Topic 10 Chapter 13

ECON101: Introductory
Microeconomics
Topic 10
International Trade
Essential reading:
Hubbard et al. (2017), Microeconomics, 4th edition,
Pearson Education Australia,
Chapter 13
ECON101: Introductory
Microeconomics
These powerpoint slides are a modified version
of the slides that form part of the teaching
resources provided by Pearson Australia with
the text book
Copyright ©2018 Pearson Australia (a division

of Pearson Australia Group Pty Ltd) –
9781488612497/Hubbard/Microeconomics/4th
edition
Chapter 13
Comparative
advantage and the
gains from
international trade
Learning objectives
1. Discuss the role of international trade in the Australian economy.
2. Explain the difference between comparative advantage and

absolute advantage in international trade.
3. Explain how countries gain from international trade.
4. Analyse the economic effects of government policies that restrict

international trade.
5. Evaluate the arguments over trade policy and globalisation.
4 Copyright ©2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd)–9781488612497/Hubbard/Microeconomics/4e
Motor vehicle tariffs reduce jobs
In Australia, the car industry was

under heavy tariff protection in
earlier decades.
A tariff is a tax imposed by the
government on imported goods that
makes the goods more expensive
and less competitive on domestic
markets.
An overview of international trade
International trade has grown enormously over the past 50 years.
 Exports: Goods and services produced domestically but sold to

other countries.
 Imports: Goods and services bought domestically but produced in

other countries.
 Tariff: A tax imposed by a government on imported goods.
Top 10 leading exporters in world merchandise
trade and Australia, 2014: Figure 13.1a
Source: Derived from the World Trade Organization (2016), International Trade Statistics, 2014, Table A6, at <www.wto.org>.
Top 10 leading exporters in world commercial
services and Australia, 2014: Figure 13.1b
Source: Derived from the World Trade Organization (2016), International Trade Statistics, 2014, Table A8, at <www.wto.org>.
The importance of trade to the
Australian economy (Cont’d)
 Exports and imports as a proportion of GDP have been increasing
over time in Australia.
 In 2016, exports by sector as a proportion of total exports were:

Mining: 43%
Services: 23%
Manufacturing: 14%
Agriculture: 14%
(Note: Percentages do not sum to 100% due to non-sectoral categories

such as non-monetary gold and goods procured in ports by carriers.)
Exports and imports as a percentage of GDP,
Australia, 1960-2016: Figure 13.2
Source: Derived from the Australian Bureau of Statistics (2016), ‘Australian national accounts: National income, expenditure and product’, Cat. No. 5206.0, Table 3, Time
Series Workbook, at www.abs.gov.au, viewed 1 July 2016.
The importance of trade to the
Australian economy (Cont’d)
Australian international trade in a world context
 International trade as a proportion of GDP is less important to

Australia than many European countries, but more important than in
the USA or Japan.
 In 2014, Australia’s exports and imports were each close to 20% of

GDP as compared to Singapore and Hong Kong where exports and
imports each comprise close to or more than 200% of GDP.
 Open economy: An economy that has interactions in trade or

finance with other economies.
International trade as a percentage of GDP,
2014: Figure 13.3
Sources: Derived from the World Bank (2016), ‘Data - Indicators’, Exports of goods and services (per cent of GDP); Imports of goods and services (per cent of GDP), at
<http://data.worldbank.org>.
Has offshoring hurt the Australian economy?
Making the Connection 13.1 There is at times a fear that

offshoring will result in higher
unemployment in Australia, but
there is no evidence to support
this.
 The number of jobs lost due
to offshoring is small relative
to the size of the economy.
 Offshoring is largely beneficial
to consumers and users of the
outsourced services due to
their lower cost.
 Jobs lost to offshoring are
often replaced by jobs growth
in other sectors of the
economy.
Comparative advantage in
international trade
 Comparative advantage: The ability of an individual, firm or

country to produce a good or service at a lower opportunity cost
than other producers.
 Opportunity cost: The highest-valued alternative that must be
given up to engage in an activity.
 Absolute advantage: The ability of an individual, firm or country
to produce more of a good or service than competitors when using
the same amount of resources.
An example of Japanese workers being more
productive than Chinese workers: Table 13.1
OUTPUT PER HOUR OF WORK
SMARTWATCHES TABLET COMPUTERS
JAPAN 12 6
CHINA 2 4
The opportunity cost of producing smart watches

and tablet computers: Table 13.2
OPPORTUNITY COSTS
JAPAN 0.5 tablet computer 2 smart watches
CHINA 2 tablet computers 0.5 smart watches
How countries gain from
international trade
 Autarky: A situation in which a country does not trade with

other countries.
Production without trade: Table 13.3
PRODUCTION AND CONSUMPTION

JAPAN 9000 1500
CHINA 1500 1000
international trade (Cont’d)
Increasing consumption through trade
 Terms of trade: The amount of imports that can be purchased per

unit of exports.
 Countries gain from specialising in producing and exporting goods in

which they have a comparative advantage and importing goods in
which other countries have a comparative advantage.
The gains from trade for Japan and China: Table
13.4
Why don’t we see complete specialisation?
1. Not all goods and services are traded internationally: Even if, for
example, Australia had a comparative advantage in the production
of medical services, it would be difficult for Australia to specialise
in their production and export them. There is no easy way for
British patients in need of appendectomies to receive them from
Australian surgeons.
2. Production of most goods involves increasing opportunity costs:

For example, when China devotes more workers to producing
tablets, the opportunity cost of producing more tablets will
increase. At some point, the opportunity cost of producing tablets
in China will rise to the level of the opportunity cost of producing
tablets in Japan. Once that happens, international trade will no
longer push China further towards complete specialisation.
Why don’t we see complete specialisation? (cont’d)
3. Tastes for products differ: Most products are differentiated.

Smartwatches, tablets, cars etc. come with a wide variety of
features. For example, when buying cars, some people are looking
for reliability and fuel efficiency, others are looking for room to carry
seven passengers, and still others want styling and high
performance.
So some car buyers prefer Toyota Corollas, some prefer Hyundai
iMax people movers, and others prefer Mercedes-Benz E-class cars.
Does anyone lose as a result of international trade?
 Industries in which a country does not have a comparative

advantage are reduced in size or cease to operate due to
specialisation in other industries, leaving some entrepreneurs and
workers unemployed.
 The net effect on employment and output is positive due to

specialisation and free trade.
Where does comparative advantage come from?
Among the main sources of comparative advantage are the following:

1. Climate and natural resources: For example because of
geology, Saudi Arabia has a comparative advantage in the
production of oil and Australia has a comparative advantage in
the production of minerals and natural gas.
2. Relative abundance of labour and capital: For example,

Australia, have many highly skilled workers and a great deal of
capital as compared to Indonesia;as a result, Australia has a
comparative advantage in the production of goods and services
such as financial services and mining, while Indonesia has a
comparative advantage in the production of goods that require
low-skilled workers and small amounts of simple machinery,
such as clothing and footwear.
Where does comparative advantage come from? (cont’d)

3. Technology: Some countries are strong in product technologies,
which involve the ability to develop new products. For example,
firms in the United States have pioneered the development of
products as computers, aircraft and many prescription drugs.
In Australia, well-known product developments include
mechanical refrigeration plants, the black box flight recorder,
ultra-sound, scanners, Wifi and a number of vaccines.
Where does comparative advantage come from? (cont’d)
4. External economies: It is difficult to explain the location of

some industries on the basis of climate, natural resources, the
relative abundance of labour and capital or technology. For
example, why does Mumbai have a comparative advantage in
making Bollywood movies or Sydney in providing financial
services? The answer is that once an industry becomes
established in an area, firms that locate in that area gain
advantages over firms located elsewhere.
External economies is also known as agglomeration economies.
Solved Problem 1
The gains from trade
The first discussion of comparative advantage appears in On the

Principles of Political Economy and Taxation, a book written by one
of the founding economists, David Ricardo, in 1817.
Ricardo provided a famous example of the gains from trade using
wine and cloth production in Portugal and England. The following table
is adapted from Ricardo’s example, with cloth measured in sheets and
wine measured in kegs:
Solved Problem 1
a) Explain which country has an absolute advantage in the production

of each good.
b) Explain which country has a comparative advantage in the

production of each good.
Solved Problem 1
c) Suppose that Portugal and England currently do not trade with

each other. Each has one year of labour to use producing cloth
and wine, and the countries are currently producing the amounts
of each good shown in the following table.
Show that Portugal and England can both gain from trade.
Assume that the terms of trade are that one sheet of cloth can be
traded for one keg of wine.
Solved Problem 1
Solving the problem:

STEP 1: Review the chapter material. This problem is about absolute
and comparative advantage and the gains from trade, so you
may want to review the section ‘Comparative advantage in
international trade’, and the section ‘How countries gain from
international trade’.
STEP 2: Answer question a) by determining who has an absolute

advantage. A country has an absolute advantage over another
country when it can produce more of a good using the same
resources. The table shows that Portugal can produce more
cloth and more wine with one year’s worth of labour than
England can. Thus, Portugal has an absolute advantage in the
production of both goods and England does not have an
absolute advantage in the production of either good.
Solved Problem 1
STEP 3: Answer question b) by determining which country has a

comparative advantage.
A country has a comparative advantage when it can produce
a good at a lower opportunity cost. To produce 100 sheets of
cloth, Portugal must give up 150 kegs of wine. Therefore, the
opportunity cost to Portugal of producing one sheet of cloth is
150/100, or 1.5 kegs of wine. England has to give up60 kegs
of wine to produce 90 sheets of cloth, so its opportunity cost
of producing one sheet of cloth is 60/90, or 0.67 keg of wine.
Solved Problem 1
STEP 3: (cont’d)
The opportunity cost of producing wine can be calculated in the same
way. The following table shows the opportunity cost to Portugal
and England of producing each good.
Portugal has a comparative advantage in wine because its opportunity

cost is lower. England has a comparative advantage in cloth
because its opportunity cost is lower.
Solved Problem 1
STEP 4: Answer question c) by showing that both countries can

benefit from trade. By now it should be clear that both
countries would be better off if they specialise where they
have a comparative advantage and trade for the other
product. The following table shows one example of trade
making both countries better off.
Solved Problem 1
STEP 4: cont.
Government policies that restrict
international trade
 Free trade: Trade between countries that is without government

restrictions.
 Free trade can lead to cheaper imported production inputs, improved

resource allocation and lower prices for domestic consumers.
 Lower production costs increase firms’ profitability, and lower prices

increase consumers’ purchasing power. Both of these effects can
increase domestic employment.
The Australian timber industry under autarky:
Figure 13.4
Price (dollars
per cubic metre) Consumer
surplus
Supply
$30
Producer
surplus Demand
0 1 000 000 Quantity (cubic metres)
The effect of imports on the Australian timber
market: Figure 13.5
Under
With imports
Price autarky
(dollars per Consumer surplus A A+B+C+D
cubic metre)
Producer surplus B+E E
Economic surplus A+B+E A+B+C+D+E
Australian
supply
A
F
$30
B G
C D World price
20
E
Imports Australian
demand
0 700 000 1 000 000 1 200 000 Quantity (cubic metres)

Tariffs
 Tariffs are the most common form of interference with free trade.
 Like any other tax, a tariff will increase the cost of selling a good.
 Tariffs reduce consumer surplus and lead to a deadweight loss.
 Tariffs increase producer surplus and generate revenue for the
government.
The effects of a tariff on timber: Figure 13.6
Loss of = Increase in + Government + Deadweight
consumer producer tariff revenue loss
surplus surplus
Price (dollars A+B+C+D A C B+D
per cubic Australian supply

metre)
Australian price =
world price + tariff
F
$25
A B C D World price
E
20
Australian demand
Quantity 0
supplied by 700 000 900 000 1 100 000 1 200 000 Quantity (cubic metres)
Australian
firms Australian timber consumption
Quotas
 Quota: A numerical limit imposed by the government on the

quantity of a good that can be imported into a country.
 Voluntary export restraint: An agreement negotiated between

two countries that places a numerical limit on the quantity of a
good that can be imported by one country from the other country.
 The effects of a quota are similar to that of a tariff.
The effect of the US sugar quota: Figure 13.7
Loss of consumer = Gain by US + Gain to foreign + Deadweight
surplus sugar producers sugar producers loss
A+C+B+D A B C+D
$3.26 billion = $1.71 billion + $0.90 billion + $0.65 billion
Price US supply
(dollars per
pound)
Sugar quota of 6.9
billion pounds
$0.33 US
price of sugar F
A B
$0.20 World C D E
price of sugar
US demand
0 9.2 17.1 24.0 26.1 Quantity of sugar
Quantity supplied by (billions of pounds)
39
US firms US sugar consumption
Gains from unilateral elimination of tariffs and quotas
 Countries gain from the reduction of their own tariffs and quotas
even if other countries do not reduce their tariffs and quotas.
Domestic support policies
 Price floor: A legally determined minimum price that sellers may

receive, which is usually above the free market equilibrium price.
 Price floors and other domestic subsidy policies increase domestic
production and can lead to domestic surpluses, the surplus of
which is often sold on international markets, driving world prices
lower than they would otherwise be.
 This reduces trade opportunities for non-protected and developing
countries.
Other barriers to trade
 Health and safety requirements.

• If a government imposes stricter requirements on imported
goods than on domestically produced goods, then this is a
barrier to trade.
 Import restrictions on national security grounds.
The arguments over trade policies
and globalisation
 During the Great Depression of the 1930s, many countries raised

tariffs in a mistaken attempt to protect domestic employment.
 This led to the collapse of international trade.
 World Trade Organization (WTO): A global organisation dealing
with the rules of trade between member countries, which aims to
achieve multilateral tariff reductions and a freer world trading
environment.
• The WTO has over 160 member countries.
 The WTO works toward reducing tariffs and increasing free trade.
and globalisation (Cont’d)
Why do some people oppose the World Trade Organization?
 Globalisation: The process of countries becoming more open to

foreign trade and investment, and a trend towards a more
integrated global system.
 Anti-globalisation: Some people believe that free trade and foreign

investment destroy the distinctive cultures of many countries,
create environmental and health problems, and can lead to the
exploitation of workers.
The unintended consequences of banning goods
made with child labour
Making the Connection 13.2
In many developing countries, the use of
child labour is common. Many people
supported banning and boycotting goods
imported from countries where child
labour is used.
Unfortunately, very often there are no
better alternatives to export-oriented
work. Lack of teachers and resources
mean that schools are not available
within a reasonable distance or only run
for a few months a year. Poor families
often cannot afford to send children to
school and rely on their income to obtain
basic foods. As such, export-oriented jobs
are usually less hazardous and better
paid.
Why do some people oppose the World Trade Organization?
(cont’d)
‘Old-fashioned’ protectionism
 Protectionism: The use of trade barriers to shield domestic
companies from foreign competition.
 Protectionism is usually (and often mistakenly) justified on the basis
of the following arguments:
• Saving jobs.
• Protecting high wages.
• Protecting infant industries.
• Protecting national security.
Dumping
 Dumping: Selling a product for a price below its cost of production.

• Usually referred to in the context of when a country sells a
product on international markets for a price below its cost of
production.
 Although controversial, the WTO will allow tariffs to be imposed to

offset the effects of dumping.
Radical environmentalism
 Argument that trade restrictions should be put in place against
countries who lack environmental protection laws.
• Poorer countries tend to lack these laws; therefore, the WTO
does not support this approach.
• WTO recommends maintaining trade, and wealthier countries

offering financial and practical assistance to help improve
production techniques and enforce environmental standards.
Radical environmentalism (cont’d)

 Argument that free trade increases carbon dioxide emissions due to
the transportation of goods and services around the world.
• Transportation emissions are only part of total production
emissions.
• Lower total emissions could occur if production occurred in
efficient markets and trade took place.
• As with all economic activities, transport should occur up to the
point where the marginal social benefit is equal to the marginal
social cost.
Positive versus normative analysis
 All interferences with free trade make some people worse off (e.g.
consumers), some people better off (e.g. the protected producers),
and reduces total income and consumption.
 Positive analysis: The reduction in economic efficiency from a tariff or
quota can be measured.
 Normative analysis: Whether a tariff or quota is bad public policy and
should be eliminated is a normative decision.
An inside look
Figure 1: The market for milk in China with and without the tariff on
Australian milk.
Key terms
Absolute advantage Opportunity cost

Autarky Price floor
Comparative advantage Protectionism
Dumping Quota
Exports Tariff
External economies Terms of trade
Free trade Voluntary export restraint
Globalisation World Trade Organization (WTO)
Imports Open economy

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ECON101: Introductory

Copyright ©2018 Pearson Australia (a division

1. Discuss the role of international trade in the Australian economy.

2. Explain the difference between comparative advantage and

3. Explain how countries gain from international trade.

4. Analyse the economic effects of government policies that restrict

5. Evaluate the arguments over trade policy and globalisation.

In Australia, the car industry was

International trade has grown enormously over the past 50 years.

 Exports: Goods and services produced domestically but sold to

 Imports: Goods and services bought domestically but produced in

 Tariff: A tax imposed by a government on imported goods.

 In 2016, exports by sector as a proportion of total exports were:

(Note: Percentages do not sum to 100% due to non-sectoral categories

 International trade as a proportion of GDP is less important to

 In 2014, Australia’s exports and imports were each close to 20% of

 Open economy: An economy that has interactions in trade or

Making the Connection 13.1 There is at times a fear that

 Comparative advantage: The ability of an individual, firm or

The opportunity cost of producing smart watches

 Autarky: A situation in which a country does not trade with

Production without trade: Table 13.3

PRODUCTION AND CONSUMPTION

Increasing consumption through trade

 Terms of trade: The amount of imports that can be purchased per

 Countries gain from specialising in producing and exporting goods in

2. Production of most goods involves increasing opportunity costs:

3. Tastes for products differ: Most products are differentiated.

 Industries in which a country does not have a comparative

 The net effect on employment and output is positive due to

Among the main sources of comparative advantage are the following:

2. Relative abundance of labour and capital: For example,

Among the main sources of comparative advantage are the following:

Among the main sources of comparative advantage are the following:

4. External economies: It is difficult to explain the location of

The first discussion of comparative advantage appears in On the

a) Explain which country has an absolute advantage in the production

b) Explain which country has a comparative advantage in the

c) Suppose that Portugal and England currently do not trade with

Solving the problem:

STEP 2: Answer question a) by determining who has an absolute

STEP 3: Answer question b) by determining which country has a

Portugal has a comparative advantage in wine because its opportunity

STEP 4: Answer question c) by showing that both countries can

 Free trade: Trade between countries that is without government

 Free trade can lead to cheaper imported production inputs, improved

 Lower production costs increase firms’ profitability, and lower prices

0 1 000 000 Quantity (cubic metres)

0 700 000 1 000 000 1 200 000 Quantity (cubic metres)

per cubic Australian supply

 Quota: A numerical limit imposed by the government on the

 Voluntary export restraint: An agreement negotiated between

 The effects of a quota are similar to that of a tariff.

Gains from unilateral elimination of tariffs and quotas

Domestic support policies

 Price floor: A legally determined minimum price that sellers may

Other barriers to trade

 Health and safety requirements.

 Import restrictions on national security grounds.

 During the Great Depression of the 1930s, many countries raised

Why do some people oppose the World Trade Organization?

 Globalisation: The process of countries becoming more open to

 Anti-globalisation: Some people believe that free trade and foreign

 Dumping: Selling a product for a price below its cost of production.