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Comparative Advantage & Barriers to Trade July 14, 2010

Posted by petrarcanomics in Role of Government.
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Comparative Advantage Theory

David Ricardo’s comparative advantage theory states that even if two producers face the situation where one producer has the absolute advantage over the other producer in both products of perspective trade it is still useful for the superior producer to specialize in the product in which he has the lower opportunity cost of the two and trade for the other good. In doing so, he is specializing in the product in which he has a comparative advantage while the other producer specializes in the other good. The two producers then trade with each other at terms of trade that benefit both. In this way, both producers can achieve a level of production greater than they could just producing what they’re capable of producing on their own.

Barrier to Trade

Barriers to trade: Quotas, tariffs, and export subsidies

  • Quotas – an agreed upon limit on imports with a trading partner. Real world example: Early 1980s quota on Japanese cars coming into the United States
  • Tariffs – a tax on imported goods
  • Export subsidies – a choice by one country to assist its domestic industries by providing subsidies to them which make it difficult for its overseas competitors.

Effects of barriers to trade:

  • All three of the barriers to trade above will decrease the supply of goods available to consumers thus increasing the price of consumer goods.
  • The only winners when barriers to trade are increased are domestic producers in the affected industry.
  • Retaliatory barriers are often erected in response to the initial barriers to trade.
  • The overall effect of barriers to trade is a net decrease in the overall level of production in global markets. Yet strong domestic interests such as domestic producers and domestic trade unions have vested interests that cause them to advocate for barriers to trade.
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