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CHAPTER

19
International Trade,
Comparative Advantage, and
Protectionism
Prepared by: Fernando
Quijano and Yvonn Quijano

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

International Trade
All economies, regardless of their size,
depend to some extent on other
economies and are affected by events
outside their borders.
The internationalization or globalization
of the U.S. economy has occurred in the
private and public sectors, in input and
output markets, and in business firms and
households.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Absolute Advantage Versus


Comparative Advantage
A country enjoys an absolute advantage
over another country in the production of a
product if it uses fewer resources to produce
that product than the other country does.
A country enjoys a comparative advantage
in the production of a good if that good can
be produced at a lower cost in terms of
other goods.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Gains from Comparative Advantage


Even if a country had a considerable
absolute advantage in the production of
both goods, Ricardo would argue that
specialization and trade are still mutually
beneficial.
When countries specialize in producing the
goods in which they have a comparative
advantage, they maximize their combined
output and allocate their resources more
efficiently.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Exchange Rates
When trade is freeunimpeded by
government-instituted barrierspatterns of
trade and trade flows result from the
independent decisions of thousands of
importers and exporters and millions of
private households and firms.
To understand these patterns we must
know something about the factors that
determine exchange rates.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Exchange Rates
An exchange rate is the ratio at which two
currencies are traded. The price of one
currency in terms of another.
For any pair of countries, there is a range of
exchange rates that can lead automatically
to both countries realizing the gains from
specialization and comparative advantage.
Exchange rates determine the terms of
trade.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

The Sources of
Comparative Advantage
Factor endowments refer to the quantity
and quality of labor, land, and natural
resources of a country.
Factor endowments seem to explain a
significant portion of actual world trade
patterns.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Trade Barriers: Tariffs,


Export Subsidies, and Quotas
Protection is the practice of shielding a
sector of the economy from foreign
competition.
A tariff is a tax on imports.
Export subsidies are government payments
made to domestic firms to encourage exports.
Closely related to subsidies is dumping. A
firm or industry sells products on the world
market at prices below the cost of production.
A quota is a limit on the quantity of imports.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

The Case for Free Trade


The case for free trade is based on the
theory of comparative advantage. When
countries specialize and trade based on
comparative advantage, consumers pay
less and consume more, and resources
are used more efficiently.
When tariffs and quotas are imposed,
some of the gains from trade are lost.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

The Case for Protection


Protection saves jobs
Some countries engage in unfair trade
practices
Cheap foreign labor makes competition
unfair
Protection safeguards national security
Protection discourages dependency
Protection safeguards infant industries
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair