Study Guide for International Economics Standards:

SSEIN1 The student will explain why individuals, businesses, and governments trade goods and services. SSEIN2 The student will explain why countries sometimes erect trade barriers and sometimes advocate free trade. a. Define trade barriers as tariffs, quotas, embargoes, standards, and subsidies. b. Identify costs and benefits of trade barriers over time. c. List specific examples of trade barriers.

Comparative advantage is the principle which holds that world output is higher if every country produces and trades the good in which it has a comparative advantage. A nation's comparative advantage occurs when it focuses on producing the good in which the opportunity cost of production is lowest. To understand why this is so, remember that the opportunity cost is the cost of one good in terms of the reduced production of other goods that could have been produced. When a nation focuses on producing the good at which its productivity advantage is greatest, or at which its productivity disadvantage is smallest, it, in effect, chooses to produce the good for which the trade-off with other goods in terms of opportunity cost is smallest. The principle of comparative advantage shows how benefits of trade are available to all parties who participate, both those with a productivity advantage and those with a productivity disadvantage. But it's also important to remember that international trade offers economic benefits for other reasons: it increases competition between firms; it increases the variety available to consumers; it often increases the level of training about matters such as accounting, management and law in low-income countries; and it disseminates new technologies and production methods. To understand the intuition behind comparative advantage, consider a group of volunteers who gather to build a home. One of the volunteers is an expert builder who is better at all tasks than anyone else in the group. However, if that person has to build the house alone, it will take him or her a long time. Comparative advantage says that the skilled builder should focus on the tasks at which that person's advantage is greatest, that is, at which the person's efforts would be hardest to replace. Others should each take on the tasks at which their disadvantage is smallest. In this way, all parties can benefit from the division of labor. Similarly, a high-productivity economy like the United States can benefit from trading with a low-productivity economy like Mexico or certain nations in Africa, because it will be better for all parties if the United States focuses on those products at which its productivity advantage is greatest, and trades with the other countries

as they produce those goods in which their productivity disadvantage is least. The gains from trade will be largest when the parties focus on producing in their area of comparative advantage. Barriers to trade are government rules that block or inhibit international trade between countries. The most common trade restrictions are: 1) tariffs, which are taxes on imports; 2) import quotas, which are limits on the quantity that can be imported; and 3) non-tariff barriers, which include administrative regulations and procedures that can be used to discourage imports. Most barriers to trade are designed to prevent imports from entering a country, and thus are used to protect domestic producers from competition and domestic workers from competition for their jobs. For this reason, a policy of high barriers to trade is referred to as protectionism. However, economists point out that protectionism benefits domestic firms by allowing them to charge higher prices to consumers; in effect, protectionism is an implicit subsidy to the protected firms, paid for by consumers. Although trade barriers may save the jobs of some domestic workers, it destroys jobs in other, probably more efficient, industries. Economic development is a sustained increase in the standard of living of a country's population. Broadly understood, the standard of living includes a rise in the average incomes of the population as measured by real per capita GDP, and also improvements in health and education, some social protection from poverty, freedom, a rule of law and other social goals. Thus, although economic development does focus on the material standard of living, it is a broader term than just economic growth. Economic development is facilitated by high investment levels in physical and human capital, higher productivity, competitive markets, low inflation, political stability and free trade. Incentives that increase factors contributing to economic development are greater economic freedom, protection of property rights and sound monetary policies. Key terms: Property Rights: Legal protection for the boundaries and possession of property. Assigning of property rights to individuals, collectives or governments depends on the economic system. Economic Freedom: The freedoms of the marketplace--the freedom of consumers to decide how they wish to allocate their spending among various goods and services; the freedom of workers to choose to change jobs, join unions and go on strike; the freedom of individuals to establish businesses and to decide what to produce and when to change their pattern of production; and the freedom of savers to decide when and where to invest their savings. Incentive: Any reward or benefit, such as money, advantage or good feeling, that motivates people to do something. Inflation: A rise in the general or average price level of all the goods and services produced in an economy. Can be caused by pressure from the demand side of the market (demand-pull inflation) or pressure from the supply side of the market (cost-push inflation).

Markets: Places, institutions or technological arrangementswhere or by means of which goods or services are exchanged. Also, the set of all sale and purchase transactions that affect the price of some good or service. Productivity: The amount of output (goods and services) produced per unit of input (productive resources) used. Human Capital: The health, education, experience, training, skills and values of people. Also known as human resources. Poverty: The state of being poor, variously defined. Sometimes defined relatively--by reference, for example, to the average household income in a nation or region. Sometimes defined absolutely--by reference, for example, to the income needed to provide for adequate food, housing and clothing in a nation or region. Income: Payments earned by households for selling or renting their productive resources. May include salaries, wages, interest and dividends. Standard of Living: The level of subsistence of a nation, social class or individual with reference to the adequacy of necessities and comforts of daily life. Gains from Trade: The increased output resulting from trade; with trade, each individual, region or nation is able to concentrate on producing goods and services that it produces efficiently, while trading to obtain goods and services that it does not produce. Division of Labor: An arrangement in which workers perform only one step or a few steps in a larger production process (as when working on an assembly line). Consumers: People who use goods and services to satisfy their personal needs and not for resale or in the production of other goods and services. Firms: Economic units that demand productive resources from households and supply goods and services to households and government agencies. Competition: Attempts by two or more individuals or organizations to acquire the same goods, services, or productive and financial resources. Consumers compete with other consumers for goods and services. Producers compete with other producers for sales to consumers. Benefit: Monetary or non-monetary gain received because of an action taken or a decision made. Trade-off: The giving up of one benefit or advantage in order to gain another regarded as more favorable. Productivity: The amount of output (goods and services) produced per unit of input (productive resources) used. Production: The act, process or result of manufacturing or refining something. Opportunity Cost: The second-best alternative (or the value of that alternative) that must be given up when scarce resources are used for one purpose instead of another.

Comparative Advantage: The ability to produce a good or service at a lower opportunity cost than some other producer. This is the economic basis for specialization and trade. Goods: Tangible objects that satisfy economic wants. Trade: Voluntary exchange of goods and services for money or other goods and services. Workers: People employed to do work, producing goods and services. Consumers: People who use goods and services to satisfy their personal needs and not for resale or in the production of other goods and services. Firms: Economic units that demand productive resources from households and supply goods and services to households and government agencies. Competition: Attempts by two or more individuals or organizations to acquire the same goods, services, or productive and financial resources. Consumers compete with other consumers for goods and services. Producers compete with other producers for sales to consumers. Producers: People and firms that use resources to make goods and services. Barriers to Trade: Restrictions on trade such as tariffs, quotas and regulations. Quotas: In international trade, the limit on the quantity of a product that may be imported or exported, established by government laws or regulations; in command economies, more typically a production target assigned by government planning agencies to the producers of a good or service. Imports: Goods and services bought from sellers in another nation. Exports: Goods and services produced in one nation and sold to consumers in other nations Taxes: Compulsory payments to governments by households and businesses. Tariff: A tax on an imported good or service. Trade: Voluntary exchange of goods and services for money or other goods and services.