Free Trade Theory Why Nations Trade Basics of

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Free Trade Theory Why Nations Trade

Free Trade Theory Why Nations Trade

Basics of Trade • Defined: 2 Countries engage in economic activity • Exports: goods/services

Basics of Trade • Defined: 2 Countries engage in economic activity • Exports: goods/services leave country • Imports: goods/services enter country • Trade Surplus: Export more than import • Trade Deficit: Import more than export

Why Trade?

Why Trade?

Ways to Limit Trade • Tariffs– taxes on imports • Quotas- limits on quantity

Ways to Limit Trade • Tariffs– taxes on imports • Quotas- limits on quantity imported • Protectionism: Gov’t policy which seeks to limit trade • Globalization: the “global” movement towards free trade – Trade without Tariffs & Quotas – free market capitalism on a global scale

Adam Smith • In his 1776 book Wealth of Nations, Adam Smith talked about

Adam Smith • In his 1776 book Wealth of Nations, Adam Smith talked about specialization

Adam Smith on Specialization When each worker made their own pins, they produced 20

Adam Smith on Specialization When each worker made their own pins, they produced 20 pins per day each Adam Smith noted that when each worker specialized in a production stage, the output by the factory increased to 4, 800 pins per worker (Page 11, Wealth of Nations) Also known as Division of Labor

Specialization works! Idaho Florida Texas Nevada + Any illegal activity you can think of…

Specialization works! Idaho Florida Texas Nevada + Any illegal activity you can think of…

David Ricardo • In his 1816 book David Ricardo developed the free trade theory

David Ricardo • In his 1816 book David Ricardo developed the free trade theory based on comparative advantage • Absolute Advantage: when a country can produce a good more efficiently – produce a good using fewer resources • Comparative Advantage: when a country can produce a good at a lower opportunity cost – country gives up less when they produce a good

Ricardo’s Trade Theory Here is my great theory! ØCountries should produce (specialize) in goods

Ricardo’s Trade Theory Here is my great theory! ØCountries should produce (specialize) in goods where they have a comparative advantage ØTrade benefits both parties (each country gets “more”) ØFree Trade promotes a more “efficient” world economy ØAbsolute Advantage is not relevant in deciding which country should produce a good