Quiz 18: Gaining From International Trade

Business

American households and businesses buy things from foreigners as it enables them to utilize their resources in production and sale of goods in which they have a comparative advantage and not waste or inefficiently utilize their scarce resources in production or sale of those goods in which they do not enjoy comparative advantage. This increases the per capita availability of goods in United States and raises the standard of living of ordinary Americans. Characteristics of the items that United States buy from foreigners are as follows - 1. United States does not have comparative advantage in the production of such items. 2. Opportunity cost of producing these goods is much higher in United States in comparison to opportunity cost of producing these items in foreign countries. 3. United States generally imports labor intensive goods. Main items imported by United States are crude oil, textiles, shoes, toys, pharmaceuticals and sporting goods etc. Characteristics of the items that United States sell to foreigners are as follows - 1. United States has the comparative advantage in the production of these items. 2. Opportunity cost of producing these goods is lower in United States in comparison to opportunity cost of producing these items in foreign countries. 3. United States generally exports capital intensive and technologically advanced goods. Main items exported by United States are electrical equipments, chemicals, civilian aircraft, and plastics.

The given statement is not correct because if trade restrictions limit the sale of cheap foreign goods in United States, then domestic price of these goods will increase. This increase in price will compel the Americans to decrease their quantity purchased. As we know that consumption and standard of living has direct relationship. Higher the consumption, higher is the standard of living and vice versa. So, decline in consumption due to increase in domestic price of imports due to restrictions implies decline in standard of living as well. Thus, restriction on cheap foreign goods instead of protecting the prosperity of Americans is leading towards the decline in prosperity. Secondly, as U.S. imposes trade restriction on cheap foreign goods to limit their quantity in U.S. market, dollar earnings of foreigners declines. This will thus reduce the quantity demanded by foreigners of U.S. exports. As U.S. exports decline, firms producing exports will cut production and may lay off workers and thus unemployment in United States will rise. This itself indicates that instead of protecting prosperity, trade restrictions on imports decreases prosperity.

If United States divides into two countries and trade barriers between the two grows, then in that case both countries will experience decline in their standard of living. Due to high trade barriers, both countries would be unable to gain from the comparative advantage of each other. This is because due to high trade barriers even if goods move from one country to another country their cost would be so high that inefficient domestic producers would be able to compete against them effectively. In this way, "divided" United States will experience a fall in standard of living. On the other hand, when United States was a single country then there would be no trade restrictions on the flow of goods within United States and each region of United States would gain from the comparative advantage of other regions. In such scenario, goods would be available at the lowest possible cost resulting in higher purchase. Higher purchase implies more consumption and better standard of living. So, division of United States into two countries and resulting high trade barriers between two countries will diminish the gains from trade accruing to both and thus reduce the standard of living in both nations.

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