Chapter 33

The Gains from

International
Trade

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 In this chapter you will learn to

1. Explain why the gains from trade depend on the pattern

of comparative advantage.

2. Describe the effects of factor endowments and climate on a

country’s comparative advantage.

3. Explain the relationship between the law of one price and

trade patterns.

4. Describe some of the reasons why countries export certain

goods and import others.
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Figure 33.1 The Growth in
World Trade, 1950–2005

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Figure 33.2 U.S. Exports and Imports
of Goods by Industry, 2005

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The Gains from Trade

Interpersonal, Interregional, and International Trade

Without trade, people must be self-sufficient.

With trade, people can specialize efficiently and satisfy other
needs by trading.

This basic principle is true for individuals, regions, and

countries:
 the gains from trade
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Table 33.1 Absolute Costs
and Absolute Advantage
Illustrating the Gains from Trade

One country has an absolute advantage in the production of a

specific product if, relative to another country, it can produce
one unit of the product using fewer resources.

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Table 33.2 Opportunity Costs
and Comparative Advantage

One country has a comparative advantage in the production of

a specific product if, relative to another country, its opportunity
cost for producing the product is lower.

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Table 33.3 The Gains from
Specialization

World production of all products can be increased if each

country specializes in producing the goods for which it has a
comparative advantage.

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Figure 33.3 The Gains from Trade
with Constant Opportunity Costs

Canada specializes in wheat, the EU specializes in cloth.

 consumption possibilities increase in both countries
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Conclusions about Gains from Trade

1. If Country A has a comparative advantage in one

product then it must have a comparative disadvantage
in another.
2. The opportunity cost of one product is not its absolute
cost, but the amount of output of other products that
must be sacrificed.
3. When opportunity costs are the same in all countries,
there are no gains from specialization and trade.
4. When opportunity costs differ across both countries,
global production can be increased by reallocating
resources.
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Gains from Trade Without Complete
Specialization

EXTENSIONS IN THEORY 33.1

The Gains from Trade Without Complete
Specialization

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The Gains from Trade with Variable
Costs

Additional gains from trade may be possible:

Economies of scale:
International trade allows small countries to produce
high enough levels of output to reap the available scale
economies.

Learning by doing:
Costs may fall as production experience
increases.

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Figure 33.4 Economics of Scale
versus Learning by Doing

Scale economies
are shown by the
downward sloping
LRAC curve.

Learning by doing
implies that LRAC
curves shift down as
experience increases.

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Sources of Comparative Advantage

Factor endowments. Countries have the CA in products that

use their abundant resources relatively intensively.

Climate. Variation in national climates affects comparative

advantages. Climate can be considered a “special” factor of
production.

Acquired. Comparative advantage can be acquired or lost

over time. It is a dynamic concept.

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 Contrasting Views

The traditional view: A government should encourage

specialization of production in goods for which it currently
has a comparative advantage.

• each country should specialize in a relatively narrow

range of distinct products.

The modern view: If comparative advantage can be acquired,

it can also be lost.

• each country should innovate and adopt the latest

technologies
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The Determination of Trade Patterns

The Law of One Price

- when an easily transported product is internationally
traded, arbitrage guarantees a single world price

Compare the world price with the U.S. domestic price:

1. If pw > pd  U.S. exports the product

2. If pw < pd  U.S. imports the product

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Figure 33.5 An Exported
Good

Countries export
goods whose world
price exceeds the
domestic price.

 Countries export
the goods for which
they are low-cost
producers.

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Figure 33.6 An Imported Good

Countries import
products whose
world price is less
than the domestic
price.

 Countries import
goods for which they
are high-cost
producers.

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Is Comparative Advantage
Obsolete?

The theory that comparative advantage determines trade

flows is not obsolete.
But the idea that comparative advantage is completely
determined by forces beyond the reach of public policy has
been discredited.

Although governments may influence patterns of comparative

advantage, it is not necessarily advisable:
- compare the costs of trade-related policies with their
likely benefits
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The Terms of Trade

The division of the gains from trade depends on the terms of

trade.

The terms of trade are measured by the ratio of the price of

exports to the price of imports.

Index of Export Prices

Terms of Trade = x 100
Index of Import Prices

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Figure 33.7 A Change in the
Terms of Trade

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A Change in the Terms of Trade

A rise in the index:

 country gets more imports per unit of exports
 a favorable change for the country

A fall in the index:

 country gets fewer imports per unit of exports
 an unfavorable change for the country
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Figure 33.8 U.S. Terms of
Trade, 1961–2006

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