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CHAPTER 8| ComparativeAdvantage
and the Gains fromInternational Trade
SOLUTIONS TO END-OF-CHAPTER EXERCISES
Answers to Thinking CriticallyQuestions
1. Although trade can create job losses for certain groups in the economy, it benefits the entire economyas a whole. Expanding trade raises living standards by increasing consumption and economic efficiency,
so reducing tariffs on trade between other countries and the United States will aid consumers in these
countries and in the United States. Reducing tariffs will transfer producer surplus to consumer surplus and
deadweight loss to consumer surplus. Also, it will convert government tariff revenue to consumer surplus.
Eliminating the tariffs will reduce the costs to foreign producers of selling their products in the United
States, and U.S. consumers will purchase a larger quantity of these products at lower prices.
2. Other countries have a comparative advantage in the production of steel, otherwise we would not be
importing steel and restricting such imports. The U.S. has a comparative advantage in the production of
heavy construction and mining equipment and aircraft.
8.1
The United States in the International EconomyLearning Objective: Discuss the role of international trade in the U.S.economy.
Review Questions
1.1 Since the early 1980s, the value of U.S. exports has been smaller than the value of U.S. imports.
In 2008, U.S. exports were about 13 percent of GDP, and U.S. imports were about 16 percent of GDP.
1.2 Although the United States is the worlds leading exporter, Figure 8-3 shows that exports and
imports as a share of total output (GDP) are smaller for the United States than for most other
industrialized countries. Because the United States has a large and diverse economy, the gains fromtrading with other economies probably arent as great as they would be if the United States were smaller
and less diversified, such as Belgium or South Korea.
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173 CHAPTER 8| Comparative Advantage and the Gains from International Trade
Problems and Applications
1.3 Agriculture would see a large decline, as would certain manufacturing industries, such as
computers and software. Many service industries, such as haircuts and medical services, would not be
affected much because the United States does not export services of these types.
1.4 You should disagree. As Figure 8-3 shows, Japan is the only high-income country that is less
dependent on international trade than is the United States in terms of share of GDP that is exported.
1.5 Preferences for domestic producers refers to purchasing products made in your own country, as
opposed to purchasing imported products, and can be the result of tariffs or other trade restrictions on
imported products. These preferences would put U.S. firms at a competitive disadvantage because other
countries will concentrate on purchasing products from domestic firms and not U.S. firms. Over half of
all Caterpillar sales are outside the United States. As a producer of heavy machinery, having difficulty
making sales in countries experiencing significant levels of real growth where heavy machinery is in
demand, such as China and India, could have a large negative impact on its overall sales levels and its
profitability.
8.2Com arative Advanta e in International TradeLearning Objective: Understand the difference between comparativeadvantage and absolute advantage in international trade.
Review Questions
2.1 Comparative advantage is the ability of an individual, business, or country to produce a good or
service at the lowest opportunity cost. It is powerful because it runs counter to most peoples intuition that
trade is based on absolute advantage. Applying the principle of comparative advantage allows us to
analyze which products countries tend to export and which they tend to import. It also allows us to see the
immense gainsto rich and poor alikethat can be generated from trading.
2.2 Absolute advantage is the ability to produce more of a good or service than competitors using the
same amount of resources. Comparative advantage is the ability to produce a good or service at a lower
opportunity cost than other producers. A country will often import goods in which it has an absoluteadvantage. For example, the United States could produce textilessuch as sheets and towelswith fewer
resources than can China, but China can produce these goods at a lower opportunity cost than the United
States. Importing textile products from China frees up resources with which the United States can produce
other goods in which it has a comparative advantage.
Problems and Applications
2.3 The goods that countries import and export change over time because the goods in which they
have a comparative advantage change over time.
2.4 The argument does not make sense because Bolivia must have a comparative advantage in
producing at least one good. Remember that comparative advantage compares opportunity costs of
producing goods between two countries. If the United States has a lower opportunity cost in one good,
then it must have a higher opportunity cost in some other good, which would give Bolivia the
comparative advantage in producing the other good.
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CHAPTER 8| Comparative Advantage and the Gains from International Trade 174
2.5 Although workers in the United States produce more output per hour than workers in Japan,
indicating that the United States has an absolute advantage in production, Japan must be able to produce
products it exports to the United States at a lower opportunity cost than could the United States. This
gives Japan a comparative advantage in producing those products it exports to the United States.
2.6 By importing textile products from China, the United States isnt surrendering its more
efficient industry. The textile industry in the United States isnt more efficient than the textile industry inChina. U.S. textile firms produce their goods at a higher opportunity cost than do the corresponding firms
in China. By moving resources out of the textile industry, the United States can do even betterfreeing
up these resources to produce the goods in which it has the comparative advantage and using this output
to trade for goods that can be produced at a lower opportunity cost elsewhere. A country increases its
income by specializing in products where it has a comparative advantage, even if this means giving up
production of products where it has an absolute advantage, but not a comparative advantage.
2.7 Obama was referring to products being produced in countries that have a comparative advantage
in the production process. Comparative advantage refers to the ability of an individual, a firm, or a
country to produce a good or service at a lower opportunity cost than competitors. Based on comparativeadvantage, some jobs in the United States will be lost to countries that have lower opportunity costs in
producing certain products and services. If T-shirts can be produced at a lower opportunity cost in anothercountry, then it makes economic sense for T-shirts to be produced in that country. Although an individual
who loses his job as a result of production from another country may be justifiably upset and prefer to paya higher price for a product to keep production at home, consumers in general are better off by purchasing
products from countries that have a comparative advantage, as this will allow resources in the United
Stated to be more efficiently allocated to products and services in which the United States has a
comparative advantage.
8.3How Countries Gain from International TradeLearning Objective: Explain how countries gain from international trade.
Review Questions
3.1 International trade increases a countrys consumption because it allows the country to specialize
in the goods and services that it can produce at the lowest opportunity cost and trade for goods and
services for which it has a higher opportunity cost.
3.2 Complete specialization would mean producing only one good. It is not typical for a country to
completely specialize because not all goods and services are traded internationally. The production of
most goods involves increasing opportunity costs, which means that before complete specialization is
reached, a country may have lost its comparative advantage in producing a good. Finally, tastes for
products differ across countries, so different countries may have comparative advantages in different
varieties of the same good.
3.3 The main sources of comparative advantage include climate and natural resources, the relative
abundance of various types of labor and capital, technology and know-how, and external economies
reductions in a firms costs that result from an expansion in the size of the industry.
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175 CHAPTER 8| Comparative Advantage and the Gains from International Trade
Problems and Applications
3.4 a. A country has an absolute advantage over another country when it can produce more of a good
using the same resources. Chile has an absolute advantage in the production of both hats and
beer because it can produce more of both goods (8 hats; 6 barrels of beer) than can Argentina
(1 hat; 2 barrels of beer) with the same amount of labor input.
b. A country has a comparative advantage when it can produce a good at a lower opportunity
cost. To produce 8 hats, Chile must give up 6 barrels of beer. Therefore the opportunity cost to
Chile of producing 1 hat is 6/8, or 0.75 barrels of beer. Argentina must give up 2 barrels of
beer to produce 1 hat, so its opportunity cost of producing 1 hat is 2 barrels of beer. Chile has a
comparative advantage in the production of hats because its opportunity cost is lower. To
produce 6 barrels of beer, Chile must give up 8 hats, so its opportunity cost of producing 1
barrel of beer is 8/6, or 1.33 hats. Argentina must give up 1 hat to produce 2 barrels of beer, so
its opportunity cost of producing 1 barrel of beer is 0.5 hats. Argentina has a comparative
advantage in the production of beer because its opportunity cost is lower.
c. As was shown in part b, Chile should specialize in producing hats, and Argentina should
specialize in producing beer. By specializing, Chile can produce 8,000 hats (1,000 labor hours
8 hats), and Argentina can produce 2,000 barrels of beer (1,000 labor hours 2 barrels ofbeer). If Chile trades 700 hats to Argentina for 700 barrels of beer, the countries will end up
with:
Hats BeerChile 7,300 700Argentina 700 1,300
Both countries are better off than they were before specializing and engaging in trade.
3.5 The commentator is confusing absolute advantage and comparative advantage. Absolute
advantage is the ability to produce more of a good or service than competitors when using the same
amount of resources. Comparative advantage is the ability of an individual, a firm, or a country to
produce a good or service at a lower opportunity cost than competitors. Every country, no matter howpoor, will have a comparative advantage in producing some good. (Often countries are poor because they
cannot or will not trade with others.)
3.6 The opportunity cost of producing one good is the amount of the other good that has to be given up.
To produce 1 cell phone, Japan must give up 0.5 digital music players. To produce one digital music player,
Japan must give up 2 cell phones. To produce one cell phone, the United States must give up 2 digital music
players. To produce 1 digital music player, the United States must give up 0.5 cell phones.
3.7 As explained in the text, this statement is correct. Production of most goods and services involves
increasing opportunity costs.
3.8 Free trade probably benefits smaller countries more because without trade it would be difficult forproducers in these countries to benefit from external economies and economies of scale. Also, larger,more populous countries are likely to have a wider range of both natural resources and people with
particular skills, so these countries can gain significantly from internal trade, but this is less likely in
smaller countries.
3.9 Although middle- and lower-income Americans may be losing jobs or receiving lower wages due
to cheaper overseas labor, this same group benefits the most from the increased buying power the imports
from low income countries generate. Lower-income consumers spend a bigger percentage of income on
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CHAPTER 8| Comparative Advantage and the Gains from International Trade 176
manufactured goods than do higher-income consumers. Because the prices of manufactured goods are
often affected by free trade, lower-income consumers benefit the most from the low prices resulting from
free trade.
3.10 Trade allows a country to specialize in producing the goods in which it has a comparative
advantage. After trading, the country can consume more. In this sense it can produce more with less and
consumers win. See Table 8-4 in the textbook for a good example of trade leading to gains for consumers.
3.11 Free trade is trade without tariffs, quotas, or other limitations on imports or exports. When a
country practices free trade, economic efficiency and the income of the average person both increase. But
some firms and those who work for them will lose, as lower priced imports drive them out of business.
Most Americans think about these adverse effects more than about the large net gains from trade.
3.12 While society as a whole benefits, not everyone wins from expanding international trade. Some
domestic suppliers and their workers lose if they are driven out of the market (and into new markets) by
lower-priced imports.
3.13 A movie studio in Southern California can take advantage of the availability of skilled workers,
the opportunity to interact with other movie studios, and being close to suppliers. Economists refer tothese advantages as external economies.
8.4Government Policies That Restrict International TradeLearning Objective: Analyze the economic effects of government policiesthat restrict international trade.
Review Questions
4.1 A tariff is a tax imposed by the government on imports. A quota is a numerical limit imposed by
the government on the quantity of a good that can be imported. Non-tariff barriers include governmentalrulesfor example, health or safety regulationsthat favor domestic firms over foreign firms.
4.2 The winners from tariffs are domestic producers and the government. The losers are domestic
consumers and domestic firms that use as an input the product that is protected by the tariff or quotaas,
for example, the U.S. candy industry loses as a result of the U.S. sugar quota. The winners from quotas
are domestic producers and whoever holds the import license. The losers, again, are domestic consumers.
Problems and Applications
4.3 Fighting protectionism refers to governments resisting the implementation of tariffs, quotas,
and non-tariff barriers to protect domestic industries. Populist policies refer to policies supported by,
and designed to promote the rights and beliefs of, the common people. Adopting populist policies, in thiscase, the desire to enact protectionist policies to protect domestic industries, are not aligned with the
concept of comparative advantage and would result in higher prices, lower consumption, and reducedefficiency, all of which would reduce economic growth and therefore prolong the recession.
4.4 In this context, economic nationalism refers to using tariffs, quotas, and non-tariff barriers to protect
domestic industries. As explained in the text, a country benefits from free trade even if other countries do
not engage in it. It gains because, by trading, it can obtain goods and services at a lower opportunity cost.
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177 CHAPTER 8| Comparative Advantage and the Gains from International Trade
4.5 You should disagree. Reducing barriers to trade reduces the number of jobs in industries that
shrink due to lower priced imports, but it increases the number of jobs in export industries and in
industries that use as inputs goods that had been protected by tariffs. It benefits all consumers as it lowers
the prices of imported goods.
4.6 a.
b.
Before the tariff, the quantity of beef sold by U.S. producers is Q1; after the tariff, the quantity
of beef sold by U.S. producers is Q3. Before the tariff, the quantity of beef imported = Q2 Q1;
after the tariff, the quantity of beef imported = Q4 Q3.
c. The winners from the tariff are domestic producers of beef and the government, which collects
the tariff revenue. The losers are domestic consumers of beef.
4.7 Firms that use steel as an input will be adversely affected by an increase in steel prices in the U.S.
In addition, U.S. firms that sell products in foreign markets may fear that foreign countries will retaliate
by imposing their own import restrictions. While Buy American restrictions would likely increase the
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CHAPTER 8| Comparative Advantage and the Gains from International Trade 178
number of American jobs in the steel industry, there will be a decrease in the number of jobs in industries
that typically export their goods or services and in industries that use steel as an input.
4.8 Consumers pay more than domestic producers receive, because some of the benefits are capturedby foreign producers. In addition, consumers bear the cost of the deadweight loss that a quota imposes on
the economy (for example, see Figure 8-7 in the textbook, which shows the effects of the sugar quota). A
straight handout would be a direct payment by the government to the firms that would otherwisereceive protection through a quota. It would be cheaper because it would avoid making consumers pay for
both the gains received by foreign producers and for the deadweight loss that represents the economic
inefficiency a quota imposes on the economy.
4.9 Subsidies to U.S. rice farmers increase the supply of rice grown in the United States. This in turn
lowers the world price of rice. Farmers in Africa receive less per pound of rice and their incomes from
rice growing are smaller.
4.10 A quota on steel imports raises the costs of producing goods that use steel. This causes the pricesof these goods to rise, thereby reducing the quantity sold. As a result, producers in these industries will
reduce their production and lay off some workers. Heavy steel users, such as the automobile industry, and
those exporting goods made with steel would be most affected.
4.11 The students reasoning is flawed. As we saw in the chapter, placing a tariff on imports of a good
will raise the price of the good. The prices charged by U.S. producers will rise by as much or more if
foreign competition is entirely eliminated than if a tariff is imposed. Also, if the imported goods are a
different style or quality than the U.S. goods, then U.S. consumers will have a reduced variety of goods
from which to choose.
4.12 Economists usually measure the standard of living by the goods and services that the typical
person in a country is able to purchase. In this case, the Chinese government will have reduced the
standard of living of its own people and raised the standard of living of people in the United States. The
standard of living in the United States is raised because U.S. consumers are able to purchase Chinese
goods at a price below their true cost of production. The standard of living in China is reduced becausethe government has used some of the countrys resources to cover the cost of goods that are sent to theUnited States. Subsidizing exports is essentially giving money away to foreign consumers.
4.13 The sugar quota helps domestic sugar growers by increasing the price of their product. It harms
sugar refineries because the total amount of sugar to be refined (domestic production plus imports) is
lower. It harms candy manufacturers and other food manufacturers because they must pay more for their
inputs and cant compete as well with foreign suppliers who can buy sugar more cheaply. It hurts
consumers, who must pay more for sugar and goods with sugar in them. It hurts farmers in developing
countries because they cant export as much to the U.S. market.
4.14 You can refer to Figure 8.7 in the text for guidance in filling out the table.
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179 CHAPTER 8| Comparative Advantage and the Gains from International Trade
8.5
The Arguments over Trade Policies and GlobalizationLearning Objective:Evaluate the arguments over trade policy andglobalization.
Review Questions
5.1 The collapse of world trade during the Great Depression and the desire to create a stable,
prosperous world economy after World War II, led to the General Agreement on Tariffs and Trade. The
WTO eventually replaced GATT when it was felt that a permanent international organization would do a
more effective job at expanding international trade and working out agreements on trade in services andintellectual property rights.
5.2 Globalization is the process of countries becoming more open to foreign trade and investment.
Some people oppose it because they believe it will make them worse off or will harm other people they
care aboutespecially poor workers in developing countries.
5.3 Protectionism is the use of trade barriers to shield domestic companies and their workers from
foreign competition. The beneficiaries are the protected domestic companies and their workers. The losersare domestic consumers and other domestic producers who cannot buy their inputs as cheaply. The main
arguments for protectionism are that it saves jobs and protects high wages, that it allows infant
industries a chance to get started and grow, and that it protects national security. It is important to weigh
the benefits of each of these against the costs.
5.4 Dumping is selling a product for a price below its cost of production. The losers from dumping
are competitors of the firm that dumps (and the dumping firm itself if it is selling below its marginalcost). Consumers are the beneficiaries. The biggest problems in implementing anti-dumping laws are that
it is difficult to measure firms costs, so it is difficult to know if they are dumping. Also, there are often
good reasons for selling goods below the cost of production. Domestic firms do this, so it is unclear why
foreign firms should not.
Problems and Applications
5.5 Clinton was probably referring to minimum wage laws, the rights to form unions, and laws to
protect the health and safety of workers. The governments of most developing countries have resisted
these proposals. They argue that when the currently rich countries were poor, they lacked these types of
labor standards, and their workers received low wages. They argue that it is easier for rich countries to
afford high wages and other labor protections than it is for poor countries. They also point out that many
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CHAPTER 8| Comparative Advantage and the Gains from International Trade 180
jobs that seem very poorly paid and unsafe by industrial country standards are often better than the
alternatives available to workers in developing countries.
5.6 When the U.S. government puts a tariff on steel imports, it protects steelworkers in West Virginiaat the expense of steelworkers in South Korea (and elsewhere) by artificially increasing the demand in the
United States for steel produced by U.S. firms. Landsburg is expressing an opinion of how things ought to
be, so he is making a normative statement. Redborn is also expressing an opinion and making a normativestatement.
5.7 The Buy American provision in the economic stimulus bill was definitely controversial, as is
demonstrated by the conflicting statements from both contributors. Both Simmermaker and Folsom are
expressing opinions, and are therefore making normative statements.
5.8 No, free trade is likely to have no effect on the total number of jobs in a country, though
compared with the situation where trade is interfered with through the imposition of tariffs and quotas,
there will be a change in composition of jobs as some industries that compete against imported goodsdecline and industries that export goods expand.
5.9. No, free trade is likely to have no effect on the total number of jobs in a country, thoughcompared with the situation where trade is interfered with through the imposition of tariffs and quotas,
there will be a change in composition of jobs as some industries that compete against imported goods
decline and industries that export goods expand.
SOLUTIONS TO CHAPTER 8 APPENDIX
Review Questions
8A.1 Large U.S. corporations first began to operate internationally in the late 1800s, as the transatlantic
cable made intercontinental communications easier and steam power reduced the cost and speed of longocean voyages.
8A.2 Foreign direct investment is the purchase or building by a domestic firm of a facility in a foreign
country. Foreign portfolio investment is the purchase by an individual or firm of stocks or bonds issued in
another country. Because Toyota is a Japanese firm, its ownership of an assembly plant in the United
States is an example of foreign direct investment.
8A.3 The ultimate reason firms expand overseas is that they think doing so will increase their profits.
The main reasons for overseas expansions are 1) to avoid tariffs or the threat of tariffs, 2) to gain access to
raw materials, 3) to gain access to low-cost labor, 4) to minimize exchange risk, and 5) to respond to
industry competition. U.S.-based oil companies have extensive overseas operations because it gives them
much greater access to the raw materials they use.
8A.4 Among the major reasons for the success of U.S. firms overseas are the strength of their brand
name products and their technological edge over foreign competitors.
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181 CHAPTER 8| Comparative Advantage and the Gains from International Trade
Problems and Applications
8A.5 In 1850 it would have been difficult to operate internationally (though some firms did so
successfully) because of limited communication and transportation capabilities.
8A.6 Both automobiles and farm machinery were assembled using unskilled labor. U.S. labor costs
were the highest in the world, so assembling these products overseas gave the firms access to low-cost
labor. In addition, both products are expensive to ship, so manufacturing overseas would reduce thesecosts, and operating overseas would avoid tariff barriers. Also, overseas consumers probably would be
more willing and able to purchase products manufactured in their own countries.
8A.7 Smaller investment is often required and there is often less risk in buying an existing firm with a
locally-recognized brand name in an overseas market, rather than building new facilities there.
8A.8 A U.S. firm might produce at a higher cost in another country if this allowed the firm to avoid
tariffs or if it feared future tariffs or other trade restrictions. Also, foreign consumers probably would be
more willing and able to purchase the firms product if it is manufactured in their country.
8A.9 In some ways, expanding internationally is similar to expanding within the United States. Manyof the same managerial decisions must be made. However, international expansion often brings in added
complications due to language, cultural, and legal differences, exchange rate risk, and potential trade
restrictions.
8A.10 In some ways, expanding internationally is similar to expanding into a new product market.
Expanding into a new product market requires learning about new technologies and the tastes and
preferences of consumers in a new area. International expansion also requires learning about the tastes
and preferences of new consumers, but the existing technology can often be applied in the new market.
Among the key differences are that international expansion often brings added complications due to
language, cultural, and legal differences and potential trade restrictions, while expanding a product line
rarely brings these complications.
8A.11 Such firms have been successful in the United States, so they often first expand into countries in
which consumers and conditions are like those in the United Statescountries with high average
incomes, those with similar legal environments, and English-speaking (or Spanish-speaking) countries.
They are also likely to expand into countries where they can gain access to raw materials and gain accessto low-cost labor.
8A.12 A tariff on textile imports would allow U.S. textile firms to increase their sales, so employment in
the U.S. textile industry would increase. Total employment in the United States may be unchanged as
employment in other industries declined while employment in textile firms increased. Higher prices for
textiles would reduce the funds consumers have available to purchase other goods, thereby reducing
production and employment in these other industries.
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