INTERNATIONAL
ECONOMICS
SEVENTEENTH EDITION
ROBERT J. CARBAUGH
© 2019 Cengage. All rights reserved.
1
Chapter 3:
Sources of
Comparative
Advantage
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2
Chapter Outline (1 of 3)
• Factor-Endowments as a Source of Comparative
Advantage
• Is International Trade Responsible for the Loss of
American Manufacturing Jobs? How about
Robots Instead?
• Is the Factor-Endowment Theory a Good
Predictor of Trade Patterns? The Leontief
Paradox
• Economies of Scale and Comparative Advantage
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3
Chapter Outline (2 of 3)
• Overlapping Demands as a Basis for Trade
• Intra-Industry Trade
• Technology as a Source of Comparative
Advantage: The Product Cycle Theory
• Dynamic Comparative Advantage: Industrial
Policy
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4
Chapter Outline (3 of 3)
• WTO Rules that Illegal Government Subsidies
Support Boeing and Airbus
• Government Regulatory Policies and
Comparative Advantage
• Transportation Costs and Comparative
Advantage
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5
Factor Endowments as a Source
of Comparative Advantage
• Ricardian theory-assumes relative labor
productivity, labor costs, product prices
differ in 2 countries before trade
• Assumption of labor as sole factor of
production rules out explanation of how
trade affects distribution of income
among factors & why some favor trade
while others oppose it
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6
Factor-Endowment Theory (1 of 5)
• Heckscher & Ohlin’s Factor-endowment
theory (Heckscher-Ohlin theory):
• Immediate basis for trade is difference
between pre-trade relative product prices of
trading nations.
• Pre-trade prices depend on production
possibilities.
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7
Factor-Endowment Theory (2 of 5)
• Capital/Labor Ratio
• Determines comparative advantage
• Country exports good using relatively
abundant resource
• Country imports good using large amount of
relatively scarce resource
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8
Factor-Endowment Theory (3 of 5)
TABLE 3.1 Producing Aircraft and Textiles: Factor Endowments
in the United States and China
Resource
United States
China
Capital
100 machines
20 machines
Labor
200 workers
1,000 workers
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9
Factor-Endowment Theory (4 of 5)
• Effect of resource endowments on
comparative advantage
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10
Factor-Endowment Theory (5 of 5)
TABLE 3.2 Total Capital Stock per Worker of Selected Countries in 2011*
Industrial Country
Developing Country
Japan
$297,565
South Korea
$233,959
United States
292,658
Mexico
85,597
Germany
251,468
Colombia
67,292
Australia
250,949
Brazil
64,082
Canada
198,930
China
57,703
Sweden
190,793
Philippines
34,913
Russia
107,182
Vietnam
24,721
*In 2005 U.S. dollar prices
Source: From Robert Feenstra, Robert Inklaar, and Marcel Timmer, University of Groningen, Groningen Growth
and Development Centre, Penn World Table, Version 8.0, 2013, available at
www.rug.nl/research/ggdc/data/penn-world-table.
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11
Applying the Factor-Endowment
Theory to U.S-China Trade
TABLE 3.3 U.S.–China Merchandise Trade: 2016 (billions of dollars)
U.S. EXPORTS TO CHINA
U.S. IMPORTS FROM CHINA
Product
Value
Percent
Product
Value
Percent
Transportation equipment
25.5
22.0
Computers and electronics
161.3
34.9
Agricultural products
17.3
14.9
Electrical equipment
40.7
8.8
Computers and electronics
17.1
14.8
Manufactured commodities
39.4
8.5
Chemicals
13.5
11.7
Machinery
30.4
6.6
Machinery
8.3
7.2
Apparel
30.3
6.5
All others
34.1
29.4
All others
160.7
34.7
Total
115.8
100.0
Total
462.8
100.0
Sources: From U.S. Department of Commerce, International Trade Administration, available at
http://www.ita.doc.gov. Scroll down to Trade Stats Express (http://tse.export.gov/) and to National Trade Data. See
also Foreign Trade Division, U.S. Census Bureau.
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12
Chinese Manufacturers Beset by
Rising Wages and a Rising Yuan
• Developing labor shortage and rising
wages because of:
• China’s one-child policy: fewer young adults
• Land policies that discourage migration from
country, since people must tend family plots or
lose them
• Inability to enroll children in city schools or
gain government services until they have
been declared urban dwellers, which may
take years
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13
Does Trade with China Take Away
Blue-Collar American Jobs?
• China has bent rules of trade (currency
manipulation, stealing intellectual property)
• Main source of growth is comparative
advantage in labor-intensive goods
• Comparative advantage may be
diminishing
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14
Factor-Price Equalization (1 of 2)
• Trade redirects demand away from relatively
expensive, scarce resource toward relatively
cheap, abundant resource in each nation.
• Cheap resource becomes relatively more
expensive.
• Expensive resource becomes relatively cheaper.
• Eventually, factor-price equalization occurs as
globalization evens things out.
• No full factor-price equalization exists in real world.
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15
Factor-Price Equalization (2 of 2)
TABLE 3.4 Indexes of Hourly Compensation for Manufacturing Workers (U.S. = 100)
1997
2015
Norway
112
132
Germany
125
112
Austria
108
104
Netherlands
99
97
Canada
80
82
Japan
96
63
South Korea
40
60
Taiwan
31
25
Mexico
15
16
Source: From International Comparisons of Hourly Compensation Costs in Manufacturing, 2013,
The Conference Board, available at http://www.conference-board.org.
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16
Who Gains & Loses from Trade? The
Stolper-Samuelson Theorem (1 of 3)
• Stolper-Samuelson Theorem
• Extension of factor-price equalization theory
• States that increase in price of a product increases
income earned by resources used intensively in its
production
• Decrease in price of a product reduces income of
resources used intensively in its production
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17
Who Gains & Loses from Trade? The
Stolper-Samuelson Theorem (2 of 3)
• Stolper-Samuelson Theorem
• Implies that export of product that embodies large
amounts of relatively cheap, abundant resource
makes resource scarcer, driving up its price/
income
• Import of product that embodies large amounts of
relatively expensive, scarce resource makes
resource less scarce, driving down its price/
income
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18
Who Gains & Loses from Trade? The
Stolper-Samuelson Theorem (3 of 3)
Stolper-Samuelson Theorem
• There are winners and losers from trade
• Magnification effect:
• Change in price of resource is greater than change
in price of good that uses the resource intensively
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19
Is International Trade a
Substitute for Migration? (1 of 2)
• Immigrants contribute to U.S. economy:
• Increase the size of the labor force
• Fill low-skilled jobs that few native-born
Americans are willing and available to do
• Bring jobs that contribute to the U.S. as a leader
in technological innovation
• Critics say:
• They take jobs away from Americans
• Suppress domestic wages
• Consume sizable amounts of public services
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20
Is International Trade a
Substitute for Migration? (2 of 2)
• Can trade reduce immigration?
• International movements in resources are not
essential
• International trade in products can achieve same
result
• Complement labor migration, short and nearlong terms
• Expanding trade results in some unemployed
workers forced to seek employment abroad
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21
Specific-Factors Theory: Trade
and the Distribution of Income
• Specific factors: factors that cannot move
easily from one industry to another
• Workers acquire skills for specific occupations, not
easily transferable to other industries
• Specific-factors theory
• Analyzes the income distribution effects of trade
in the short term, when resources are immobile
among industries
• Resources specific to import-competing industries lose
as a result of trade
• Resources specific to export industries gain as a result
of trade
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22
Does Trade Make the Poor Even
Poorer? (1 of 4)
• Wage gap: skilled versus unskilled workers
• Caused by some combination of trade,
technology, education, immigration, and union
weakness
• Income inequality: pervasive
• Wages of skilled workers “relative” to those of
unskilled workers
• Outcome of the interaction between supply and
demand in the labor market
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23
Does Trade Make the Poor Even
Poorer? (2 of 4)
• Wage ratio
• Wage of skilled workers divided by the wage
of unskilled workers
• Labor ratio
• Quantity of skilled workers available divided
by the quantity of unskilled workers
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24
Does Trade Make the Poor Even
Poorer? (3 of 4)
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25
Does Trade Make the Poor Even
Poorer? (4 of 4)
• International trade and technological
change increase demand for skilled
workers
• Immigration decreases supply of skilled
workers relative to unskilled workers
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26
Is International Trade Responsible for the Loss
of American Manufacturing Jobs? How about
Robots Instead?
• Machines do much of the work that
humans used to do
• Automation of American factories is more
important factor than international trade in
the loss of American factory jobs
• Presence/impact of robots will grow over
time
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27
Is the Factor-Endowment Theory a Good
Predictor of Trade Patterns? The Leontief
Paradox (1 of 2)
• Wassily Leontief: 1st attempt to test factorendowment theory empirically
• Given: U.S. has relatively abundant capital,
relatively scarce labor
• According to theory, U.S. will:
• Export capital-intensive goods
• Import-competing goods will be labor intensive
• Leontief tested capital/labor ratios for 200 export
industries & import-competing industries in U.S. in
1947
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28
Is the Factor-Endowment Theory a Good
Predictor of Trade Patterns? The Leontief
Paradox (2 of 2)
• Leontief’s findings:
• Capital/labor ratio for U.S. exports lower than
import-competing industries
• Exports were less capital-intensive than
import-competing goods
• Findings contradicted predictions of the
factor-endowment theory: Leontief paradox
• Later studies found mixed results
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29
Economies of Scale and
Comparative Advantage
• Increasing returns to scale
• Exit when expansion of the scale of
production capacity of a firm or industry
causes total production costs to increase
less proportionately than output
• Can be internal or external
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30
Internal Economies of Scale
(1 of 2)
• Internal economies of scale provide
additional cost incentives for specialization
in production
• Countries will specialize in products that
have a large domestic demand (home
market effect)
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31
Internal Economies of Scale
(2 of 2)
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32
External Economies of Scale
(1 of 2)
• External economies of scale exist outside
firm and within industry
• When firm’s average costs decrease as
industry’s output increases
• Cost reduction could be caused by decrease
in resource prices or amount of resources per
output
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33
External Economies of Scale
(2 of 2)
• Concentration of industry’s firms in geographic
area attracts large pool of specialized workers;
new knowledge of production technology spreads
among firms in area
• Expanding industry is source of growth, tax
revenues
• Component suppliers cluster close to
manufacturing center, increasing access to
specialized inputs
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34
Overlapping Demands as a Basis
for Trade (1 of 2)
• Theory of overlapping demands:
• Factor-endowment theory explains trade in
primary products and agricultural goods
• Does not explain trade in manufactured goods,
since main force influencing manufactured-good
trade is domestic demand conditions
• Firms within country: manufactured goods for
which there is large domestic market
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35
Overlapping Demands as a Basis
for Trade (2 of 2)
• Consumer demand conditioned
strongly by income levels
• Country’s per capita income yields particular
demand pattern
• Nations with high per capita incomes demand
luxuries
• Nations with low per capita incomes demand
necessities
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36
Intra-Industry Trade (1 of 3)
• Inter-industry trade
• Exchange between nations of products of
different industries
• Based on inter-industry specialization
• Each nation specializes in industries in which it
enjoys comparative advantage
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37
Intra-Industry Trade (2 of 3)
• Advanced industrial nations emphasize
intra-industry trade
• Two way trade in a similar commodity
• Existence of intra-industry trade
incompatible with models of comparative
advantage
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38
Intra-Industry Trade (3 of 3)
TABLE 3.5 Intra-industry Trade Examples: Selected
U.S. Exports and Imports, 2016 (in millions of dollars)
Category
Exports
Imports
Food and beverages
130,703
130,260
Industrial supplies
397,756
443,767
Capital goods
579,366
589,972
Automotive
149,978
350,256
Consumer goods
193,646
583,791
Source: From U.S. Census Bureau, U.S. International Trade in Goods and Services, End-Use
Categories and Commodities: FT 900, 2016.
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39
Technology as a Source of Comparative
Advantage: The Product Cycle Theory (1 of 2)
• Technological innovations
• Nations differ in rates of technological
innovation
• Result in:
• New methods of producing existing commodities
• Production of new commodities
• Commodity improvements
• Often transitory
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40
Technology as a Source of Comparative
Advantage: The Product Cycle Theory (2 of 2)
• Manufactured goods undergo
predictable trade cycle:
1. Manufactured good introduced to home
market
2. Domestic industry shows export strength
3. Foreign production begins
4. Domestic industry loses competitive
advantage
5. Import competition begins
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41
Radios, Pocket Calculators, and
the International Product Cycle
• Pocket calculators illustrate product life
cycle model
• Invented in US 1961; $1,000
• By 1970, competing pocket calculators from
several U.S. & Japanese firms; $400
• More firms entered market; some assembled
product in foreign countries with lower costs
• Still more firms entered, improved technology;
by mid 1970’s, pocket calculators sold for
$10-$20, sometimes less
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42
Japan Fades in the Electronics
Industry
• Essence of product life cycle model seen in
experience of Japanese electronics industry
• In late 1980s, Japan prepared to dominate world
electronic market
• Industry weakened during 2000-2010, exports
declining, losses increasing; executives blamed
value of yen
• Sources of comparative advantage change with time
• Competitiveness is not just about what products to offer
but which NOT to offer
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43
Dynamic Comparative Advantage:
Industrial Policy (1 of 2)
• Dynamic comparative advantage
• Comparative advantage in particular industry
can be created through mobilization of skilled
labor, technology, and capital
• Industrial policy
• Government actively involved in creating
comparative advantage
• Strategy to revitalize, improve, and develop
an industry
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44
Dynamic Comparative Advantage:
Industrial Policy (2 of 2)
• Industrial policy (cont.)
• Antitrust immunity, tax incentives, R&D
subsidies, loan guarantees, low-interest-rate
loans, trade protection
• Requires government to identify “winners”
• Encourage resources to move into industries with
highest growth prospects
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45
WTO Rules that Illegal Government
Subsidies Support Boeing & Airbus (1 of 3)
• U.S. complains that Airbus receives unfair
subsidies from European governments:
• Loans at below market interest rates
• Repayment delayed until after aircraft is sold
• Repayment cancelled if sales fall short
• Airbus says their subsidies prevent U.S.
from holding worldwide monopoly in
jetliners
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46
WTO Rules that Illegal Government
Subsidies Support Boeing & Airbus (2 of 3)
• Airbus says Boeing benefits from indirect
government subsidies
• Government organizations support aeronautics
research shared with Boeing; also, military sponsored
research & procurement
• Boeing subcontracts part of production to Japan &
China, whose producers receive government subsidies
• In 1992, U.S. & Europe agreed to curb subsidies
• 33% cap on government subsidies for product
development; indirect subsidies limited to 4% of firm’s
revenue
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47
WTO Rules that Illegal Government
Subsidies Support Boeing & Airbus (3 of 3)
• 2005, Boeing & Airbus filed suits at WTO,
contending other received illegal subsidies
• 2010-11, WTO ruled that both received
illegal subsidies
• Boeing said would comply & reject illegal aid
• Airbus resisted abandoning aid from
European govts
• 2017, WTO declares that neither
government has removed illegal subsidies
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48
Government Regulatory Policies
& Comparative Advantage
• Government regulations
• Workplace safety
• Occupational Safety and Health Administration
• Product safety
• Consumer Product Safety Commission
• Clean environment
• Environmental Protection Agency
• May improve wellbeing of the public
• Can result in higher costs for domestic firms
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49
Transportation Costs &
Comparative Advantage
• Costs of moving goods, freight charges,
packing and handling expenses, and
insurance premiums
• Obstacle to trade and impede realization
of gains from trade liberalization
• Differences across countries in transport
costs
• Source of comparative advantage
• Affect volume and composition of trade
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50
Trade Effects
• Trade effects of transportation costs
• High-cost importing country
• Produce more, consume less, and import less
• Low-cost exporting country
• Produce less, consume more, and export less
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51
Falling Transportation Costs
Foster Trade
• Growing international trade
• Worldwide decrease in trade barriers
• Economic opening of nations that have
traditionally been minor players
• Rising shipping costs = trade
dampened/diverted while looking for shorter,
less costly routes
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52
How Containers Revolutionized
the World of Shipping
• Late 1950s, businessman Malcom
McLean founded first American
transportation company to specialize in
containerization
• More efficient than packing and unpacking
individual items
• Drove down international shipping costs,
improved reliability
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53
The Port of Prince Rupert: Shifting
Competitiveness in Shipping Routes
• Shipping companies seek the fastest and
least costly routes to transport Asian
products to U.S.
• Canada more competitive
• Shows that once port loses business, it is
difficult to get it back
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54
INTERNATIONAL
ECONOMICS
SEVENTEENTH EDITION
ROBERT J. CARBAUGH
© 2019 Cengage. All rights reserved.
1
Chapter 1: The
International
Economy and
Globalization
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2
Chapter Outline
• Economic Interdependence: Federal Reserve Incites
Global Backlash
• Globalization of Economic Activity
• Waves of Globalization
• The United States as an Open Economy
• Why Is Globalization Important?
• Globalization and Competition
• Common Fallacies of International Trade
• Is International Trade an Opportunity or a Threat to
Workers?
• Has Globalization Gone Too Far?
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3
Economic Interdependence (1 of 2)
High degree of economic interdependence
• No nation exists in economic isolation
• All aspects of a nation’s economy linked to
economies of trading partners
• Reflects historical evolution of the world’s
economic and political order
• Economic interdependence is complex, and its
effects are uneven
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4
Economic Interdependence (2 of 2)
• High degree of economic
interdependence (cont.)
• Steps toward international cooperation
• Mutually advantageous for trading nations
• Protectionist pressures
• Some developing nations argue that liberalized
trading system serves to keep them in poverty
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5
Economic Interdependence: Fed
Policy Incites Backlash
• Domestic economic policies have spillover
effects on other economies
• Quantitative easing by Fed, intended to
stimulate U.S. economy during Great
Recession
• criticized by U.S. trading partners as attempt
to improve American competitiveness through
depreciation of dollar
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6
Globalization of Economic
Activity (1 of 2)
• Globalization
• Process of greater interdependence between
countries and their citizens
• Increased international flows of
• Goods, services, people
• Investments in equipment, factories, stocks, bonds
• Globalization is political, technological,
cultural, and economic
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7
Globalization of Economic
Activity (2 of 2)
• What forces are driving globalization?
• Technological change
• Advances in transport technology
• Widespread liberalization of investment
transactions
• Development of international financial
markets
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8
Waves of Globalization (1 of 14)
• History of globalization tied to evolution of
trade
• In late 1700s and 1800s, mass production
and improved transportation made
international trade easier; most goods
tradeable
• Rise of global manufacturing in 1990s
characterized by geographical fragmentation
of productive processes and offshoring of
industrial tasks
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9
Waves of Globalization (2 of 14)
• First Wave of Globalization: 1870–1914
• Decreases in tariff barriers
• Technological developments
• Declining transportation costs; shift from sail
to steamships; railways
• Driven by European and American
businesses and individuals
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10
Waves of Globalization (3 of 14)
• First Wave of Globalization: 1870–1914 (cont.)
• Exports as share of world income nearly
doubled to 8%
• Per capita incomes increased 1.3% per year
• Previous 50 years: 0.5% per year
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11
Waves of Globalization (4 of 14)
• First Wave of Globalization: 1870–1914 (cont.)
• Nations that actively participated in
globalization became richest countries in
world
• Ended by World War I
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12
Waves of Globalization (5 of 14)
• Great Depression of 1930s
• Governments practiced protectionism
• Raised tariffs on imports
• Tried to shift demand into domestic markets to
promote domestic sales and jobs
• Exports as share of national income fell from 8%
to 5%
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13
Waves of Globalization (6 of 14)
• Second Wave of Globalization: 1945–1980
• Renewed incentive for globalization
• Falling transportation costs fostered increased
trade
• Trade liberalization not uniform
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14
Waves of Globalization (7 of 14)
• Differential impacts of second wave
• Developed countries largely freed of barriers
• Greatly increased the exchange of manufactured
goods
• Raised incomes
• Developing countries
• Only agricultural exports that do not compete with
agriculture in developed country free of barriers
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15
Waves of Globalization (8 of 14)
• Second Wave of Globalization: 1945–1980
(cont.)
• New kind of trade
• Rich country specialization in manufacturing
niches
• Gained productivity through agglomeration
economies
• Firms clustered together
• Some clusters produced same product; others connected
by vertical linkages
• Benefits only those in clusters
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16
Waves of Globalization (9 of 14)
• Second Wave of Globalization: 1945–1980
(cont.)
• Developing countries as group left behind
• Continuing trade barriers, unfavorable investment
climates, antitrade policies, dependence on
agricultural and natural-resource products
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17
Waves of Globalization (10 of 14)
• Latest Wave of Globalization (1980–
present)
• Some developing countries (e.g. China, India,
Brazil) broke into world markets for
manufacturing
• Other developing countries marginalized,
causing incomes to decrease and poverty to
rise
• Significant international capital movements
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18
Waves of Globalization (11 of 14)
• Latest Wave of Globalization (1980–
present) (cont.)
• Some developing countries have competitive
advantage in labor-intensive manufacturing
(e.g. Bangladesh)
• Protectionist policies in developed countries
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19
Waves of Globalization (12 of 14)
• Latest Wave of Globalization (1980–
present) (cont.)
• Foreign outsourcing
• Products manufactured in more than one country
• Manufacturing moved to wherever costs were
lowest
• Job losses for some workers in developed countries
• Cries for laws restricting outsourcing
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20
Waves of Globalization (13 of 14)
• Latest Wave of Globalization (1980–
present) (cont.)
• By 2000s, foreign outsourcing of
professionalized work
• Information Age
• Internet, high-speed data
• Sending upscale jobs offshore
• Accounting, chip design, engineering, basic research,
and financial analysis
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21
Waves of Globalization (14 of 14)
• Latest Wave of Globalization (1980–
present) (cont.)
• Integrated factory floor increasingly
replaced by network of individual,
specialized suppliers
• Countries tend to specialize in specific
stages of production
• E.g. Boeing 787 Dreamliner
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22
TABLE 1.1 The Fruits of Free
Trade: A Global Fruit Basket
On a trip to the grocery store, consumers can find goods from all over the globe.
Fruit
Country
Fruit
Country
Apples
New Zealand
Limes
El Salvador
Apricots
China
Oranges
Australia
Bananas
Ecuador
Pears
South Korea
Blackberries
Canada
Pineapples
Costa Rica
Blueberries
Chile
Plums
Guatemala
Coconuts
Philippines
Raspberries
Mexico
Grapefruit
Bahamas
Strawberries
Poland
Grapes
Peru
Tangerines
South Africa
Kiwifruit
Italy
Watermelons
Honduras
Lemons
Argentina
Source: From “The Fruits of Free Trade,” Annual Report, Federal Reserve Bank of Dallas, 2002, p. 3.
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23
The U.S. as an Open Economy
(1 of 8)
• Trade patterns
• Openness
• Rough measure of the importance of international
trade in a nation’s economy
• Nation’s exports and imports as a percentage of its
Gross Domestic Product (GDP)
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24
The U.S. as an Open Economy
(2 of 8)
• Openness (cont.)
• Large countries – lower measures of
openness
• Less reliant on international trade
• Firms can attain optimal production size without
having to export due to the population and
economic size
• Small countries – higher measures of
openness
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25
The U.S. as an Open Economy
(3 of 8)
• Openness of the U.S. economy, 1890–
2018
• Less open to international trade, 1890–1950
• Two world wars + Great Depression of the 1930s
• Reduced dependence on trade
• National security reasons
• Protect home industries from import competition
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26
The U.S. as an Open Economy
(4 of 8)
• Openness of the U.S. economy, 1890–
2018 (cont.)
• After World War II — negotiated reductions in
trade barriers
• Rising world trade; technological improvements in
shipping and communications
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27
The U.S. as an Open Economy
(5 of 8)
• Openness of the U.S. economy, 1890–
2018 (cont.)
• Relative importance of international trade
increasing
• Example: need for personal computers with
imported components
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28
The U.S. as an Open Economy
(6 of 8)
TABLE 1.3 Top 8 Countries with Whom the United States Trades,
2016
Value of U.S.
Total Value of
Country
Exports of Goods
(in billions of
dollars)
Value of U.S.
Imports of Goods
(in billions of dollars)
Trade
(in billions of
dollars)
China
115.8
462.8
578.6
Canada
266.8
278.1
544.9
Mexico
231.0
294.2
525.2
Japan
63.3
132.2
195.5
Germany
49.4
114.2
163.6
United Kingdom
55.4
54.3
109.7
South Korea
42.3
69.9
112.2
France
30.9
46.8
77.7
Source: From U.S. Department of Commerce, U.S. Census Bureau, Foreign Trade: U.S. Trade in Goods by Country, 2017.
© 2019 Cengage. All rights reserved.
29
The U.S. as an Open Economy
(7 of 8)
• Labor and Capital
• Labor mobility in U.S. has not risen in past
100 years
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30
The U.S. as an Open Economy
(8 of 8)
• U.S. increasingly tied to rest of the world
through investment flows
• Foreign ownership increasing
• Concerns over rising cost of debt
• International branches of U.S. banks
• U.S. securities are increasingly globalized
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31
Why Is Globalization Important?
(1 of 5)
• Law of Comparative Advantage
• Each nation gains by producing goods in
which it has relative advantage
• If a good or service can be obtained more
economically through trade, it makes sense to
trade for it, not produce it
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32
Why Is Globalization Important?
(2 of 5)
• Law of Comparative Advantage (cont.)
• International trade also gains from
competitive process
• Competition essential to innovation, efficiency
• Global competition can result in high-cost
domestic producers exiting market
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33
Why Is Globalization Important?
(3 of 5)
• Open economies
• More competition lowers prices
• Strong incentive for highest quality
• Weakens monopolies
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34
Why Is Globalization Important?
(4 of 5)
• Open economies (cont.)
• More firm turnover
• Less productive firms exit
• Improvement for industry
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35
Why Is Globalization Important?
(5 of 5)
• Economic growth rates closely related to
openness, education, communications
infrastructure
• International trade can provide stability for
producers via exports
• Rapid growth increases demand for
commodities
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36
Globalization and Competition
(1 of 3)
• Globalization Forces Kodak to Reinvent Itself
• Kodak had 90% camera market; did not address
competition with new technology
• Fuji entered U.S. market with lower-priced film and
supplies; Kodak ignored them
• By mid-1990s, Fuji had 17% of market, Kodak, 75%
• Kodak finally developed digital camera but was
undercut by smart phones; filed for Ch 11
bankruptcy
• Kodak now a small digital imaging company
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37
Globalization and Competition
(2 of 3)
• Bicycle Imports Force Schwinn to
Downshift
• Schwinn bicycles once standard
• Competitors produced mountain bikes and
racing bikes; cheap imports entered market
• Schwinn moved production to non-union
state; obtained foreign parts. Uneven quality;
Schwinn declared bankruptcy
• Today Schwinn made in China
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38
Globalization and Competition
(3 of 3)
• Element Electronics Survives by Moving TV
Production to America
• Once, 150 U.S. TV manufacturers
• Imports from Japan, China, South Korea, others
• Flat panel TVs lighter, cheaper to ship from Asia
• By 2000, no U.S. TV manufacturers
• Costs in China rising; U.S. factories more
competitive
• Element Electronics became only TV
manufacturer in U.S.; “Made in America” logo
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39
Common Fallacies of
International Trade (1 of 2)
• “Trade is a zero-sum activity”
• False; both partners gain from trade
• “Imports result in unemployment and
burden the economy, while exports
promote growth and jobs”
• False; source of fallacy is failure to consider
connection between imports and exports
© 2019 Cengage. All rights reserved.
40
Common Fallacies of
International Trade (2 of 2)
• “Tariffs, quotas, and other imports result in
more jobs for domestic workers”
• False; fails to recognize that a reduction in
imports does not occur in isolation
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41
Is the United States Losing Its
Innovation Edge?
• Some economists say U.S. is losing its
innovation edge
• Manufacturing is key to R & D that generates
inventions
• Other economists disagree
• All of the key technologies and high-valueadded activities are U.S.
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42
International Trade: Opportunity
or Threat to Workers? (1 of 6)
• International trade is both opportunity and
threat for firms and workers (e.g. exports
and closing mill in NC)
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43
International Trade: Opportunity
or Threat to Workers? (2 of 6)
TABLE 1.4 Millions of American Jobs Supported by Exports:
Totals, Goods, and Services
Year
Total
Goods
Services
2009
9.6
5.8
3.8
2010
10.2
6.2
4.0
2011
10.9
6.6
4.3
2012
11.2
6.7
4.5
2013
11.4
6.7
4.7
2014
11.6
6.8
4.8
2015
11.5
6.7
4.8
Source: Chris Rasmussen, Office of Trade and Economic Analysis, International Trade
Administration, U.S. Department of Commerce, Jobs Supported by Exports 2015: An Update, April 8,
2016.
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44
International Trade: Opportunity
or Threat to Workers? (3 of 6)
• International trade increases total
productivity
• Wages paid by exporters higher than nonexporters
• Exporting industries require more
educated workforce
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45
International Trade: Opportunity
or Threat to Workers? (4 of 6)
• Not all workers gain from international
trade
• Some places lose jobs to cheap imports
• Concern over mass immigration for lowwage work
• Particular threat to unskilled workers in
developed countries
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46
International Trade: Opportunity
or Threat to Workers? (5 of 6)
• Hurts unskilled workers in import-competing
industries
• Wages increase for skilled workers
• Workers — more productive
• Imports do NOT decrease the total jobs in
nation
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47
International Trade: Opportunity
or Threat to Workers? (6 of 6)
• International trade
• Just another kind of technology
• Adds value to inputs
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48
Has Globalization Gone Too Far?
(1 of 2)
• Mainstream economists=open economies
provide more than closed
• Critics=U.S. trade policies primarily benefit
large corporations rather than average
citizens
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49
Has Globalization Gone Too Far?
(2 of 2)
• Gnawing sense of unfairness and
frustration over environment, American
workers, international labor standards
• Noneconomic aspects of globalization also
shape international debate
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50
INTERNATIONAL
ECONOMICS
SEVENTEENTH EDITION
ROBERT J. CARBAUGH
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51
Chapter 2:
Foundations of
Modern Trade
Theory:
Comparative
Advantage
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52
Chapter Outline (1 of 2)
• Historical Development of Modern Trade Theory
• Production Possibilities Frontiers
• Trading Under Constant-Cost Conditions
• Dynamic Gains from Trade: Economic Growth
• Changing Comparative Advantage
• Trading under Increasing-Cost Conditions
• The Impact of Trade on Jobs
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53
Chapter Outline (2 of 2)
• Wooster, Ohio, Bears the Brunt of Globalization
• Comparative Advantage Extended to Many
Products & Countries
• Factor Mobility, Exit Barriers, and Trade
• Empirical Evidence on Comparative Advantage
• The Case for Free Trade
• Comparative Advantage & Global Supply Chains
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54
Main Concepts
• Basis for trade: why do nations export
and import certain products?
• At what terms of trade are products
exchanged in world market?
• Gains from international trade:
production & consumption
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55
Historical Development of
Modern Trade Theory (1 of 11)
• The Mercantilists, 1500–1800
• Promoted favorable trade balance by
encouraging exports and discouraging
imports
• Sought rise in domestic output & employment
• Advocated government regulation of trade (tariffs,
quotas, other commercial policies)
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56
Historical Development of
Modern Trade Theory (2 of 11)
• Criticisms of Mercantilism
• David Hume’s price-specie-flow doctrine
• A favorable trade balance is possible only in short
run
• Adam Smith, The Wealth of Nations (1776)
• Static view; world’s wealth not fixed quantity
• International trade increases general level of
productivity within a country as well as increases
world output
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57
Historical Development of
Modern Trade Theory (3 of 11)
• Why Nations Trade? Absolute Advantage
• Assumption:
• Production costs differ among nations due to
different productivities of factor inputs
• Absolute Cost Advantage
• Countries that use less labor to produce one unit of
output
• Labor theory of value – assumes that within a
nation, labor is only factor of production
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58
Historical Development of
Modern Trade Theory (4 of 11)
• Principle of Absolute Advantage
• Two-nation, two-product world
• Each nation produces good absolutely more
efficiently than trading partner
• With trade and specialization
• Countries export goods – if have absolute cost
advantage
• Countries import goods – if have absolute cost
disadvantage
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59
Historical Development of
Modern Trade Theory (5 of 11)
TABLE 2.1 A Case of Absolute Advantage When Each
Nation Is More Efficient in the Production of One Good
World output possibilities in the absence of specialization
OUTPUT PER LABOR HOUR
Nation
Wine
Cloth
United States
5 bottles
20 yards
United Kingdom
15 bottles
10 yards
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60
Historical Development of
Modern Trade Theory (6 of 11)
• Why Nations Trade: Comparative
Advantage
• Emphasizes relative cost differences based
on opportunity costs; basis for trade
• Mutually advantageous trade possible even
when nation has absolute cost disadvantage
in production of both goods
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61
Historical Development of
Modern Trade Theory (7 of 11)
TABLE 2.2 Examples of Comparative Advantages in
International Trade
Country
Product
Canada
Lumber
Israel
Citrus fruit
Italy
Wine
Jamaica
Aluminum ore
Mexico
Tomatoes
Saudi Arabia
Oil
China
Textiles
Japan
Automobiles
South Korea
Steel, ships
Switzerland
Watches
United Kingdom
Financial services
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62
Historical Development of
Modern Trade Theory (8 of 11)
Assumptions of Ricardo’s Principle of
Comparative Advantage
1. World consists of 2 nations & 2 goods
2. Labor, fully employed & homogenous, is sole
input
3. Labor can move freely only within nation
4. Technology fixed for both nations; all firms
within nation utilize common production
methods
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63
Historical Development of
Modern Trade Theory (9 of 11)
5. Costs do not vary with level of production &
proportional to labor use
6. Perfect competition prevails in all markets;
firms are price takers; products are identical
7. Free trade occurs between nations; no
barriers
8. Transportation costs zero; consumers don’t
care whether domestically produced or
imported
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64
Historical Development of
Modern Trade Theory (10 of 11)
9. Firms make production decisions to maximize
profits; consumers maximize satisfaction
10. No money illusion; consumers and firms take
account of all prices in their decisions
11. Trade is balanced (exports pay for imports),
implying no money flows between nations
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65
Historical Development of
Modern Trade Theory (11 of 11)
TABLE 2.3 A Case of Comparative Advantage When the
United States Has an Absolute Advantage in the
Production of Both Goods
World output possibilities in the absence of specialization
OUTPUT PER LABOR HOUR
Nation
Wine
Cloth
United States
40 bottles
40 yards
United Kingdom
20 bottles
10 yards
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66
Production Possibilities
Frontiers (1 of 2)
• Production possibilities frontiers
• Various alternative combinations of two goods
a nation can produce when all factor inputs
are used in their most efficient manner
• Maximum output possibilities of a nation,
given land, labor, capital, entrepreneurship
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67
Production Possibilities
Frontiers (2 of 2)
• Marginal rate of transformation (MRT)
• The amount of a product a nation must
sacrifice to obtain an additional unit of another
good
• Rate of sacrifice = opportunity cost of a product
• MRT equals the absolute value of slope of
production possibilities frontier
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68
Trading Under Constant-Cost
Conditions (1 of 13)
• Constant opportunity costs
• Straight line production possibilities
• Assumes factors of production perfect
substitutes, and all units of a factor are of
same quality
• Autarky
• Absence of trade
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69
Trading Under Constant-Cost
Conditions (2 of 13)
TABLE 2.4 Gains from Specialization and Trade: Constant
Opportunity Costs
(a) Production Gains from Specialization
BEFORE
SPECIALIZATION
AFTER
SPECIALIZATION
NET GAIN (LOSS)
Autos
Wheat
Autos
Wheat
Autos
Wheat
United States
40
40
120
0
80
−40
Canada
40
80
0
160
−40
80
World
80
120
120
160
40
40
(b) Consumption Gains from Trade
BEFORE TRADE
AFTER TRADE
NET GAIN (LOSS)
Autos
Wheat
Autos
Wheat
Autos
Wheat
United States
40
40
60
60
20
20
Canada
40
80
60
100
20
20
World
80
120
120
160
40
40
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70
Trading Under Constant-Cost
Conditions (3 of 13)
• Consumption Gains from Trade
• Consumption gains for both countries
• Consumption points:
• Beyond domestic production possibilities frontiers,
so countries consume more of both goods
• Terms of Trade
• Rate at which country’s export product is
traded for other country’s export product
• Defines relative prices of the two products
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71
Trading Under Constant-Cost
Conditions (4 of 13)
• Domestic terms of trade: set of post-trade
consumption points that a nation can achieve is
determined by the rate at which its export product is
traded for the other country’s export product
• Slope of production possibilities frontier
• Relative prices at which the two commodities can be
exchanged at home
• Terms of Trade for exports
• For country to consume beyond production
possibilities frontier, international terms of trade must
be more favorable than domestic terms of trade
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72
Trading Under Constant-Cost
Conditions (5 of 13)
• Trading possibilities line
• International terms of trade for both countries
• Trade triangle for a country
• Exports – along horizontal axis
• Imports – along vertical axis
• Terms of trade equal to slope
• Complete specialization
• Produces only one product
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73
Trading Under Constant-Cost
Conditions (6 of 13)
• Domestic cost ratio
• Negatively sloped production possibilities
frontier
• Transforms into a positively sloped cost-ratio line
• Sets outer limits for equilibrium terms of
trade
• Constitutes the no-trade boundary
• Region of mutually beneficial trade
bounded by cost ratios of the two countries
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74
FIGURE 2.2 Equilibrium Terms of
Trade Limits
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75
Trading Under Constant-Cost
Conditions (8 of 13)
• Theory of Reciprocal Demand
• Within outer limits of the terms of trade, actual
terms of trade determined by relative strength
of each country’s demand for other country’s
product
• Production costs determine outer limits of terms of
trade
• Reciprocal demand determines terms of trade
within those limits
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76
Trading Under Constant-Cost
Conditions (9 of 13)
• Theory of Reciprocal Demand
• Best applies when both nations are of equal
economic size
• If two nations are of unequal economic size
• Relative demand strength of smaller nation can be
dwarfed by larger nation
• Domestic exchange ratio of larger nation will prevail
• Small nation can export as much of the commodity as it
desires
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77
Trading Under Constant-Cost
Conditions (10 of 13)
• Importance of Being Unimportant
• For two nations of approximately same size
engaged in international trade, gains from
trade will be shared equally between them
• If one nation is significantly larger
• Larger nation – fewer gains from trade
• Smaller nation – most of the gains from trade
• Larger nation may continue to produce
comparative-disadvantage good because smaller
nation cannot meet all demand
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78
Trading Under Constant-Cost
Conditions (11 of 13)
• Terms-of-Trade estimates
• Commodity terms of trade (a.k.a. barter
terms of trade)
• Measure of the international exchange ratio
• Measures the relation between the prices a nation
gets for its exports and the prices it pays for its
imports
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79
Trading Under Constant-Cost
Conditions (12 of 13)
• Improvement in a nation’s terms of trade
• Rise in export prices relative to import prices
• A smaller quantity of export goods sold
abroad to obtain a given quantity of imports
• Deterioration in a nation’s terms of trade
• Rise in import relative to export prices
• Given quantity of imports requires sacrifice of
greater quantity of exports
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80
Trading Under Constant-Cost
Conditions (13 of 13)
TABLE 2.5 Commodity Terms of Trade, 2015 (2000 = 100)
Country
Export Price
Index
Import Price Index
Terms of Trade
Germany
242
212
114
Brazil
347
305
114
United States
193
183
105
Australia
295
291
101
Argentina
216
238
91
United Kingdom
162
180
90
Canada
148
178
83
Japan
130
171
76
Sources: From International Monetary Fund, IMF Financial Statistics, Washington, DC, January 2017. See
also World Bank, Export Value Index (2000 = 100) at http://data.worldbank.org/indicator and Import Value
Index (2000 = 100) at http://data.worldbank.org/indicator.
© 2019 Cengage. All rights reserved.
81
Dynamic Gains from Trade
• Dynamic gains from international trade
• Effect of trade on country’s growth rate and
volume of additional resources made
available to/utilized by trading country
• Can arise from increased investment in
equipment, economies of large-scale
production, increased competition, internet
use, etc.
• Dwarf static gains from trade
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82
Changing Comparative
Advantage (1 of 2)
• Patterns of comparative advantage
change over time
• Productivity increases
• Production possibilities frontier changes
• More output can be produced with same amount of
resources
• Producers must hone skills to compete in
more profitable areas
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83
FIGURE 2.3 Changing
Comparative Advantage
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84
Trading Under Increasing-Cost
Conditions (1 of 7)
• Increasing opportunity costs
• Gives rise to a production possibilities
frontier that appears bowed outward from
diagram’s origin
• Larger in terms of what is sacrificed
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85
FIGURE 2.4 Production Possibilities Frontier
under Increasing-Cost Conditions
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86
Trading Under Increasing-Cost
Conditions (3 of 7)
• Increasing-Cost Trading Case
• One country specializes, producing one good;
other country specializes in producing the other
good
• Process of specialization continues in both
nations until
• Relative cost of one good is identical in both nations
• One country’s exports of one good equal other
country’s imports of the good
• Domestic rates of transformation are same
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87
FIGURE 2.5 Trading under
Increasing Opportunity Costs
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88
Trading Under Increasing-Cost
Conditions (5 of 7)
• Production Gains
• More of each good is being produced
• Consumption gains
• Both countries consume more of at least one
good
• Trade Triangle
• Denotes country’s exports, imports, and terms
of trade
• Same for both countries
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89
Trading Under Increasing-Cost
Conditions (6 of 7)
TABLE 2.6 Gains from Specialization and Trade: Increasing
Opportunity Costs
(a) Production Gains from Specialization
BEFORE
SPECIALIZATION
AFTER
SPECIALIZATION
NET GAIN (LOSS)
Autos
Wheat
Autos
Wheat
Autos
Wheat
United States
5
18
12
14
7
−4
Canada
17
6
13
13
−4
7
World
22
24
25
27
3
3
(b) Consumption Gains from Trade
BEFORE TRADE
AFTER TRADE
NET GAIN (LOSS)
Autos
Wheat
Autos
Wheat
Autos
Wheat
United States
5
18
5
21
0
3
Canada
17
6
20
6
3
0
World
22
24
25
27
3
3
© 2019 Cengage. All rights reserved.
90
Trading Under Increasing-Cost
Conditions (7 of 7)
• Partial Specialization
• Trade generally leads each country to
specialize only partially in production of good
in which it has comparative advantage.
• Increasing costs constitute mechanism that
forces costs in two trading nations to
converge.
• When cost differentials are eliminated, the
basis for further specialization ceases to exist.
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91
The Impact of Trade on Jobs
(1 of 2)
• The extent to which an economy is open
• Influences mix of jobs within an economy
• Can cause dislocation in certain areas or
industries
• Has little effect on the overall level of
employment
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92
FIGURE 2.6 The Impact of Trade
on Jobs
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93
Wooster, Ohio, Bears the Brunt
of Globalization
• When resin prices skyrocketed, Rubbermaid
tried to raise prices to compensate.
• Walmart ceased carrying its products, broke
relations, & turned to foreign producers with
lower labor costs.
• Profits plunged 30%; closed 9 manufacturing
plants; laid off 10% of workforce.
• Newell Corp purchased Rubbermaid; 1,000
more jobs lost in Wooster.
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94
Comparative Advantage Extended to
Many Products & Countries (1 of 3)
• More than two products:
• Comparative advantage ranks goods by
degree of comparative cost.
• Each country exports products in which it has
greatest comparative advantage.
• Each country imports products in which it has
greatest comparative disadvantage.
• Cutoff point between exports & imports
depends on relative strength of international
demand.
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95
Comparative Advantage Extended to
Many Products & Countries (2 of 3)
• More than two countries:
• Multilateral trading relations
• Bilateral balance should not pertain to any two
trading partners
• Trade surplus with trading partners that buy
many products it supplies at low cost
• Trade deficit with trading partners that are
low-cost suppliers of goods it imports
intensively
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96
FIGURE 2.8 Multilateral Trade among
the United States, Japan, and OPEC
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97
Factor Mobility, Exit Barriers,
and Trade (1 of 2)
• Trading assumes factors of production are
mobile between different uses.
• Factor mobility: ability to move factors of
production out of one production process into
another.
• How realistic is it that factors of production can
move freely within an industry in a country,
can move across industries in a country, and
are immobile across national borders?
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98
Factor Mobility, Exit Barriers,
and Trade (2 of 2)
• Exit barriers hinder market adjustments
that would occur through comparative
advantage.
• Exit barriers in U.S. steel industry caused
by:
• Relatively fixed cost of union-negotiated
wages & benefits.
• Antiquated plants with no other use; contract
termination fines; environmental problems.
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99
Empirical Evidence on
Comparative Advantage (1 of 2)
• Ricardian model
• Implies nations export goods in which their
labor productivity is relatively high.
• Testing Ricardian model
• MacDougall, 1951
• Export patterns of 25 industries in the United
States and United Kingdom (1937) examined
• 20 industries fit predicted pattern
© 2019 Cengage. All rights reserved.
10
0
Empirical Evidence on
Comparative Advantage (2 of 2)
• Testing Ricardian model (cont.)
• Stephen Golub
• Found that relative unit labor costs help explain
trade patterns of U.S. vis-à-vis United Kingdom,
Japan, Germany, Canada, and Australia.
• Limits of Ricardian model
• Labor not the only factor input; production and
distribution costs also impact trade
• Differences in product quality impact trade as
well
© 2019 Cengage. All rights reserved.
10
1
Can American Workers Compete
with Low-Wage Workers Abroad?
• Argument highly political
• Bernie Sanders believes U.S. cannot
compete.
• Opponents believe that Sanders’s
understanding of free trade is inaccurate.
• Lawrence found a strong relationship
between average productivity (GDP per
capita) and average wages.
© 2019 Cengage. All rights reserved.
10
2
The Case for Free Trade (1 of 2)
• Main arguments
• For world as whole, free trade results in
higher level of output and income than would
occur in absence of free trade.
• It allows each individual nation to achieve
higher level of production and consumption
than would be achieved in isolation.
© 2019 Cengage. All rights reserved.
10
3
The Case for Free Trade (2 of 2)
• Additional benefits of free trade:
• Increased monopoly
• More innovation
• Wider range of product choices
• Reduces international political animosities
• However, trade sometimes harms particular
domestic industries and workers, prompting
calls for protections from imports.
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10
4
Comparative Advantage & Global
Supply Chains (1 of 3)
• Ricardian theory assumes production
cannot move to other nations.
• Today, labor, technology, capital, and
ideas all shift around globe.
• Today, many goods are supplied by
global supply chains, international
production networks that allow firms to
move goods and services efficiently
across national borders.
© 2019 Cengage. All rights reserved.
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Comparative Advantage & Global
Supply Chains (2 of 3)
• Global supply chains use outsourcing
• Subcontracting work to another firm, or
purchasing components rather than
manufacturing them
• Advantages of outsourcing
• Reduced costs & increased competitiveness
• Creation of new industries and products
© 2019 Cengage. All rights reserved.
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Comparative Advantage & Global
Supply Chains (3 of 3)
• Reshoring Production to U.S.
• Wage gap narrowing
• Cost of shipping goods by ocean freight
increasing sharply; goods in transit for weeks
• Distance made it difficult to customize goods
to local markets; natural disasters, geopolitical
shocks disrupt supply chains
• Many firms now returning some production to
U.S.
© 2019 Cengage. All rights reserved.
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