Recall that the production possibilities curve for a particular country is determined by the factors of production and the technology available to it. New trade theory suggests that the ability of firms to gain economies of scale (unit cost reductions associated with a large scale of output) can have important implications for international trade 1. What developed countries trade with each other look very The key lies in the opportunity costs of the two goods in the two countries. Roadway’s production possibilities curve is given in Panel (a); it is the same one we saw in Figure 17.1 “Roadway’s Production Possibilities Curve” and Figure 17.2 “Measuring Opportunity Cost in Roadway”. These gains are, thus, of two types gain from exchange and gain from specialisation in production. Gains from international trade Define trade International trade is the exchange of goods and services between countries. Then use the graphs below to answer the following questions. Explain and illustrate the conditions under which two countries can mutually benefit from trading with each other. Suppose the equivalent amounts for Beta are 8,000 computers and 8,000 washing machines per month. So, from a policy perspective, it is important for the U.S. to promote trading policies that will keep this sector open. International trade leads countries to specialize in goods and services in which they have a comparative advantage. When trade began, factors of production shifted into boat production, in which Seaside had a comparative advantage. Different countries have different factor endowments eg climate, skilled labour force, and natural resources vary between nations. Figure 17.2 “Measuring Opportunity Cost in Roadway” shows the opportunity cost of producing boats at points A, B, and C. Recall that the slope of a curve at any point is equal to the slope of a line drawn tangent to the curve at that point. 9. Chapter 6 Economies of Scale and International Trade. In turn, consumers have responded to the prices charged by sellers of boats and trucks. Before the 1980s, China did not trade internationally: It was self-sufficient. Basis of International Trade A country specializes in a specific commodity due to mobility, productivity and other endowments of economic resources. International trade - International trade - Arguments for and against interference: Developing nations in particular often lack the institutional machinery needed for effective imposition of income or corporation taxes (see income tax). She predicts that, as the economies of our trading partners grow, their demand for services will also increase. Despite the fact that Roadway can produce more of both goods, it can still gain from trade with Seaside—and Seaside can gain from trade with Roadway. First, many noneconomists believe that it is more advantageous to trade with other members of one’s nation or ethnic group than with outsiders. Enhanced reputation. The fact that the opportunity costs differ between the two countries suggests the possibility for mutually advantageous trade. We have chosen points R3 and S3 at specific points, but any point along the tangent line that is up to the right from R1 and S1 would suffice to illustrate the fact that both countries can end up consuming more of both goods. We have learned that the absolute value of the slope of a production possibilities curve at any point gives the quantity of the good on the vertical axis that must be given up to produce an additional unit of the good on the horizontal axis. American Enterprise Institute 1789 Massachusetts Avenue, NW Washington, DC 20036 Main telephone: 202.862.5800 Main fax: 202.862.7177 The economic case has been a powerful force in moving the world toward freer trade. Perhaps a friend across the table offered to trade her bag of grapes for your stack of crackers. In 2019, international trade subtracted $576.8 billion from GDP. The production possibilities curve for a second hypothetical country, Seaside, is given in Panel (b). increases by area A + B; decreases by area B. Once trade between Roadway and Seaside begins, the terms of trade, the rate at which a country can trade domestic products for imported products, will seek market equilibrium. Surely agricultural goods represent an important comparative advantage for the United States. Other private services include such areas as education, financial services, and business and professional services. Notice that each country produces on its production possibilities curve, but international trade allows both countries to consume a combination of goods they would be incapable of producing! Get an answer for 'Countries gain from trade by producing: a. the goods they produce at the highest opportunity cost. Each will increase production of the good or service in which it has a comparative advantage up to the point where the opportunity cost of producing it equals the terms of trade. prices in the future, it could use policies which encourage the accumulation of oil inventories and minimize the potential for future adverse shocks. b. the goods they can produce at the lowest opportunity cost. Suppose two countries each produce two goods and their opportunity costs differ. That occurs at point B in Panel (a) of Figure 17.5 “International Trade Induces Greater Specialization”; Roadway now produces 7,000 trucks and 7,000 boats per year. Now look at the intersection of the production possibilities curves with the horizontal axes. Specifically, suppose that if Alpha devotes all its factors of production to computers, it is able to produce 10,000 per month, and if it devotes all its factors of production to washing machines, it is able to produce 10,000 per month. The country with a lower opportunity cost for a particular good or service has a comparative advantage in producing it and will export it to the other country. increases by area C + D; decreases by area C. These developed countries also are the ones who seem to gain the most from international trade. Here, the terms of trade are one truck in exchange for one boat. Contact. In Seaside, however, a truck could be exchanged for five boats. The essential point is that Roadway will produce more of the good—trucks—in which it has a comparative advantage. increased employment in the domestic export sector. Seaside’s curve is given in Panel (b). producers; the price of shoes falls, the quantity of shoes they sell decreases, and producer surplus decreases. This is a net economic gain after deducting the losses to firms and workers in the domestic industry. Politics of International Trade. Seaside could produce only 7,000 boats. How does Seaside fare? Suppose Roadway ships 2,500 trucks per year to Seaside in exchange for 2,500 boats, as shown in the table in Figure 17.6 “The Mutual Benefits of Trade”. Recently America’s comparative advantages lie in certain stages of the production process and in areas of the service sector. most trade is between countries at similar stages of de-velopment - countries with similar factor endowments and similar technologies. Seaside will produce more boats (and fewer trucks). Finally, note the fact that the two countries end up at C (Panel (a)) and C′ (Panel (b)). International trade promotes efficiency in production as countries will try to adopt better methods of production to keep costs down in order to remain competitive. Assume that no trade occurs between the two countries. The final terms of trade will be somewhere between one-half boats for one truck found in Roadway and five boats for one truck in Seaside. Seaside moves along its production possibilities curve to point B′, at which the slope equals −1. Now let us assume that trade opens up. Some truck producers in Seaside will be displaced as cheaper trucks arrive from Roadway. If Roadway concentrated all of its resources on the production of trucks, it could produce 10,000 trucks per year. By shipping their boats to Roadway, they can get two trucks for each boat. Chapter 1: Economics: The Study of Choice, Chapter 2: Confronting Scarcity: Choices in Production, 2.3 Applications of the Production Possibilities Model, Chapter 4: Applications of Demand and Supply, 4.2 Government Intervention in Market Prices: Price Floors and Price Ceilings, Chapter 5: Elasticity: A Measure of Response, 5.2 Responsiveness of Demand to Other Factors, Chapter 6: Markets, Maximizers, and Efficiency, Chapter 7: The Analysis of Consumer Choice, 7.3 Indifference Curve Analysis: An Alternative Approach to Understanding Consumer Choice, 8.1 Production Choices and Costs: The Short Run, 8.2 Production Choices and Costs: The Long Run, Chapter 9: Competitive Markets for Goods and Services, 9.2 Output Determination in the Short Run, Chapter 11: The World of Imperfect Competition, 11.1 Monopolistic Competition: Competition Among Many, 11.2 Oligopoly: Competition Among the Few, 11.3 Extensions of Imperfect Competition: Advertising and Price Discrimination, Chapter 12: Wages and Employment in Perfect Competition, Chapter 13: Interest Rates and the Markets for Capital and Natural Resources, Chapter 14: Imperfectly Competitive Markets for Factors of Production, 14.1 Price-Setting Buyers: The Case of Monopsony, Chapter 15: Public Finance and Public Choice, 15.1 The Role of Government in a Market Economy, Chapter 16: Antitrust Policy and Business Regulation, 16.1 Antitrust Laws and Their Interpretation, 16.2 Antitrust and Competitiveness in a Global Economy, 16.3 Regulation: Protecting People from the Market, Chapter 18: The Economics of the Environment, 18.1 Maximizing the Net Benefits of Pollution, Chapter 19: Inequality, Poverty, and Discrimination, Chapter 20: Macroeconomics: The Big Picture, 20.1 Growth of Real GDP and Business Cycles, Chapter 21: Measuring Total Output and Income, Chapter 22: Aggregate Demand and Aggregate Supply, 22.2 Aggregate Demand and Aggregate Supply: The Long Run and the Short Run, 22.3 Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium, 23.2 Growth and the Long-Run Aggregate Supply Curve, Chapter 24: The Nature and Creation of Money, 24.2 The Banking System and Money Creation, Chapter 25: Financial Markets and the Economy, 25.1 The Bond and Foreign Exchange Markets, 25.2 Demand, Supply, and Equilibrium in the Money Market, 26.1 Monetary Policy in the United States, 26.2 Problems and Controversies of Monetary Policy, 26.3 Monetary Policy and the Equation of Exchange, 27.2 The Use of Fiscal Policy to Stabilize the Economy, Chapter 28: Consumption and the Aggregate Expenditures Model, 28.1 Determining the Level of Consumption, 28.3 Aggregate Expenditures and Aggregate Demand, Chapter 29: Investment and Economic Activity, Chapter 30: Net Exports and International Finance, 30.1 The International Sector: An Introduction, 31.2 Explaining Inflation–Unemployment Relationships, 31.3 Inflation and Unemployment in the Long Run, Chapter 32: A Brief History of Macroeconomic Thought and Policy, 32.1 The Great Depression and Keynesian Economics, 32.2 Keynesian Economics in the 1960s and 1970s, 32.3. The terms of trade determine the extent to which each country will specialize. b) A country can only hurt itself by using government policies to promote exports. It sends 2,500 of those boats to Roadway, so it ends up with 3,500 boats per year. This stimulates a country to go for international trade. The slope of a line tangent to the production possibilities curve at point B, for example, is −1. Notice that the opportunity cost of an additional boat in Roadway is two trucks, while the opportunity cost of an additional boat in Seaside is 0.2 trucks. Before the 1980s, China did not trade internationally: It was self-sufficient. It neither exports nor imports goods and services. Their production possibilities curves are given in Figure 17.3 “Comparative Advantage in Roadway and Seaside”. This occurs at point B′; Seaside produces 3,000 trucks and 6,000 boats per year. Suppose the world consists of two countries, Alpha and Beta. Use them to sketch curves of a typical shape. 2/ b. Before trade, truck producers in Roadway could exchange a truck for half a boat. Explain and illustrate the mutual benefits of trade. That transition will be completed when the two countries are back on their respective production possibilities curves. We have so far assumed that no trade occurs between Roadway and Seaside. Imagine for a moment how your household would fare if it had to produce every good or service it consumed. For one household, that may be landscaping, for another, it may be the practice of medicine, for another it may be the provision of childcare. People participate in international trade because they make themselves better off by doing so. Similarly, Seaside will specialize more in boat production. People or entities trade because they believe that they benefit from the exchange. 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