebraska each have two workers, and one worker in each state produces each product. What would production be in each state? What would be the total production of artichokes and what is the total production of cattle in both states together?

Question 16.02

What would be the production of cattle in California?

A

10,000 head

B

1,000 head

C

100 head

D

Cattle will not be produced in California


Question 16.03

What would be the production of cattle in Nebraska?

A

10,000 head

B

1,000 head

C

100 head

D

Cattle will not be produced in Nebraska

Now compute the total production of cattle and artichokes in both states together.

Table 16.2: Total production of cattle and artichokes when both states produce both goods.

The answers you should have reached are shown in Table 16.3.

Table 16.3: Total production of cattle and artichokes when both states produce both goods.

Now suppose workers in California and Nebraska specialize in the production of the product in which they are most technically efficient. In other words, workers in each state specialize in the production of a product which requires fewer resources compared to the other state. Complete the table again. Which state is the most efficient in the production of artichokes? Of cattle?

Table 16.4: California grows artichokes; Nebraska raises cattle.
Figure 16.3: California has an absolute advantage in making artichokes; i.e., California can produce more artichokes with the same resources as Nebraska. [3]

The results in Table 16.4 should look like the following:

Table 16.5: California grows artichokes; Nebraska raises cattle.

With the same resources, total production has increased. Total production of cattle has increased from 1,100 head to 2,000 head; the production of artichokes has increased from 11,000 to 20,000 bushels. We say that Nebraska has an absolute advantage in the production of cattle and California has an “absolute advantage” in the production of artichokes. That means that firms in Nebraska can produce more cattle with the same resources as firms in California, and producers in California can produce more artichokes with the same resources as producers in Nebraska.

An alternative way of considering the comparison is that firms in California use fewer resources per bushel of artichokes produced than firms in Nebraska (and Nebraska uses fewer resources to produce cattle than California).

​California: 1 worker / 10,000 bushels of artichokes = .0001 worker hours per bushel.

Nebraska:1 worker / 1,000 bushels of artichokes = .001 worker hours per bushel.

Thus, the cost of producing artichokes in Nebraska is greater than the cost of producing artichokes in California. California has an absolute advantage in artichokes. Nebraska’s cost of producing cattle is less than California’s. Nebraska has an absolute advantage in producing cattle.

The primary reasons for absolute advantage are geography (the example we just described) and economies of scale . In some products, primarily agricultural products, geography plays an obviously important role. But some products are made more efficiently – that is, with fewer resources per unit of output – if the production facilities are larger.

Question 16.04

Question 16.04

Can you think of some reasons why economies of scale may arise?

Hover here to see the hint for Question 16.04.
Click here to see the answer to Question 16.04.

One example is automobiles. Every city could produce automobiles. However, large amounts of capital are necessary to do so inexpensively. Consider the approximate costs of manufacturing automobiles shown below:

  • Production of 1 car per year; cost of $100,000 per automobile.
  • Production of 100 cars per year; cost of $50,000 per automobile.
  • Production of 10,000 cars per year; cost of $25,000 per automobile.
  • Production of 200,000 cars per year; cost of $15,000 per automobile.

A city (and a country, for that matter) may not be able to produce all products profitably. Even a fairly large city would need to build a factory that produces more cars than it needs and sell the excess to individuals in other areas. Only in cities such as Chicago, Houston, Los Angeles, and New York will consumers buy more than 100,000 cars per year.

Cities, states, and countries have other differences – skills of their labor forces and natural resources – that create absolute advantages in specific goods and services. For example, there is a very obvious reason that many Middle Eastern countries (and Texas) specialize in the production of oil.

Figure 16.4: Production of automobiles is an example of the principle of economies of scale at work. [4]

16.5 Comparative Advantage

But the rationale for trade among individuals and cities and countries goes further. David Beckham’s athletic prowess in soccer extended beyond the field. He was also quite good at fencing. Why didn’t he do both?

Bill Gates was a fantastic businessperson. He organized workers to produce what would later be used around the world even before the world recognized a demand for the product. He was also reportedly one of the world’s best software designers. Why didn’t he write software?

Figure 16.5: Bill Gates had a comparative advantage in recognizing future demand and organizing a business to meet those demands. [5]​

Should David Beckham have spent more time fencing or playing soccer? David Beckham had what economists call a comparative advantage in soccer. He may have been a very skilled fencer but his time could be better spent being paid to play soccer than to practice fencing. Similarly, Bill Gates had a comparative advantage in recognizing future demand and organizing a business to meet those demands. He was also an extremely talented software designer but his time could be better spent running a business to produce an innovative product which nobody else had thought of before. Compared to other software designers in the world, he was relatively more efficient at organizing a business than designing computer software.

The concept of comparative advantage was first developed by David Ricardo in 1817 to explain why countries should engage in international trade even when they do not have an absolute advantage in the production of any good or service. He showed that as long as productivity differs between two countries, each country can increase its total consumption by exporting the good for which it has a comparative advantage while importing the good for which it has a comparative disadvantage. In this chapter, we assume that individuals and countries specialize and trade commodities based on their comparative advantage rather than absolute advantage. Thus, even if a country does not possess an absolute advantage in the production of any good or service, it may still have an incentive to produce and export a commodity which it can produce comparatively more efficiently.

Consider the following example: suppose that Table 16.6 shows how many automobiles a worker in California can produce working full-time. Additionally, it shows how many computer chips that same worker could produce if she worked full-time producing computer chips. It also shows how many automobiles or computer chips a worker in Michigan can produce. (We assume that all other inputs are the same.)

Table 16.6: Number of autos or computer chips one worker can produce in each state.

Which state has an absolute advantage in the production of automobiles? Which one has the absolute advantage in the production of computer chips?

Michigan is better at producing automobiles and at producing chips. One Michigan worker can produce three automobiles, while one worker in California can only produce one automobile. A Michigan worker can produce 100 computer chips, but a worker in California can only produce 75. Michigan has an absolute advantage in both.

To keep the arithmetic simple, assume that there are only 20 workers in California and only 10 workers in Michigan. (The realism is not diminished by that assumption. We need only multiply the results by the actual, much larger numbers.) Is there any opportunity for trade?

Let’s consider. First, suppose that both states split their resources evenly between chips and cars. What will be the production of computer chips in California? What about the production of computer chips in Michigan?

Table 16.7: Total production of autos and computer chips when both states produce both goods.
Question 16.05

Match the following total production figures for computer chips with their states.

Premise
Response
1

California

A

750

2

Michigan

B

500

C

1250

​Now compare the total production if workers in each state produce both goods with total production if the workers in Michigan produce only cars, and the workers in California produce only chips.

Table 16.8: Michigan produces autos; California produces chips.

Your results should show that total production of automobiles and chips have increased as a result of the specialization (Tables 16.7 and 16.9). The suggestion was made above that workers in California specialize in chips, and workers in Michigan specialize in automobiles. Why this way and not the reverse? If it were the reverse, production would have decreased.

Michigan, while having an absolute advantage in both goods, is relatively more efficient at producing automobiles. It can produce three times as many automobiles with the same resources. Michigan workers can only produce 25 percent more computer chips than California workers. Thus, we say it has a comparative advantage in the production of automobiles.

Table 16.9: Michigan produces autos; California produces chips.

California, on the other hand, has the smallest disadvantage in the production of chips. It can produce three-quarters of what Michigan can. However, it can only produce a third of the automobiles Michigan can. California has a comparative advantage in the production of computer chips.

Comparative advantage means that even though one individual or businesses in one state may be better at everything, it still may be economically efficient to specialize. If the production processes are different, the opportunity costs will be different. Individuals in the state or country with the absolute advantages in both should specialize where businesses are the most efficient compared to businesses in the other state or country. The individuals without absolute advantages should specialize where they are the least inefficient.

Figure 16.6: California has a comparative advantage in the production of computer chips and a comparative disadvantage in the production of automobiles. [6]

16.5.1 Opportunity Cost

Specialization is going to increase production of both automobiles and computer chips. That is, with the same resources, real GDP will increase. The opportunity cost of producing automobiles in Michigan is less than in California. The opportunity cost of producing computer chips in California is less than in Michigan. Look back at Table 16.6.

Michigan: The opportunity cost of one automobile is 33 1/3 computer chips. If Michigan produced one more car, they would give up 100/3 or 33 1/3 computer chips by doing so.

California: The opportunity cost of one automobile is 75 computer chips. California moves one worker from computer chips to automobile manufacturing and gets one car and gives up 75 computer chips.

The opportunity cost of producing cars in Michigan is lower.

Alternatively, look at the opportunity cost of producing chips.

For Michigan, the cost of 100 chips is three cars. For California, the cost of 100 chips is 1 1/3 cars. The cost in California is less; that is, we give up fewer autos if California produces chips. We give up fewer chips if Michigan produces autos.

We give up fewer computer chips if Michigan produces cars, thus Michigan should specialize in cars. Because California gives up fewer automobiles to produce chips, California should produce computer chips.

We can distinguish the labor productivity figures, as indicated in the table above, from the labor requirement to produce one unit of a product. The table in the last example presents the number of automobiles or computer chips produced by a worker working full-time. These numbers measure the productivity of a worker in each type of industry. An alternative way to represent productivity is by specifying the number of hours needed to produce one automobile or computer chip in each state. This is the labor requirement for producing a unit of each good or service. Before computing opportunity cost ratios for each state, the unit labor requirements (hours needed to produce one unit) would have to be converted into labor productivities (units produced per hour) by taking a reciprocal of the labor hours required to produce one unit of output.

16.5.2 Production Possibilities Frontier (PPF)

The concept of production possibilities, studied in the chapter on An Economic Model, can be used to display the differences in opportunity costs of producing computer chips and automobiles in Michigan and California. Recall that the production possibilities frontier plots the maximum output of goods and services that a country (or a state, in this case) can produce when making full use of its existing resources. Since California has 20 workers and one worker can produce either one automobile or 75 computer chips, the maximum production of automobiles and computer chips in California can be computed in the following way:

Maximum automobile production in California: 20 x 1 = 20 automobiles

Maximum computer chip production in California: 20 x 75 = 1500 computer chips

This implies that if California employs all of its workers in producing only automobiles, it can make 20 automobiles but no computer chips. Similarly, if it produces only computer chips and no automobiles, it can produce 1500 computer chips. Using the same logic, we can compute the maximum production of automobiles and computer chips in Michigan:

Maximum automobile production in California: 10 x 3 = 30 automobiles

Maximum computer chip production in California: 10 x 100 = 1000 computer chips

Michigan has only 10 workers; therefore the total production of automobiles in Michigan can never exceed 30 automobiles, nor can its total production of computer chips exceed 1000 computer chips.

We can depict the different combinations of maximum outputs of automobiles and computer chips in both states by drawing a production possibilities diagram (or PPF) for each state. Figure 16.7 shows the PPF for the state of California, assuming that there are only 20 workers in California and that these workers only make either computer chips or automobiles. The total production of automobiles is given on the horizontal axis, while the total production of computer chips is plotted on the vertical axis. By joining the two points representing the maximum output of each product when all of the workers make either computer chips or automobiles, we can derive the PPF for the state of California. California can pick any point on or below its PPF, but not outside its PPF. Moreover, any point below the PPF indicates that California is not making full use of its resources (or all the workers are not fully employed). Similarly, we can plot a production possibilities frontier for Michigan. Figure 16.7 also illustrates the PPF for the state of Michigan.

Figure 16.7: Production possibilities frontiers for California and Michigan.

16.5.2.1 Production Possibilities Frontier and Opportunity Cost

The slope of the production possibilities curve represents the opportunity cost of making one additional automobile in terms of computer chips. California gives up 75 computer chips for every additional automobile that it produces; Michigan gives up only 33 1/3 computer chips for one more automobile. The lower opportunity cost of making automobiles in Michigan, as computed above, is illustrated by the flatter slope of its PPF.

Of course, if we choose to depict the production of automobiles on the vertical axis, we still get the same result. But this time we will measure the opportunity cost of making computer chips in terms of automobiles, and we will see a flatter PPF for California than for Michigan because California has a lower opportunity cost for making computer chips.

Notice the shape of the PPF. Since the opportunity cost ratios are constant, we get linear production possibilities frontiers. In other words, we ignore the possibility of diminishing returns, or increasing opportunity costs, discussed earlier in the chapter on An Economic Model. The same conclusions would be reached even allowing for diminishing returns. However, in order to focus on the effect of trade and specialization, we assume that there are no diminishing returns in this case.

16.5.2.2 Production Possibilities Frontier and Gains from Trade

Trade can help each state achieve a point beyond its PPF. Before specializing in the production of a single commodity and trading between states, each state produces and consumes both goods. By allowing each state to specialize in the production of a product in which it possesses a lower opportunity cost, trade can lower the cost of exchanging automobiles for computer chips in California and the cost of exchanging computer chips for automobiles in Michigan. With complete specialization, each state can focus on the production of the product in which it has a comparative advantage, thereby increasing total production of both products, as shown in the previous section.

Thus, each state moves from a point in the middle of its PPF to an end of its PPF, reflecting complete specialization in the production of a good. Note that complete specialization arises due to our simplifying assumption of constant opportunity cost ratios and the subsequently linear shape of the production possibilities frontier. In reality, diminishing returns may result in bowed out PPFs and incomplete specialization. Each state also now enjoys greater consumption possibilities. If California is able to purchase automobiles from Michigan at a price lower than California’s opportunity cost of making an automobile, and in return, supply computer chips to Michigan at a price below Michigan’s opportunity cost of making computer chips, both states gain from the exchange of products. This means that both states can now trade with each other and consume at a point outside their respective production possibilities. This is shown by the outward shift (or rather pivoting) of their PPFs in Figure 16.8.

Figure 16.8: The production possibilities frontier for California and Michigan after trade.

Inter-state trade enables both states to have more of both goods beyond the limit dictated by their production possibilities. In fact, the higher the difference is in their respective opportunity cost ratios and the slopes of the two PPFs, the greater the potential to gain from complete specialization and trade.

Question 16.06

Question 16.06

Explain why the concept of opportunity cost should be used to determine how countries specialize and trade.

Hover here to see the hint for Question 16.06.
Click here to see the answer to Question 16.06.

16.5.2.3 A Possible Exception

If the production processes are very similar, then there may be little or no gains from trade. The greater the differences in processes (and therefore costs), the greater the gains from trade. The U.S. appears to have a comparative advantage in the production of software; European countries seem to have a comparative advantage in the production of shoes. It is not clear who has a comparative advantage in the production of automobiles, as automobiles are produced both here and in Europe. It is doubtful that total production would be enhanced through specialization in automobile production, but the increased competition is certainly helpful in encouraging innovation and in holding prices down.

Consider the situation if California and Michigan had the same production processes, that is, if both could produce one automobile and 75 computer chips with one worker. Would specialization and trade benefit either? (Based on the discussion of comparative advantage and production possibilities frontiers, the answer is no, but you should show the results.) There is one possible scenario in which both states may gain from specialization and trade despite having the same production processes. If specialization allows a state or a country to produce a greater quantity of a good, it may gain from cost savings which arise due to economies of scale. By producing a large volume of a good, it simply becomes more efficient at making it. This helps lower the average cost of producing that commodity, thereby making more efficient use of its scarce resources.

Question 16.07

Assume once again that both California and Michigan can produce one automobile or 75 computer chips with one worker. If California has 20 workers, which of the following is the most accurate depiction of California’s PPF?


Question 16.08

If Michigan has 10 workers, which of the following is the most accurate depiction of Michigan’s PPF?

The table below describes the number of yards of cloth and barrels of wine that can be produced with a week's worth of labor in England and Portugal. Assume that no other inputs are needed.

Question 16.09

The table below describes the number of yards of cloth and barrels of wine that can be produced with a week's worth of labor in England and Portugal. Assume that no other inputs are needed. Match the following goods with the country that possesses an absolute advantage in its production.

question description
Premise
Response
1

Cloth

A

Portugal

2

Wine

B

Portugal

C

England

D

England


Question 16.10

Which country has the highest opportunity cost for producing a yard of cloth?

question description
A

England

B

Portugal


Question 16.11

If the countries start trading with each other, which country will specialize in and export cloth?

question description
A

England

B

Portugal

C

Cloth will not be produced.

Graphing Question 16.01

Graphing Question 16.02

Question 16.12

Question 16.12

Bill Gates, co-founder of Microsoft, was reputed to be the best computer programmer in his company. He was also apparently the most creative business mind by far in the company. Why did he specialize in one or the other activity (that is, programming or managing the business)?

Hover here to see the hint for Question 16.12.
Click here to see the answer to Question 16.12.

Question 16.13

Question 16.13

Why might two countries want to specialize and trade even when both countries could produce all goods?

Hover here to see the hint for Question 16.13.
Click here to see the answer to Question 16.13.

Question 16.14

Question 16.14

If a country is better than every other country at producing almost all of the goods it wants, why would it benefit from trade? Explain in your own words.

Hover here to see the hint for Question 16.14.
Click here to see the answer to Question 16.14.


Question 16.15

If one state has an absolute advantage in the production of two goods, what should it do?

A

It should produce both of the goods, and allow the other state to produce a good in which it has an absolute advantage.

B

It should produce the good in which it has a comparative advantage and let another state produce the good in which it has a comparative advantage.

C

It should produce the good where its opportunity cost is the highest.

D

It will use fewer resources in the production of one good and more resources in the production of the other.

Given the following amounts of production resulting from one hour of work, answer the following questions:

Question 16.16

Match the following goods with the state that possesses an absolute advantage in its production.

question description
Premise
Response
1

Apples

A

Tennessee

2

Oranges

B

New York

C

Tennessee

D

New York


Question 16.17

Match the following goods with the state that possesses a comparative advantage in its production.

question description
Premise
Response
1

Apples

A

Tennessee

2

Oranges

B

New York


Question 16.18

The U.S. has an absolute advantage in both the production of software and the production of computers when compared to Mexico. But the U.S. has a comparative advantage in the production of software. What should the U.S. produce?

A

Software and computers

B

Software - and let Mexico produce computers

C

Computers - and let Mexico produce software

D

One cannot tell unless we also know the opportunity costs for both countries.


Question 16.19

If labor is the only input and all goods can be produced with fewer hours of work in the U.S. than in Thailand, then the U.S. will ___________.

A

Have an absolute advantage in the production of all goods.

B

Not necessarily have an absolute advantage in the production of all goods.

C

Have a comparative advantage in the production of all goods.

D

Have a comparative and an absolute advantage in the production of all goods.


Question 16.20

Suppose the following table shows the amount of labor required for the manufacturer of Beanie Babies and Pokémon characters. Which of the following will be true?

question description
A

The U.S. should produce both Beanie Babies and Pokémon characters.

B

The U.S. should produce Beanie Babies, and Canada should produce Pokémon characters.

C

Canada should produce Beanie Babies, and the U.S. should produce Pokémon characters.

D

Canada should produce both Beanie Babies and Pokémon characters.

Trade and the U.S. Presidential Election:

16.6 International Trade

Many of the examples represented in this chapter focus on trade among individuals and businesses within specific neighborhoods or in different cities and states. The same analysis applies to trade among individuals and businesses in different countries, as illustrated in some of the questions above. Specialization and trade allow us to produce more with the same resources and therefore the average real standard of living must be greater as a result of the trade.

International trade is an important part of our economy. We send more than 10 percent of everything we produce to consumers and businesses abroad. Almost 15 percent of everything U.S. consumers, businesses, and governments purchase is produced abroad.

Large, diverse economies have less of a need for trade than do smaller, more specialized economies. That is one of the reasons European economies trade more than we do. France trades with Belgium, which trades with Germany, which trades with England, which trades with France. Likewise, Tennessee trades with New York, which trades with Illinois, which trades with Michigan, which trades with California, which trades with Tennessee. In the first case, there is significant international trade. In the second, there is zero international trade because we can get a wide variety of goods from different parts of a very large and diverse country.

Our imports are obvious to most of us – much of our clothing, many of our automobiles, and much food comes from abroad. Our exports are less obvious except to those who work in the industries producing those goods. Table 16.10 shows categories of goods and services that make up our exports and imports, and the corresponding percentages of total exports and imports accounted for by each category.

ECN16_Table16.10_updated.jpg
Table 16.10: Types of U.S. exports and imports (2018).

Click here to see the source of the data.

Question 16.21

Question 16.21

We have shown that all individuals and countries can gain from trade. Can you think of a reason why some individuals or countries may object to free trade?

Hover here to see the hint for Question 16.21.
Click here to see the answer to Question 16.21.

16.7 Objections to Free Trade


“I will renegotiate NAFTA. If I can’t make a great deal, we’re going to tear it up. We’re going to get this economy running again.”  - Donald J. Trump, October 19, 2016 [4]
 “While I believe firmly in open markets and free trade, I also believe an open market needs a level playing field.”
- Philip Hammond, British Conservative Party politician [5]
“Not only must we fight to end disastrous unfettered free trade agreements with China, Mexico, and other low wage countries, we must fight to fundamentally rewrite our trade agreements so that American products, not jobs, are our number one export.”  - Bernie Sanders, Democratic presidential nomination in 2016 [6]
“If we sign the North American Free Trade Agreement, we will hear a giant sucking sound as jobs and investment go to Mexico.”  - Ross Perot, a presidential candidate in 1993. [7]

The advantages of trade occur whether we are talking about individuals and businesses within city blocks, cities, counties, states, or countries. We can be better off by producing more total output with the same resources if we specialize and trade. Still, there is continual political pressure to limit our imports in an effort to protect American businesses.

Think back to our examples. Workers in the artichoke industry in Nebraska are hurt.  In our Michigan and California example, the automobile manufacturers in California and the chip manufacturers in Michigan are hurt.  In our New York and Tennessee example, the apple growers in New York and orange growers in Tennessee were hurt.  We all gain the benefits, but a few pay a lot of the costs. For that reason, those who pay the costs are going to speak out loudly.

One of the more common objections to international trade has been that low-wage workers in other countries will compete unfairly with workers in the U.S. We have seen in our comparative advantage model that even if other countries are not as efficient as we are in producing goods, it still pays to specialize and trade. But if we do, the “low-wage countries” will specialize where they are least disadvantaged. U.S. workers in those industries will indeed be hurt. Yes, trade makes all of us together better off. Another way of stating the conclusion is that since total output increases, total output per person (our average standard of living) increases. Yet, workers in those domestic industries where businesses in other countries specialize lose their businesses and jobs.

It is not true, however, that all “low-wage countries” will be low-cost countries. Let’s look at an example of how a low-wage country cannot compete with a high-wage country.

Assume the following data for the U.S.:

Wages                       $ 10.00 per hour

Productivity           DVDs produced per worker per hour = 20

​Question 16.22

Question 16.22

Based on the U.S. wages and productivity figures, what is the cost to make a DVD in the U.S.?

Click here to see the explanation to Question 16.22.

Assume the following data for Argentina:

Wages                        $ 2.00 per hour

Productivity             DVDs produced per worker per hour = 3

Question 16.23

Question 16.23

Based on the wages and productivity figures for Argentina, what is the cost to make a DVD in Argentina?

Click here to see the explanation to Question 16.23.

The conclusion is that because there are dramatic differences in productivity, there can be dramatic differences in wages, and the products will still be less expensive to produce in the high-wage economy. To compare the costs of production, we must know the relative wage and productivity levels in the two countries. If wages are low in a country, it is very likely that the productivity of labor is also low in that country. Therefore, the cost of production could possibly be higher compared to a high-wage country.

Question 16.24

Question 16.24

Will a low-wage country take jobs and business away from the U.S.? Explain why or why not in your own words.

Hover here to see the hint for Question 16.24.
Click here to see the answer to Question 16.24.

Figure 16.9: Trade restrictions often take the forms of administrative and bureaucratic regulations to limit the number of imports. [7]

Due to reasons discussed above, countries will often limit the amount of international trade they conduct with the rest of the world. There is a range of different methods that may be used to restrict the volume of trade, such as tariffs, quotas, and many other nontariff barriers. For instance, an import license issued by the government authorizing the import of a certain product into its territory may be required to import that product from a foreign country. Administrative and bureaucratic regulations can delay the import of certain goods, which increases uncertainty and the cost of importing the good. In this chapter, we focus on two of the many protectionist measures countries use to limit the number of foreign goods imported: tariffs and quotas.

16.8 Tariffs

A tariff is a tax or a duty on an imported good, expressed either as a fixed amount or a fixed percentage of the value of the imported product. Before 1900, tariffs were the most important source of federal revenues in the U.S., and they are still important to many industries, even serving as the main source of government revenue in most developing countries. Think back to our supply and demand models.

Now, let’s establish a tariff on imported automobiles. If the tariff is $1,000 per automobile, to be paid by the supplier when each automobile crosses the U.S. border, show what will happen in the market for automobiles produced abroad and in the domestic market.

The initial supply and demand curves should approximate the curves drawn in Figures 16.10 and 16.11.

Figure 16.10.png
Figure 16.10: Equilibrium in the U.S. auto market for domestically produced automobiles.
Figure 16.11.png
Figure 16.11: Equilibrium in the U.S. auto market for imported automobiles​.

In Figure 16.12, there is a new supply curve that increased the price by $1,000 at each quantity supplied. The producers will need to raise prices by $1,000 in order to pay the new tax and pay their costs. Another way of considering the model is that at current prices, producers will cut back production. Prices in the market will begin to rise, and quantities supplied will increase from the new, lower amount. Quantities demanded will decrease. We will end up in a new equilibrium where the price has increased, and the equilibrium quantity has decreased. But notice that prices have not gone up by the full $1,000 amount. The effect of the tax will be to lower the prices that producers actually receive (the market price minus the tariff) and raise the price that consumers pay (the market price). In our example, we show that the price went up to $20,500 and the price producers receive fell to $19,500. Given the nature of these particular supply and demand curves, the tax is shared equally. The important point is that with normal supply and demand curves, the tax is shared.

Figure 16.12.png
Figure 16.12: Equilibrium in the U.S. imported auto market after tariff.​​

Question 16.25

Question 16.25

What elasticity of supply or demand curves will cause the consumers to have to pay a larger portion? A smaller portion?

Hover here to see the hint for Question 16.25.
Click here to see the answer to Question 16.25.

The price of a substitute good has gone up. The demand for the domestic good increases. Prices of domestic goods rise and more are produced. The results are shown in Figure 16.13.

Figure 16.13: Equilibrium in the U.S. domestically produced auto market after tariff.

Conclusion:

  • Prices of imports increase.
  • Quantities of imports decrease.
  • Prices of domestic goods increase.
  • Quantities of domestic goods increase.
  • U.S. employment increases.

This is what we wanted to accomplish.

Question 16.26

Imagine that the U.S. establishes a tariff on imported soccer uniforms. Click on the point that shows where the new equilibrium in the market for soccer uniforms produced abroad is most likely to be.


Question 16.27

Click on the point which shows the new equilibrium for uniforms in the domestic market when a tariff is established.

Graphing Question 16.03

Graphing Question 16.04

Graphing Question 16.05

16.9 Quotas

Quotas are limits on the amounts that can be imported.

Figure 16.14: Equilibrium in the U.S. auto market for domestically produced automobiles.​

A quota would set a maximum number of automobiles to be imported. An example might be a quota of 2.7 million automobiles when the current number being imported is 3 million, as shown in Figure 16.14. The effect of the quota is shown in Figure 16.15.

If we only allow 2.7 million to be imported, what happens at the current price of $20,000? There is a shortage; the quantity demanded is greater (3 million) than the number supplied (2.7 million). The price will begin to increase. The quantity supplied cannot legally increase, but the quantity demanded will decrease. That process will continue until there is no longer a shortage.

Figure 16.15: Equilibrium in the U.S. domestically produced auto market after quota.​

The new price, $20,500, is shown in Figure 16.15. In this example, we designed the quota to have the same effect as the tariff, and it did. The difference between a tariff and a quota is what happens to the increase in price. In both cases, the price increased to $20,500. With a tariff, the producer received $19,500 and paid $1,000 to the government. With a quota, the price increased to $20,500 and the producer received $19,500. This time, there is no tax. Where does the $1,000 difference go? It really depends upon how the law is written. It may go to the producer. It may go to the importer of the automobiles. The point is that the $1,000 is up for grabs. A producer faced with a choice of whether to be subject to a tariff or a quota would certainly prefer a quota if the producer can receive the increase in price. Someone in the production or distribution process gets the difference. That is the important difference between a tariff and a quota.

What happens in the domestic market? The result in the market for automobiles produced domestically is exactly the same as in the case with the tariff. Because prices of automobiles produced abroad have increased, the demand for the substitute good, the domestic automobiles, will increase.

Question 16.28

Question 16.28

Give one reason why a country might decide to place a tariff or a quota on an imported good? What are the real costs to the country of doing so?

Hover here to see the hint for Question 16.28.
Click here to see the answer to Question 16.28.

We should not be surprised that when trade negotiations went on in the early 1980s with Japan, and it looked like the U.S. was going to establish a tariff or a quota on Japanese automobiles, Japan “voluntarily” agreed to a 2.8 million-car quota. This is an example of a voluntary export restraint (VER). A voluntary export restraint is a limit on the quantity of exports to a specified country during a given period of time which is imposed by the exporting country. The resulting increase in the price of Japanese automobiles was $1,000. The resulting increase in the price of American automobiles was $1,400.

Question 16.29

The creation of a quota on German automobiles sold in the U.S. may affect prices and quantities of German autos sold in the U.S., and the prices and quantities of U.S. autos sold in the U.S. Assume that the quota is set at a level lower than the current level of imports. Click on the point which represents the new equilibrium in the domestic automobiles market in the U.S.


Question 16.30

Now assume that the quota is set at a level higher than the current level of imports. Click on the point that represents the new equilibrium in the U.S. domestic automobiles market.


Question 16.31

President Trump recently blamed China’s trade barriers as partially responsible for our trade deficit. Assume he is successful in getting China’s trade barriers lowered. What is the likely effect in the U.S.?

A

Full employment output will be raised

B

Full employment output will be lowered

C

Prices in the U.S. will rise

D

U.S. imports will fall


Question 16.32

A tariff will cause which of the following to happen?

A

A decrease in the price the consumer pays for the imported good and an increase in the price of similar domestically produced goods.

B

A decrease in the price the consumer pays for the imported good and a decrease in the price of similar domestically produced goods.

C

An increase in the price the consumer pays for the imported good and a decrease in the price of similar domestically produced goods.

D

An increase in the price the consumer pays for the imported good and an increase in the price of similar domestically produced goods.


Question 16.33

Assume a tariff has been imposed on a good imported into the U.S. What will happen to the price U.S. consumers pay and the price foreign exporters receive?

Premise
Response
1

Price U.S. consumers pay

A

Increase

2

Price foreign exporters receive

B

Decrease

C

No change


Question 16.34

Assume that instead of establishing a tariff, we set a quota on French computers exactly equal to the number of French computers that would be sold under a specific tariff. The resulting price of the French computers in the U.S. would be ______________ the price under the tariff, ______________.

A

Lower than, because no tax is involved.

B

Higher than, because the French manufacturers will get the increased revenue from the quota.

C

The same as, because demand has not changed.

D

Cannot tell, because it depends upon what happens in the U.S. manufactured computer market.


Question 16.35

If wages are lower in Mexico than in the U.S., we would expect that U.S. imports from Mexico would be _________.

A

High, because the costs of producing in Mexico are lower than in the U.S.

B

High, if productivity is lower in Mexico than in the U.S.

C

Low, if productivity is higher in Mexico than in the U.S.

D

High, if productivity is higher in Mexico than in the U.S.


Question 16.36

The establishment of a quota will have which of the following effects?

A

An increase in the price of imported goods; a decrease in the price of domestically produced goods; a decrease in the quantity of both imported and domestically produced goods.

B

A decrease in the prices of imported and domestically produced goods; a decrease in imports; an increase in the quantity of domestically produced goods.

C

An increase in the price of imported goods; an increase in the price of domestically produced goods; a decrease in the quantity of both imported and domestically produced goods.

D

An increase in the prices of imported and domestically produced goods; a decrease in the quantity of imported goods; an increase in the quantity of domestic goods.


Question 16.37

Which of the following is true when comparing tariffs and quotas?

A

The government will likely gain more revenue with a tariff than with a quota.

B

A quota will be more effective in reducing imports.

C

A tariff will increase the price of imports more than a quota will.

D

Both quotas and tariffs on imports into the U.S. will eventually cause U.S. exports to rise.


Graphing Question 16.06

Graphing Question 16.07

Graphing Question 16.08

Graphing Question 16.09

Graphing Question 16.10

16.10 Are There Legitimate Reasons to Protect Ourselves Against International Competition?

There are a number of legitimate reasons to protect industries, but a word of caution is necessary in each case. We have experienced constant or falling real wages among low-skilled workers for several years. A part of the cause seems to be competition from abroad. When it takes a long time for those workers to be retrained and to find new jobs, there are real costs to the increased trade. If we are experiencing high unemployment and we lower tariffs, it may be that workers put out of work will find it even more difficult to find new jobs, making the situation worse. However, this should not be used as an excuse for establishing tariffs during high unemployment. Those tariffs are likely to be met by countervailing tariffs imposed by trading partners, and international trade will be reduced as a result.

This section describes the principle reasons why countries establish tariffs and quotas. For instance, a primary goal of restricting trade is often simply to protect domestic businesses and workers from foreign competition. Trade may also be limited for political purposes. Finally, the threat of trade barriers is often used as a strategy to get other countries to lower their trade restrictions.

Figure 16.16: Protecting American businesses and jobs from foreign competition is the primary reason to establish tariffs and quotas. [8]

16.10.1 Protecting Local Businesses and Jobs

The primary reason used in establishing tariffs and quotas is to protect local businesses and workers from competition from abroad. The infant industry argument for protecting new local firms is that these small firms (or new industries) may not have the economies of scale that their older foreign competitors enjoy. These ‘infant’ industries temporarily need protection until they can attain similar economies of scale. The infant industry argument is, therefore, commonly used as a rationale for trade protectionism in many developing countries which have insufficiently developed financial systems. In developed countries, on the other hand, adequate financing opportunities are available for new businesses through well-functioning banking and financial markets, which reduce the need to protect new businesses.

If we do not have retraining programs or assistance to move workers from one industry to another, those workers will suffer in industries where others abroad are specializing and able to produce at lower costs. But if we retrain those workers, help them find new jobs, and use monetary and fiscal policy to maintain full employment, there will be less of a need to protect those industries. Moreover, if financial markets are sufficiently developed, the infant industry argument for protection may no longer be valid.

16.10.2 Political Goals

We may want to protect some American industries because we deem their existence in the U.S. is in our best national defense interests. For example, we may want to be sure our airplane manufacturing and aerospace industries survive here so that we are not dependent upon production in another country. Likewise, we may want to reduce our dependency on other countries to supply goods and services vital to our defense. The most recent industry protected for this stated reason is the semiconductor manufacturing industry. The purpose was to ensure the availability of the computer chips necessary for so much of our military capabilities. If those industries cannot survive international competition, tariffs and quotas may be the only way to ensure their survival.

Tariffs and quotas may also be used for other political purposes. We have often placed economic sanctions on countries such as Iran, Iraq, Cuba, and a long list of others. For decades, we had imposed a quota equal to zero on Cuban cigars, not for economic reasons, but political reasons.

Figure 16.17: There are several legitimate reasons to protect local industries from international competition. [9]

16.10.3 Strategic Trade

The threat of tariffs and quotas is often used as a strategy to get other countries to lower their tariffs and quotas, and as a strategy it may work. However, if U.S. tariffs and quotas are actually established just because another country has tariffs and quotas on our goods, we are hurt as a result. The price and quantity effects of tariffs and quotas on U.S. produced goods are the same as when a tariff or a quota is imposed on U.S imports.

We also use negotiations about tariffs and quotas to bargain to get other countries to improve working conditions and environmental regulations. Not many of us like the idea of buying items produced by forced child labor, for example. 

16.11 Benefits and Costs of Protecting U.S. Business

The benefits of protecting American industry through trade restrictions are that American businesses sell more goods domestically at higher prices. But those benefits accrue to the workers and owners of those companies. Part of the costs can be viewed much the same way. Consumers pay higher prices, reduce their purchases of imported goods, and increase their consumption of domestic goods. In addition, we lose the increased production that we gain from specialization.

One example of the cost is the voluntary quotas established in the early 1980s on Japanese-manufactured automobiles. Total U.S. production of automobiles was 8 million per year. The Japanese manufacturers agreed to limit their exports to the U.S. to 2.8 million cars. A more recent example of restricting trade in order to benefit American businesses is that of the U.S. lumber industry. In April 2017, the U.S. Commerce Department proposed import duties ranging from three percent to 24 percent on Canadian softwood lumber exports to the U.S. in an attempt to counter what it perceives to be an unfair trade policy. For decades, the main concern raised by the U.S. lumber industry has been that the Canadian lumber production is sourced from public lands, and therefore, is heavily subsidized. Although the imposition of duties will benefit the U.S. lumber producers, it is anticipated to drive up the cost of home construction in the U.S., eventually hurting U.S. consumers.

Question 16.38

Question 16.38

Are there any disadvantages associated with limiting the number of imports coming into the country?

Hover here to see the hint for Question 16.38.
Click here to see the answer to Question 16.38.

Figure 16.18: Textile and apparel industry was heavily protected in the past in the form of import quotas. [10]

The benefits of the quota are gained by a small number of companies and workers. Because of that, they are going to be outspoken and willing to devote considerable effort to political activity.

Another even more subtle cost of protecting U.S. firms is the possibility of retaliation by other countries. If we establish tariffs and quotas on Japanese products, one not too surprising response on Japan’s part would be to establish tariffs and quotas on U.S. products. Thus, U.S. exporters will sell fewer products and they will be hurt. Another part of the cost of trade protection in the automobile industry may be paid by Dell through their falling exports of computers.

We have tariffs and quotas in more than 3,000 different products and services. There are hot debates, sometimes seemingly silly, about whether products fall in the categories to be restricted. Not too long ago, a shipment of 30,000 antique red London telephone booths was stopped with the statement that the cast iron booths were really steel, which is restricted by quotas.

On another occasion, 30,000 tennis shoes manufactured in Asia included an extra pair of shoelaces. A decision was made that the laces were a clothing product and therefore the importer must obtain a quota permit to bring them into the U.S.

However silly these distinctions may seem, the results are not frivolous or silly to the producers (or to consumers, if we consider the total cost). We restrict the importation of raw sugar cane to a little over 1 million tons per year. As a result, the U.S. price of sugar is 22 cents per pound. The world price is 9 cents. Most packaged food products and beverages use corn syrup as an ingredient instead of sugar precisely because of this import quota. The estimated cost per person per day for sugar is only one and a half cents. That is why few people object. However, the total cost is almost $1.5 billion dollars per year. This figure explains why sugar growers are interested in keeping the quota.

Some of the unique tariffs, quotas, and “non-tariff barriers” in a number of countries are shown in Table 16.11.

ECN16_Table16.11_updated.jpg
Table 16.11: Examples of recent U.S. trade barriers.


* A tariff-rate quota (TRQ) is a two-level tariff, which imposes a lower tariff rate on a given volume of imports and a higher tariff rate on all subsequent imports.
Click here to see the source of the data.

Question 16.39

Question 16.39

A lowering of tariffs and the elimination of quotas will mean increased competition from foreign producers. This shift will lead to increased unemployment and decreased profits in some industries. Why should we allow this to happen?

Hover here to see the hint for Question 16.39.
Click here to see the answer to Question 16.39.

Peeling Away the Rhetoric over Shrimp Tariffs [8]

"Earlier this month, the U.S. Department of Commerce issued a preliminary ruling that a seven-month investigation had determined that China and Vietnam have been "unfairly" dumping cheap shrimp in U.S. markets, thus threatening the jobs of hard-working American shrimpers. To enable the Americans to compete fairly with the Asians, it imposed antidumping tariffs on Chinese exporters as high as 112%. Vietnamese shrimpers got off lightly by comparison, with tariffs of up to 93%."

                   -Greg Rushford for The Washington Post, July 22, 2004

10 Reasons Why Canada Should Eliminate Most Import Tariffs [9]

“In order to be considered a toy, the Tribunal was required to determine if the goods could “be said to amuse infants or children.” Dr. Fennell testified that “…past the age of six months, I would be comfortable saying that these objects could provoke amusement at that higher level of smiling and laughing.” Ultimately the CITT sided with Mattel. “Given the tax consequences, companies spend millions on some of the best legal and scientific minds in the country to determine how much fun a child could have using a chair.”

                    - Mike Moffat for Canadian Business, March 15, 2016

Read the full articles here and here and answer the following questions.

Question 16.40

Question 16.40

What are the core issues in the article about importing shrimp?

Hover here to see the hint for Question 16.40.
Click here to see the answer to Question 16.40.

Question 16.41

Who is hurt by subjecting shrimps to tariffs?

A

Consumers by paying a higher price for the imported shrimp

B

Restaurants because their inputs now cost more

C

Foreign producers of the imported shrimp

D

U.S. shrimp fishermen


Question 16.42

Why are anti-dumping duty and quota similar?

A

In both cases, someone other than the government is receiving the increase in prices of foreign shrimp.

B

Both lower the price of the imported good.

C

Both raise the quantity bought of the imported good.

D

None of the above – anti-dumping duties and quotas are two very different trade policies.


Question 16.43

Match the following policy options with the goal each policy aims to achieve.

Premise
Response
1

Establish a tariff

A

Raises efficiency¸ but hurts the shrimp companies in the U.S.

2

Eliminate or lower the tariff

B

Lowers efficiency¸ but benefits the U.S. shrimp industry

Question 16.44

Question 16.44

Which policy would you choose?

Hover here to see the hint for Question 16.44.
Click here to see the answer to Question 16.44.

16.12 Summary

  • Trade benefits an economy by expanding the amount that can be produced with given resources, increasing choices, and increasing competition. This is true whether it is trade among individuals in a neighborhood, a city, a state, a country, or the world.
  • The concepts of comparative and absolute advantage provide explanations of how trade can expand production.
  • A country has an absolute advantage in the production of a good or service if businesses and individuals in that country can produce the good or service with fewer resources.
  • A country has a comparative advantage in the production of a good or service if businesses and individuals in that country have a lower opportunity cost than businesses and individuals in another country.
  • If businesses and individuals specialize in the production of goods and services where they have comparative advantages, production can be expanded.
  • Some business owners and employees are hurt by increased trade. The businesses that are forced to change what they produce and provide have to pay costs for which they are not necessarily compensated.
  • Tariffs and quotas are often used to protect specific industries and groups of workers that are damaged by increased trade and competition.
  • Tariffs and quotas result in higher prices of both foreign and domestic goods and services, smaller quantities of foreign goods, and services and greater quantities of domestic goods and services.

16.13 Key Concepts 

  • Protecting American businesses and jobs
  • Infant industry argument
  • Political goals
  • Strategic trade
  • Tariffs 
  • Quotas 
  • Dumping 
  • Antidumping Tariff 
  • Voluntary export restraint (VER)

16.14 Glossary

Absolute advantage: An individual or a business in a country has an absolute advantage in the production of a good if it can produce that good using fewer resources.
Antidumping Tariff: A tariff or a duty imposed by the domestic government on imports that it believes are priced below market value or below the price charged in the exporting country’s domestic market.
Comparative advantage: An individual or a business has a comparative advantage over another in one good relative to another good if its opportunity cost is less.
Dumping: When a country exports a product at a price that is lower in the foreign market than the price charged in the domestic market.
Economies of scale: When all inputs are doubled, output more than doubles.
Infant industry argument: The reason for temporarily protecting new industries because they do not yet have the economies of scale that their older foreign competitors enjoy.
Non-tariff barrier: Government policy to restrict imports through methods other than a tariff or a quota.
Production Possibilities Frontier (PPF): The production possibilities frontier plots the maximum output of goods and services that a country can produce with its resources.
Quota: A legal limit on the amount of a good or service that can be imported.
Tariff: A tax on an imported good.
Specialization: An individual, business, or country focusing on the production of a limited number of goods and services in order to attain a higher level of efficiency.
Voluntary Export Restraint (VER): A voluntary export restraint is a limit imposed by the exporting country on the quantity of exports to a specified country during a given period of time.
Tariff-Rate Quota (TRQ): A two-level tariff which imposes a lower tariff rate on a given volume of imports and a higher tariff rate on all subsequent imports.





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Answer Keys:

Answer to Question 16.01

Trade is buying and selling of goods and services on the parts of individuals and businesses. Trade occurs between rational people because everyone benefits. Trade enables individuals and countries to obtain goods and services that they cannot produce for themselves, either because they do not possess the resources to produce them or simply because they cannot produce them in an efficient way. Specialization and trade allow us to produce more with the same resources and the average real standard of living is greater as a result.

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Answer to Question 16.04

Economies of scale take place when firms expand their scale of production and, as a result, the unit cost of production decreases. By producing larger quantities of output, businesses are able to specialize and produce goods more efficiently, reducing the resources needed per unit of output. Another possible reason for a lower average cost of production is that the business overhead costs are spread over a larger scale of output, which decreases the overhead costs attributed to a single unit of output.

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Answer to Question 16.06

If country A’s opportunity cost is less than another’s (B), country A should specialize where its opportunity cost is the smallest. Country A, by producing where the opportunity cost is the lowest, is giving up less than if Country B produced the good. Thus, the world gives up less by producing where opportunity cost is the lowest.

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Answer to Question 16.12

Even though he was more efficient in both programming and managing than anyone else, he specialized in the area where he was the most efficient relative to others and let someone else specialize in the area where Bill Gates was, on a relative basis, less efficient. Total production thus increased. An alternative answer would be that he specialized where the opportunity cost was less and let someone else specialize where their opportunity costs were less. For example, he would have had to give up very valuable results of successful business management, if he were to program. However, by managing, he gave up a less valuable output, that of programming.

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Answer to Question 16.13

Total production can increase when countries can engage in specialization. If total production increases and trade takes place, both countries can have more of both goods and therefore be better off.

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Answer to Question 16.14

Even though a country may be more efficient in producing most goods than any other country, it should specialize in the area where it is the most efficient relative to others and let some other country specialize in the area where it is, on a relative basis, less efficient. This way, the total production in both countries will increase. For example, the U.S. should specialize where its opportunity cost is less and let other countries specialize where their opportunity costs are less compared to the U.S.

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Answer to Question 16.21

Someone who loses his or her job or business as a result of competition from someone else pays significant costs from trade. The next section lists some of the objections to free trade.

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Answer to Question 16.24

It may seem that due to international trade, low-wage workers in other countries will unfairly compete with workers in the U.S. This may not always be true because even if other countries are not as efficient as the U.S. is in producing goods, it still pays to trade. The low-wage countries will indeed specialize where they are least disadvantaged, and U.S. workers in those industries will be hurt. Yet, since total output increases, total output per person (or the average standard of living) increases. Moreover, as shown in the examples above, it is not true that all “low-wage countries” are also low-cost countries and thus will not be able to compete with a high-wage country. Due to dramatic differences in productivity, there can be dramatic differences in wages and the products will still be less expensive to produce in the high-wage economy.

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Answer to Question 16.25

As the price begins to increase with a tariff, the quantity demanded decreases more with very elastic demand than if demand were less elastic. An equilibrium is reached before the price has increased as much as it would have with a less elastic demand curve. Consumers will, therefore, pay a smaller portion of the tax and producers a larger portion. If demand is relatively inelastic, consumers will end up paying a larger portion. We will not dwell on the issue here, but the elasticity of supply will also affect the portions paid by consumers and producers.

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Answer to Question 16.28

A tariff or quota may be placed upon a good in order to protect workers in that industry, to protect an industry that is deemed vital for national security, or to allow a new industry time to grow before being subject to competition. The costs to the country are higher prices of imported and domestic goods and less overall production.

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Answer to Question 16.38

As mentioned earlier, the prices of Japanese cars rose $1,000, and U.S. automobiles rose $1,400 in price. The total cost per U.S. job saved, per year, has been estimated to be about $150,000. You might ask why would we ever pass a law that helped protect jobs at the cost of $150,000 per year. The answer is that the $150,000 cost is not obvious. U.S. purchasers of Japanese and U.S. automobiles pay it in small increments, and those increments are not obvious. This is because increases in prices of Japanese and U.S. automobiles are not labeled as ‘due to limits on imports.’

Consumers end up paying higher prices, reducing their purchases of imported goods, and increasing their consumption of domestic goods. In addition, we lose the increased production that we gain from specialization. A more subtle cost of protecting local firms is the possibility of retaliation by other countries.

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Answer to Question 16.39

The reason we may allow this to happen is that with increased trade, prices will be kept low and businesses will be forced to produce products which are competitive in quality. With the specialization that will result, more can be produced and consumed by both countries. The resulting unemployment in the formerly protected industries can be reduced with the use of proper fiscal and monetary policy.

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Answer to Question 16.40

The core issue seems to be whether to place tariffs on imported shrimp. The article discusses the investigation by the U.S. Department of Commerce that was supposed to determine if China and Vietnam had been unfairly dumping cheap shrimp in U.S. markets. It also addresses some of the pros and cons of imposing such a tariff. Subjecting shrimps to a tariff will hurt consumers who will now have to pay a higher price for the imported shrimp. Moreover, foreign producers and local restaurants will be adversely affected if such a tariff is imposed. However, the U.S. shrimp fishermen will benefit by subjecting shrimps to tariffs. A tax on foreign shrimp will make it more expensive compared to domestic shrimp, resulting in an increase in the demand of U.S. shrimp and a rise in the price received by U.S. shrimp fishermen.

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Answer to Question 16.44

Given that there is no evidence of a particular need to protect U.S. shrimp producers, we should lower the tariff.

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Data Sources

Table 16.10

Table 16.12

Explanation Key

Question 16.22

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Question 16.23

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Image Credits

[1] Image courtesy of pngcm03 under CC0 1.0.

[2] Image courtesy of Coolcaesar under CC BY-SA 3.0.

[3] Image courtesy of Toby Hudson under CC BY-SA 3.0.

[4] Image courtesy of Steve Jurvetson under CC BY 2.0.

[5] Image courtesy of Steve Jurvetson under CC BY 2.0.

[6] Image courtesy of Jon Sullivan in the Public Domain.

[7] Image courtesy of James R. Tourtellotte, CBP, U.S. Dept. of Homeland Security in the Public Domain.

[8] Image courtesy of Cherie A. Thurlby in the Public Domain.

[9] Image courtesy of Jim Winstead under CC BY 2.0.

[10] Image courtesy of Cumulus Clouds under CC BY-SA 3.0.

Think of an example of each type of trade: trade between individuals, exchange of goods across countries, and exchange of goods between businesses. What are the benefits associated with each kind of trade?
Specialization: An individual, business, or country focusing on the production of a limited number of goods and services in order to attain a higher level of efficiency.
Absolute Advantage: An individual (or a business or a country) has an absolute advantage in the production of a good if that individual can produce that good using fewer resources than another individual would.
Economies of Scale: When all inputs are doubled, output more than doubles.
Economies of scale arise when doubling of inputs in a production process results in more than doubling of output.
Comparative Advantage: Compare two individuals’ opportunity costs of producing the same good. The individual with the lowest opportunity cost (that is, the one who gives up the fewest number of other goods) has the comparative advantage in the production of that good.
Production Possibilities Frontier
The production possibilities frontier plots the maximum output of goods and services that a country can produce with its resources.
Assume that there are two countries, A and B, and country A’s opportunity cost is less than country B’s.
Bill Gates specialized in the area where he was the most efficient relative to others.
What will happen to total production when countries engage in specialization?
Countries should specialize in the production of goods in which they are the most efficient relative to other countries. Think of the U.S. example, a country that possesses an absolute advantage in the production of most goods and yet does not specialize and export all of those goods.
Who tends to lose when a country starts to import certain goods instead of producing those goods itself?
When comparing wages across countries, it may be useful to also compare differences in labor productivities across those countries, as shown in the examples above.
Tariff: A tax on an imported good.
A very elastic demand curve means that consumers are very sensitive to changes in prices.
Quotas
Legal limits on the amounts of a good or service that can be imported
Refer to the examples just discussed. What happens in the domestic market when a tariff or a quota is placed on an imported good?
Infant Industry Argument
The reason for temporarily protecting new industries because they do not yet have the economies of scale that their older foreign competitors enjoy
Refer to the soccer uniforms example discussed in the previous section. What happens in the domestic market when a tariff is placed on an imported good?
What are the possible benefits of higher competition from foreign producers?
When a country exports a product at a price that is lower in the foreign market than the price charged in the domestic market.
A tariff or a duty imposed by the domestic government on imports that it believes are priced below market value or below the price charged in the exporting country’s domestic market.
Why would one government want to restrict importation of shrimp? Why would other governments oppose those restrictions?
Compare the advantages and disadvantages of imposing a tariff.