Page 773 - Economics

CONFIRMING PAGES

PART TEN
682
International Economics
3 _
at 1 W 1 C . At this point the underlying basis for fur-
4 QUICK REVIEW 35.1
ther specialization and trade—differing cost ratios—has
disappeared, and further specialization is therefore un- • International trade enables nations to specialize, increase
economical. And, most important, this point of equal productivity, and increase output available for consumption.
cost ratios may be reached while the United States is still • Comparative advantage means total world output will be
producing some coffee along with its wheat and Brazil is greatest when each good is produced by the nation that has
the lowest domestic opportunity cost.
producing some wheat along with its coffee. The primary • Specialization is less than complete among nations because
effect of increasing opportunity costs is less-than-com- opportunity costs normally rise as any given nation produces
plete specialization. For this reason we often find domes- more of a particular good.
tically produced products competing directly against
identical or similar imported products within a particular
economy. (Key Question 4)
Supply and Demand Analysis
The Case for Free Trade of Exports and Imports
The case for free trade reduces to one compelling argu- Supply and demand analysis reveals how equilibrium prices
ment: Through free trade based on the principle of com- and quantities of exports and imports are determined. The
parative advantage, the world economy can achieve a more amount of a good or a service a nation will export or import
efficient allocation of resources and a higher level of mate- depends on differences between the equilibrium world price
rial well-being than it can without free trade. and the equilibrium domestic price. The interaction of
Since the resource mixes and technological knowledge world supply and demand determines the equilibrium world
of the world’s nations are all somewhat different, each na- price —the price that equates the quantities supplied and
tion can produce particular commodities at different real demanded globally. Domestic supply and demand determine
costs. Each nation should produce goods for which its do- the equilibrium domestic price —the price that would pre-
mestic opportunity costs are lower than the domestic op- vail in a closed economy that does not engage in interna-
portunity costs of other nations and exchange those goods tional trade. The domestic price equates quantity supplied
for products for which its domestic opportunity costs are and quantity demanded domestically.
high relative to those of other nations. If each nation does In the absence of trade, the domestic prices in a closed
this, the world will realize the advantages of geographic economy may or may not equal the world equilibrium
and human specialization. The world and each free-trad- prices. When economies are opened for international trade,
ing nation can obtain a larger real income from the fixed differences between world and domestic prices encourage
supplies of resources available to it. Government trade exports or imports. To see how, consider the international
barriers lessen or eliminate gains from specialization. If effects of such price differences in a simple two-nation
nations cannot trade freely, they must shift resources from world, consisting of the United States and Canada, that are
efficient (low-cost) to inefficient (high-cost) uses in order both producing aluminum. We assume there are no trade
to satisfy their diverse wants. barriers, such as tariffs and quotas, and no international
One side benefit of free trade is that it promotes transportation costs.
competition and deters monopoly. The increased com-
petition from foreign firms forces domestic firms to find
and use the lowest-cost production techniques. It also Supply and Demand in the
compels them to be innovative with respect to both United States
product quality and production methods, thereby con- Figure 35.3a shows the domestic supply curve S and the
d
tributing to economic growth. And free trade gives con- domestic demand curve D for aluminum in the United
d
sumers a wider range of product choices. The reasons to States, which for now is a closed economy. The intersec-
favor free trade are the same as the reasons to endorse tion of S and D determines the equilibrium domestic
d
d
competition. price of $1 per pound and the equilibrium domestic
A second side benefit of free trade is that it links na- quantity of 100 million pounds. Domestic suppliers
tional interests and breaks down national animosities. produce 100 million pounds and sell them all at $1 a
Confronted with political disagreements, trading partners pound. So there are no domestic surpluses or shortages
tend to negotiate rather than make war. of aluminum.

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