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The Benefits of International Trade

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International trade allows countries to consume more goods than they can produce on their own. They can do so by specializing in the production of goods for which they have a comparative advantage. This is true even if the country has an absolute advantage on producing all goods more efficiently than the other countries it can trade with.

Discussion Questions

  1. What are the benefits to international trade?
  2. How can trade allow countries to consume more than they can produce on their own?
  3. What are the downsides to allowing more international trade?
  4. Are the downsides to trade worth their benefits?

Related Resources

  • To view the other videos in the Econ 1 series, click here.
  • To view all of the online classwork to Econ 1: Principles of Economics, click here
  • Read John Taylor's blog on The Fed's Inflation Target and Policy Rules; click here.
View Transcript

Now we're going to consider the gains from international trade between people and different countries and we're going to focus on what is comparative advantage.

Well the main difference is when there's a trade across borders between one country and another, there's a possible that trade maybe restricted unlike the restrictions that might occur if you traded with friends and people in your own neighborhood.

Let's begin with some definitions that focus on this idea of comparative advantage. To begin with is what's called the absolute advantage. That's a case in which a country can produce a good more efficiently than another country. Comparative advantage is a different concept. It's really comparing not only the relative efficiency of two goods, it's comparing the relative efficiency in two different countries.

Examples will help a lot.

So, we'll consider the United States and South Korea and we'll consider two goods - pharmaceutical production could be a vaccine and some electronics production could be the TV sets. In this particular case, we're assuming that one day a work produces 6 units of vaccines and three TV sets. And in South Korea, one day of work produces 1 unit of vaccines and 2 units of TV. So you can see right away that the US has an absolute advantage in producing vaccines and also an absolute advantage in producing TV sets.

But let's consider which country has a comparative advantage in which good.

How do we find out which country has a comparative advantage in each good? Well we need to consider that table carefully.

Again, remember that the US has an absolute advantage over Korea in both vaccines and TV sets simply because 6 is greater than 1 and 3 is greater than 2 in that table. We say the US has a comparative advantage, however, in producing vaccines, these pharmaceutical goods, because 6 over 1 is greater than 3 over 2. The capability of the United States in producing pharmaceuticals is six times greater than Korea. It's only 50% (or 3 over 2) times that Korea can do in TV sets. A country cannot have a comparative advantage in both goods, so by definition, the US has comparative advantage in vaccines, it must be the case that Korea has a comparative advantage in TV sets.

Goal to think about the advantages that might occur in improving the gains from trade in this circumstance.

Let's do this numerical example so it may be that the unit of vaccines is $100 and TV sets is $100. They have the same price so you can exchange a unit of vaccines for a TV set. It's 1 to 1.

Then how can the US gain from trade in this particular case? Well, for example, the US could reduce TV production by three units by removing some workers out of TV production, and move those workers to vaccine production. With the numerical example, that would mean it can increase vaccines production by six units. Now, with the six units of vaccine, US can go to Korea and trade for six TV sets. At the end it has six TV sets, which is three more than it had if it was producing the TV sets by itself.

It's actually able to consume more TV sets and produce the same amount of vaccines as it did before. So, this is a gain for trade.

You might think that if the US is gaining from trade, then obvious Korea can't be. Is Korea being exploited by this comparative advantage? By no means. Let's consider Korea, because Korea can also gain from trade. Let see how it does it.

Suppose Korea increases TV production by six by moving worker out of the vaccines production into the TV production. But now it can take its 6 TV sets and trade with the US and get 6 vials (or units of vaccines) so Korea comes out ahead and has 3 more units (3 more vials of vaccines) than it did at the start.

So, let's draw a picture and in this picture lets be sure what the production possibilities are.

Let's assume to start that the price of a unit of vaccines for a TV set is 1 to 1. And let's assume that in the US that we have 10,000 workers that could be either producing vaccines or TVs. And let's assume in Korea that we have 30,000 workers that could be either producing vaccines or TVs.

With this information, we can draw a production possibility curve for the two countries. Let's draw them side-by-side. In this diagram, we're going to have vaccines on the vertical axis and TVs on the horizontal access. And let's get this diagram on the left be the US and the right can be Korea.

If they were all producing vaccines, you'd have 60,000 units of vaccine.

Let's draw the curves. As I mention if in the US all 10,000 workers are producing vaccines, we get 60,000 as the maximum we can produce. If all those 10,000 workers are producing TVs, we get 30,000. So those are two points on the production possibilities curve and indeed as we move workers out of vaccines production and into TV production in the US, we move down that production possibilities curve.

We can do the same thing in Korea. Suppose all the 30,000 workers in Korea are producing vaccines. In that case, we get 30,000 vaccines, one per each worker. And if they all go into producing TVs, the 30,000 workers would produce 2 each, in which case we would get 60,000 and that's the production possibility curve for Korea. So, they're different and that's what the curves would look like if they were unable to trade.

But now let's consider the possibility of trade. Using the curves, let's just suppose that the US specializes in producing vaccines. It could produce 60,000 vaccines but if it can trade and it can also trade on 1 to 1 ration, it can trade vaccines its producing for TVs.

So now it's possible through trade to consume more TVs and more vaccines than the production possibilities curve in the first place.

This same thing can be true in Korea. Suppose Korea specializes completely in producing TVs and it would produce 60,000 of TVs but now it can go and trade those with US 1 to 1 and get as many as 60,000 units of vaccines through trade.

It shifted it out. Its consumption possibilities are greater than its production possibilities. It's almost like a new technology has been invented. It's not a new technology, it's just trade.