MIC ECON Lec 15 – International Trade



LEARNING OBJECTIVE The purpose of this topic is to establish why nations trade and why they tend to restrict trade in spite of the gain they derive from trade. The reason for trade is founded on the comparative advantage which leads each country to specialize. An extensive list of reasons for protectionism is drawn. Efforts to increase trade conclude the section.

INTERNATIONAL TRADE PATTERNS The importance of international trade can be measured by the volume of exported merchandise which, in absolute and in relation to domestic output, has been growing, and by the degree of interdependence of world economies. In addition, international trade is a substitute for resource mobility. Finally, it also affects domestic prices, the level of employment, and all domestic government policy actions.

The United States has been historically more isolated than many other countries because of distance and the large size and prosperity of its domestic market. However, this is changing: American companies are now increasingly interested in foreign markets. In numerous product lines most of the products are imported (for instance, electronics).

COMPARATIVE ADVANTAGE The reason why nations trade is tied to the concept of comparative advantage. A nation has a comparative advantage if it is able to produce a good relatively more efficiently than another country. Nations will specialize in the goods in which they have a comparative advantage, and will trade them with other nations. The resource endowment of a country is a major source of its comparative advantage.

The United States has been blessed with abundant fertile land in idwestern states, and its farmers have been ingenious to cultivate it efficiently. As a result, the United States has a comparative advantage in corn and wheat, which it indeed exports.

SPECIALIZATION Each nation specializes in the production in which it has a comparative advantage. Specialization allows each nation to use its abundant resource more intensively and to relieve the scarcity of its scarce resource to some extent. The price of the abundant resource goes up and the price of the scarce resource goes down. Because of the laws of diminishing returns and increasing opportunity costs, specialization is never complete.

In Scotland, the land was not suitable for much else than raising sheep. Thus, Scotland specialized in making fine wool cloth.

EFFECT FROM TRADE The major effect of trade is specialization. In addition, prices of resources and commodities will change. Trade will take place only if the terms of trade, or relative price of the goods being traded, are between the terms of trade of the two countries. Consequently, the prices of the commodities in the two countries will tend to equalize.

In a tropical country, bananas and tropical fruit may be very inexpensive, while in northern countries these items would be rarities and very expensive without trade. As a result of shipments of bananas to the north, the difference in the price of bananas is decreased. There is also an increase in salary and welfare for those who pick the bananas.

GAINS FROM TRADE When two nations trade, both nations gain from the trade. Each nation is able to obtain more of the commodity from the other country than it could produce by itself. Thus, each country is able to consume beyond its production possibility curve. In addition, the income received by the owners of the abundant resource is improved.

Growing bananas in the United States would be very costly. Americans benefit from being able to import bananas from tropical countries. The tropical countries can import manufactured products from the United States in exchange for the bananas. All countries benefit.

PROTECTIONISM Protectionism consists in various forms of restrictions to international trade; these restrictions include

– tariffs (or duties assessed on imported goods), – quotas (or volume restrictions on imported goods), – non-tariff barriers (such as import licenses and regulations), – voluntary export restrictions (quotas on export by trading partner).

Very rare are the countries which do not have any tariff at all. Tariffs are usually highest on consumer finished products. They are moderate on semifinished goods. Raw materials and advanced technology products have little or no tariffs.

PROTECTIONISM The effect of protectionism is to increase the domestic prices of previously imported goods. Incomes from the abundant resource will decrease. Gains from trade are foregone. Consumers suffer a loss of consumer surplus. Efficiency in production is decreased.

The United States maintains a tariff on sugar. In the 1980’s the worldwide wholesale price of sugar has been around 8 cents a pound. As a result of the tariff, the wholesale price of sugar in the United States is 21 cents a pound. This produces windfall revenues for a handful of very large American producers. The consumer pays a higher price and endures a hardship (small but real nevertheless).

PROTECTIONISM REASONS Reasons for protectionism include – self-sufficiency, – infant industry, – foreign dumping, – diversification, – economic stimulation.

After independence, the government of the United States defended its tariffs on British silverware by pointing out that its manufacture was just emerging and could not compete with the well established and experienced producers in England.

TRADE LIBERALIZATION Efforts to free trade are both worldwide and regional. The WTO (World Trade Organization, which used to be called GATT or General Agreement on Tariffs and Trade) is a multilateral negotiation process involving over 100 countries.The WTO has reduced tariffs by more than half since 1947. Economic integration, such as the European Union (also known as European Economic Community or Common Market) which groups 12 European nations, or NAFTA (or North American Free Trade Agreement) which includes the United States, Canada and Mexico, lifts tariffs and increases trade between nations.

In 1988, the United States and Canada signed an agreement to allow freer trade between the two countries, with Mexico joining later to form NAFTA. All three nations can expect to benefit significantly from the agreement.



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