[MUSIC] Welcome to the power of macroeconomics. Lecture nine. International trade and protectionism. >> Here is some alphabets soup for you, NAFTA, GATT and the Euro. And then of course there are words like tariffs and quotas and trade deficits. And dumping, and non-tariff barriers and protectionism. People across the globe are now speaking this language of international economics on television, in the newspapers, in corporate offices, in stores and in union halls. And while it may seem like a foreign language to you now, it is a language that we must come to master. In this lecture we're going to examine the economic principles governing international trade. The questions we want to examine are these. Why do nations trade? And how do nations decide what to import and export? To answer these questions, we must explore the mysteries of absolute advantage versus comparative advantage. The idea of absolute advantage, as a basis for trade, was said forth by Adam Smith. A country that can produce a good at a lower cost than another country is said to have an absolute advantage in the production of that good. For example, Saudi Arabia has millions of barrels of cheaply accessible oil but growing food in its desert climate and sandy soil is very expensive. In contrast, the United States can grow food cheaply in its temperate climate and fertile soi,l but American oil isn't as cheap to extract as Saudi crude. Because it can produce a certain amount of oil with fewer resources, Saudi Arabia has an absolute advantage over the United States in producing oil, just as the United States has a absolute advantage over Saudi Arabia in producing food. And the theory of absolute advantage would predict. In this case, quite correctly. That America should sell food to Saudi Arabia and buy oil from it. At first glance, the principle of absolute advantage appears to make imminent sense. Nonetheless it has a significant implication and one that is badly flawed. Take a look at this table to see what I mean. Here we have two countries, Germany and Algeria, producing two goods food and auto with the same amount of resources. From the table it is clear that the Germans are able to produce both food and autos with fewer resources than Algeria. In this case, the theory of absolute advantage would predict that Germany has nothing to gain from trading with Algeria. After all why should Germany trade with the country that cannot produce anything as efficiently as it can. Why indeed? Because this is where a more subtle understanding of trade patterns enters the picture. This more subtle understanding is embodied in the theory of comparative advantage. The Theory of Comparative Advantage was first set forth in 1817 by the same English economist who helped us in an earlier lecture develop a theory of land rent, namely David Ricardo. The historical context for the development of Ricardo's Theory of Comparartive of Advantage is interesting in on of itself. At the time, Europe was considering protecting it's market from American imports through the use of tariffs and quotas. Europe's concern was that America with its abandoned land and inexpensive labor would have in absolute advantage in producing many goods and might therefore not import anything from Europe but mealy export its cheaper goods, thereby destroying jobs in Europe. Ricardo addressed these concerns by articulating the Principle of Comparative Advantage. It holds that each country will benefit if it specialized in the export of those goods that it can produce at relatively low cost. Conversely, each country will benefit if it imports those goods that it produces at relatively high cost. And it is this simple principle that provides the unshakeable basis for international trade.
