Free Trade and Protectionism

Free Trade and Protectionism - 23 February Free trade and...

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23 February: Free trade and protectionism I. Trade theory One of the most widely-accepted truisms of economics is that free trade is a good thing. This perception derives from David Ricardo’s notion of “comparative advantage,” which Nobel laureate Paul Samuelson called “the most beautiful idea in economics.” Elegant it is, but also simplistic and empirically limited. The underlying idea is that if everyone specializes in what they are most efficient at, they will be able to exchange with those who have different specializations to the benefit of all. Notably, gains arise from trade even when one country or individual is more efficient than the other at producing everything . In other words, comparative advantage is distinct from absolute advantage. To find comparative advantage, it is necessary to do a cross-comparison of relative prices (which are inherently comparisons, since they are relative). Ricardo’s classic example considers a world with only two products (wine and cloth), two countries (England and Portugal), and input into production (labor), though the logic extends to more complex settings. If a bolt of cloth requires seven English worker-days or five Portuguese worker-days to make, while a cask of wine takes three English worker-days or one Portuguese worker-day, Portugal can produce either good more efficiently. In England, if there is no trade, a cask of wine is worth 7 3 bolts of cloth, while in Portugal the cask costs only 5 1 bolt. Wine is cheaper in Portugal. Meanwhile, a bolt of cloth costs 3 1 2 casks in England and 5 casks in Portugal, so cloth is relatively cheap in England. When the world opens up to trade, the Portuguese will produce wine and the English will produce cloth, leading to aggregate gains. For example, if the opening up causes 21 English workers to go from winemaking to cloth production and 10 Portuguese workers to move the other way, total output of wine goes up three casks (Portugal produces ten more casks than before, while England produces seven fewer, for a net gain of three) and that of cloth increases by a bolt (Portugal’s production falls by two units while England’s increases by three). Comparative advantage is silent about the distribution of these gains: this does not tell us if England is any better off, or whether the winemakers hoard all the extra production. Ricardo only gives us a partial equilibrium.
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This note was uploaded on 08/01/2011 for the course POL S 381 taught by Professor Roberturbatsch during the Spring '09 term at Iowa State.

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Free Trade and Protectionism - 23 February Free trade and...

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