Source: Images of PPFs created by Kate Eskra
Hi Welcome to macroeconomics. This is Kate. This tutorial is an analysis of trade barriers. As always, my key terms are in red and examples are in green.
So in this tutorial, we'll talk about how nations benefit from trade when they're fully employed and specialize according to comparative advantage. We'll talk about the argument for trade barriers that arises when an economy is not fully employed. And we'll talk about also why some critics argue that trade barriers are not beneficial at all.
So remember the key idea about gains from trade is that trade allows countries to enjoyed more of both goods and move beyond their previous resource and productivity constraints both goods can be produced at the lowest opportunity cost. And this is when we decide who produces what based on comparative advantage.
And comparative advantage deals with the concept of opportunity cost, which is what we give up. It's the sacrifice made by choosing one value or opportunity over another. It's the value of the foregone opportunity. It's what we sacrifice whenever we decide to focus on one thing over another.
So whenever, for example, the United States decides to devote resources-- like land, labor, and capital-- to producing textiles, when we give up, well, we give up the opportunity to use those resources to produce something else, like cars. So what is given up is then our opportunity cost. And that's what comparative advantage is all about. It's an advantage conferred with the country to one good's production relative to another.
When I think of comparative advantage, I think of who gives up less. So when countries specialize in the goods or services for which they have the lower opportunity cost, that's when we say they enjoy a comparative advantage. And if they specialize according to comparative advantage, both countries actually end up benefiting.
So in an example I've used in previous tutorials, when the United States produces textiles-- let's say we decide to devote our resources to producing clothes here. Don't we give up a lot more in terms of something like cars than Mexico maybe would? Think about the technology and the skill level of our workforce compared to that of Mexico's.
We give up a lot when we decide to produce something like clothes or textiles here. Mexico, then, would enjoy the comparative advantage in textiles because they don't give up as much when they devote their resources to that goods production. The United States, then, would enjoy the comparative advantage in cars.
So then theoretically, free trade is good for everybody. It benefits all countries. Not everyone agrees on this, though. There are a variety of arguments for trade barriers.
And those things, most of them and most of what we're going to focus on here, mostly it's concerns for domestic jobs. But there are environmental concerns, concerns about international labor standards. Some feel that trade is actually unfair to poor countries.
Other people feel that it's other countries that benefit more than the United States. There's a lot of arguments that have been presented in the media and for trade barriers to be set up. But mostly, we'll focus on this argument here.
So the basis for trade, the idea that free trade is so good, was that both nations benefit when specializing in whatever they enjoy the comparative advantage in. So I decided, or we decided, the United States should produce cars because they give up fewer textiles when they do that. And Mexico should produce textiles because they give up fewer cars.
However, the advantages and gains from trade were calculated based upon scenarios assuming full employment of resources in both nations. So full employment is defined as equal to the point at which an economy exhibits a natural rate of unemployment, usually around 5%. And it occurs when the economy is at its long run supply capacity.
So a PPF shows the maximum combination of two goods that can be produced when an economy's resources are being utilized. This x-intercept here-- this one's for the United States and this one's for Mexico-- shows how many cars can be produced when all resources are devoted to car production. So it's 21 for the United States or eight for Mexico. The y-intercept shows how many textiles can be produced with specialization in textiles. So seven million in the case of the US or four million in the case of Mexico.
So the idea is that this shows a trade off. It shows us how many of one thing we have to give up when we want one more of the other good. So for example, for every one textile that the United States decides to produce, they give up the ability to produce three cars. Why do they give up three cars? Because we're assuming that resources are fully utilized and fully employed so that if they want to produce one more textile, they're going to have to take resources out of cars and put it into textiles because resources are fully utilized.
But what if the United States is in a recession? That would be represented by a production level somewhere inside the curve where they're not actually producing a maximum combination. That means that some resources are unemployed. The economy's operating at less than capacity.
If we were focusing all on production of cars, now if we go back to producing textiles, we could really utilize currently unemployed workers and other resources. So in a way, there really isn't an opportunity cost with doing that. This trade off situation is kind of void because with unemployment, we don't have to give anything up to produce textiles. There are people who want jobs and don't have them. So producing textiles domestically could actually raise US GDP now.
Remember, unemployment is defined as the percentage rate of the number of individuals that would like to work, are an active part of the labor force, to the number of individuals that comprise the active labor force. So if we have people going unutilized, so they're unemployed, they want to work. And if we start producing textiles, we could employ those currently unemployed people.
So since the idea of comparative advantage no longer applies, this situation presents an argument then for a nation to set up trade barriers. And trade barriers are all about protecting a domestic industry from competition. They're defined as barriers to free market pricing set in place to confer advantage of a country. And examples include things like taxes and subsidies.
So I just kind of outlined the different trade barriers that the different forms they can take. Taxes-- so if we placed taxes on imported textiles, we make them more expensive, enticing people to buy domestically. If we pay subsidies, that provides domestic producers with payments to give them an advantage over foreign competition. And quotas actually restrict the amount of foreign textile imports allowed. And so it's like a quantity ceiling, a maximum amount allowed to be imported.
So are trade barriers good or bad? Well, much disagreement on this. People think different things.
One of the things that we can pretty much say is when an economy is fully employed, trade barriers are pretty unnecessary, and they're counterproductive if you follow those theories of comparative advantage and gains from trade, because free trade and specialization then allows for resources to be used the most efficiently. Free trade helps economies fully employed to achieve economic growth and move beyond their previous production capacities, as we've shown. But as we just talked about with high unemployment, trade barriers can actually benefit a domestic economy by utilizing workers in other resources that are currently unemployed.
Critics, though, point out that trade barriers still have some issues. Some say they're just bad for the global economy overall. Others say they only really just serve special interest groups, like specific industries that are lobbying for protection from foreign competition. They can reduce the incentive for domestic firms to produce more efficiently.
Whenever we put up trade barriers, we're reducing competition. And then firms domestically don't have the incentive to do it better, do it for less expensive, et cetera. And then finally, once you put up trade barriers, it's pretty difficult to remove them once the economy has improved. Because again, industries get really used to those trade barriers being there for them.
So in this tutorial, we talked about how people and nations benefit when they specialize in whatever they enjoy the comparative advantage in in trade. And when economies are fully employed, gains from trade are obvious. However, when an economy has unemployment, it can benefit from some of those trade barriers.
Thanks so much for listening. Have a great day.