Trade I Absolute Comparative Advantage i Theory of

Trade

I. Absolute & Comparative Advantage i. Theory of Comparative Advantage: developed by David Ricardo- he stated that a trading nation should produce a certain product if it can do so at an opportunity cost lower than that of another trading nation. a. The old view of international trade was absolute advantage: the ability of one trading nation to make a product more efficiently than another trading nation. i. If Portugal could make grape juice more efficiently than England, and if England could make cloth more efficiently than Portugal, then trade would be beneficial to both. ii. Ricardo challenged this view-what if Portugal made both products more efficiently than England? Would trade still be beneficial? He said yes- all based on opportunity cost.

iii. For Portugal, every yard of cloth costs 3 jugs of grape juice in lost opportunity. iv. In England, every yard of cloth costs only 2 jugs of grape juice. 1. Portugal would be wise to buy cloth from England to specialize in grape juice. c. Comparative Advantage: the idea that a nation will specialize in what it can produce at a lower opportunity cost than any other nation.

II. Regional & World Trade Organizations i. Since the 1930 s, nations have sought to expand trade and reduce or eliminate trade barriers. Organized themselves into groups. a. European Union i. 20% of global trade exports & imports—world’s biggest trader. ii. Established monetary union- all use the Euro. iii. Removed barriers to free trade among member nations. 1. Ultimate goal it have Europe’s national borders are free as the borders of the US states.

b. NAFTA- North American Free Trade Agreement i. 1990 - free trade between US, Mexico & Canada ii. In 1994 it eliminated tariffs in half of the goods exported to Mexico from the US. c. WTO- World Trade Organization i. In 1944 Allied Nations met to make plans after WWII. They produced GATTGeneral Agreement on Tariffs & Trade- which laid out rules and policies for international trade. Developed into WTO- now has 150 nations ii. Purposes of WTO: 1. Negotiating & administering trade agreements 2. Resolving trade disputes 3. Monitoring trade policies of member nations 4. Providing support to developing countries.

III. Trade Barriers- def: any law passed to limit free trade among nations. 5 types a. Almost all nations pass some sort of laws that limit trade. i. Lead to higher prices on restricted items ii. Economic retaliation by other nations iii. Basically political in nature b. Quotas: limits on the amount of a product that can be imported. i. The US has a quota on the amount of textiles allowed to be imported. They limit supply and keep textile prices relatively high

c. Tariffs: a fee charged for goods brought into a country from another country. 2 types: i. Revenue tariffs: taxes on imports specifically to raise money-rarely used. ii. Protective tariff: a tax on imported goods to protect domestic goods. 1. Raise prices on goods produced more cheaply elsewhere, which minimizes the price advantage the imports have over domestic goods. d. Voluntary Export Restraint: a country’s self-imposed restriction on exports. e. Embargoes: a law that cuts off trade with a specific country. Used often for political purposes. US & Cuba. f. Informal Trade Barriers: indirect—licenses, environmental regulations and health and safety measures.

IV. Impact of Trade Barriers a. Higher Prices & Trade Wars V. Arguments for Protectionism a. Protecting Domestic Jobs b. Protecting infant or start up industries c. Protecting national security VI. Foreign Exchange a. Foreign exchange market: where currencies of different countries are bought and sold. The exchange rate is the price of currency in the currencies of other nations. b. Flexible rate of exchange: a system in which the exchange rate for currency changes as supply & demand for the currency changes. c. The Fed keeps track of the international value of the dollar. They determine if the dollar is strong or weak as measured against another currency.