Micro Handout 22: Comparative Advantage

Transcription

1 Amherst College Department of Economics Economics 111 Section 5 Fall 2015 Micro Handout 22: Comparative Advantage Broadly speaking, economists support free trade: when polled, more than 90 percent of economists believe that trade restrictions reduce general economic welfare. 1 During the last quarter century, American administrations have generally supported trade liberalization. The Clinton administration strongly advocated NAFTA (North American Free Trade Agreement) and pushed for freer trade in other international forums. The Bush administration urged Congress to pass fast-track authority that would allow the administration to negotiate agreements reducing trade barriers even more. The Obama administration recently completed the negotiation of the Trans-Pacific Trade Agreement with Australia, Canada, Japan, Malaysia, Mexico, Peru, Vietnam, Brunei, Chile, Singapore, New Zealand, and the United States. Many Americans and members of Congress do not share the enthusiasm of economists and the recent administrations, however. In a December 10, 1998 Wall Street Journal article, Jackie Calmes reported on the difficulties encountered by the administration in its efforts to promote free trade: President Clinton keeps trying to sell the idea that foreign trade is good for the U.S. economy. Yet eight years into a record peacetime expansion, many Americans still aren t buying. The latest poll for The Wall Street Journal and NBC News illustrates the hurdle faced by the administration and other free traders. Given a choice of statements, a lopsided 58% majority of those polled agreed that foreign trade has been bad for the U.S. economy because cheap imports have cost wages and jobs here. Just 32% said trade has been good because foreign demand for U.S. goods has spawned economic growth and produced jobs for Americans. In a January 27, 1999 Wall Street Journal article, Michael M. Phillips also reported on the administration s efforts: President Clinton s top economic advisers went to Capitol Hill yesterday to present their free-trade agenda for the year - and left with a clear picture of how controversial that agenda will be. Sen. Kent Conrad (D. N.D.) railed against Canadian wheat imports Sen. Frank Murkowski (R. Alaska) complained that the glut of foreign oil has pushed down oil prices and cost jobs in the energy industry. Most vehement was Democrat Sen. John D. Jay Rockefeller IV (D. W.Va.) who condemned what he called an illegal flood of cheap steel from Japan, Russia, Brazil and elsewhere. [But] Generally, free trade benefits the nation as a whole Project: Understand the reasons behind the trade controversy; more specifically: Is it true that free trade benefits the nation as a whole as Phillips writes? If so, why then have a majority of Americans and many members of Congress opposed free trade? 1 Fuller and Geide-Stevenson, A Survey of Republicans, Democrats and Economists, Eastern Economic Journal, Winter 2007, pp Alston, Kearl, and Vaughan, "Is There a Consensus Among Economists in the 1990s?", American Economic Review, May 1992, pp Kearl, Pope, Whiting, and Wimmer, "A Confusion of Economists?", American Economic Review, May 1979, pp

2 2 To address these questions, assume that the table below indicates how much more (or less) wheat and textiles can be produced in the United States and Mexico when one more (or less) worker is employed: United States Mexico Wheat Textiles Wheat Textiles 1 worker 1 worker 1 worker 1 worker 200 bushels bushels 100 Absolute Advantage Which country enjoys an absolute advantage in the production of wheat? textiles? Why might these differences in absolute advantage exist? Mr. A: American workers are more productive than their Mexican counterparts; hence, trade with Mexico can only hurt the U. S. Preview: Theory of Comparative Advantage Specialization: If each nation specializes in (produces more of) the good in which it enjoys a comparative advantage, the production of goods in the world as a whole can increase. Trade: Furthermore, if, after specialization, each nation exports the good in which it enjoys a comparative advantage and imports the good in which it suffers a comparative disadvantage, citizens in each nation can have more goods available to enjoy. Opportunity Cost What do we mean by opportunity cost? First focus on wheat production. Suppose that one American worker moves from the textile industry to the wheat industry: U. S. Wheat U. S. Textile more bushels worker fewer What is the opportunity cost of producing 200 bushels of wheat? What is the opportunity cost of producing 1 bushel of wheat?

3 3 Suppose that one Mexican worker moves from the textile industry to the wheat industry: Mexican Wheat Mexican Textile Mexico produces 1 Mexico produces more bushels worker fewer What is the opportunity cost of producing 20 bushels of wheat? What is the opportunity cost of producing 1 bushel of wheat? Question: Who has a comparative advantage in the production of wheat? Next, consider textile production: Suppose that one American worker moves from the wheat industry to the textile industry: U. S. Wheat U. S. Textile fewer bushels worker more What is the opportunity cost of producing 200 of textiles? What is the opportunity cost of producing 1 yard of textiles? Suppose that one Mexican worker moves from the wheat industry to the textile industry: Mexican Wheat Mexican Textile Mexico produces 1 Mexico produces fewer bushels worker more What is the opportunity cost of producing 100 of textiles? What is the opportunity cost of producing 1 yard of textiles? Question: Who has a comparative advantage in the production of textiles?

4 4 Specialization Specialization: If each nation specializes in (produces more of) the good in which is enjoys a comparative advantage, the production of goods in the world as a whole can increase. Suppose that each country does so by transferring workers: From the industry in which it does not enjoy a comparative advantage. To the industry in which it does enjoy a comparative advantage. In the U.S., workers would be transferred from production to production. In Mexico, workers would be transferred from production to production. More specifically, suppose that one American worker is transferred from the textile industry to the wheat industry. What happens to wheat and textile production in the U.S.? Wheat Textile more bushels worker fewer Next, let us keep worldwide production of textiles constant: Question: How many Mexican workers must be transferred from the wheat industry to the textile industry to keep textile production constant in the world as a whole? Answer: workers. What happens to wheat and textile production in Mexico? Wheat Textile Mexico produces Mexican produces fewer bushels workers more Summarize your answers in the table below: Summary of Changes in Wheat Textile United States bushels Mexico bushels World bushels What are the worldwide gains from specialization?.

5 5 Specialization and Trade Suppose that we wish to keep textile consumption constant in the U.S. and also constant in Mexico. How many of textiles would Mexico export to the U.S.? Wheat Textile Textile Trade more bushels worker 200 fewer fewer bushels workers 200 more Scenario #1: U.S. exports 200 bushels of wheat in exchange for 200 of cloth Terms of Trade: 1 bushel of wheat per yard(s) of textiles. Wheat Wheat Textile Textile Trade Trade 200 more bushels worker 200 fewer 200 bushels 40 fewer bushels workers 200 more Wheat (bushels) Textile () Prod Trade Cons Prod Trade Cons United States Mexico World How many more bushels of wheat could Mexicans now consume? Which nation enjoys all the gains from specialization? Would Mexico have an incentive to agree to these terms of trade? Would the U.S. have an incentive to agree to these terms of trade?

6 6 Scenario #2: U.S. exports 40 bushels of wheat in exchange for 200 of cloth Terms of Trade: 1 bushel of wheat per yard(s) of textiles. Wheat Wheat Textile Textile Trade Trade 200 more bushels worker 200 fewer 200 bushels 40 fewer bushels workers 200 more Wheat (bushels) Textile () Prod Trade Cons Prod Trade Cons United States Mexico World How many more bushels of wheat could the Americans now consume? Which nation enjoys all the gains from specialization? Would the U.S. have an incentive to agree to these terms of trade? Would Mexico have an incentive to agree to these terms of trade? Taking Stock Specialization Wheat Textile U.S. enjoys a Mexico enjoys a comparative 200 more bushels worker 200 fewer comparative advantage advantage in wheat in textile production 40 fewer bushels workers 200 more production Wheat Textile United States +200 bushels 200 Mexico 40 bushels +200 World +160 bushels 0 Trade Terms of Trade: 1 bushel of wheat per 1 yard of textiles Mexico enjoys all the benefits of specialization, U.S. none Terms of Trade: 1 bushel of wheat per 5 of textiles. U.S. enjoys all the benefits of specialization Mexico none

7 7 Scenario #3: U.S. exports 100 bushels of wheat in exchange for 200 of cloth Terms of Trade: 1 bushel of wheat per yard(s) of textiles. Wheat Wheat Textile Textile Trade Trade 200 more bushels worker 200 fewer 200 bushels 40 fewer bushels workers 200 more Wheat (bushels) Textile () Prod Trade Cons Prod Trade Cons United States Mexico World Theory of Comparative Advantage Summary: The Importance of Opportunity Cost. Specialization: If each nation specializes in (produces more of) the good in which it enjoys a comparative advantage, the production of goods in the world as a whole can increase. Trade: Furthermore, if, after specialization, each nation exports the good in which it enjoys a comparative advantage and imports the good in which it suffers a comparative disadvantage, citizens in each nation can have more goods available to enjoy. Question: Why is free trade controversial? Question: Would you expect all groups within each nation to support specialization and trade? How would Americans associated with the U.S. wheat industry feel about this? How would Americans associated with the U.S. textile industry feel?