Why Nations Trade
Council for Economic Education, New York, NY
From Geography: Focus on Economics, Lesson 3
Why do countries trade? Shouldn't a strong country such as the United States produce all of the computers, television sets, automobiles, cameras, and VCRs it wants rather than import such products from Japan? Why do the Japanese and other countries buy wheat, corn, chemical products, aircraft, manufactured goods, and informational services from the United States?
Because countries have different natural, human, and capital resources and different ways of combining these resources, they are not equally efficient at producing the goods and services that their residents demand. The decision to produce any good or service has an opportunity cost, which is the amount of another good or service that might otherwise have been produced. Given a choice of producing one good or another, it is more efficient to produce the good with the lower opportunity cost, using the increased production of that good to trade for the good with the higher opportunity cost.
When a country can produce more of a good with the same resources that another country can, it is said to have an absolute advantage in the production of that good. If the second country has an absolute advantage in producing a good that the first country wants, both will be better off if they specialize and trade.
But trade is usually beneficial to both countries even if one has an absolute advantage in the production of both goods that are to be traded. Given any two products, a nation has a comparative advantage in the product with the lower opportunity cost. The terms of trade must be such that both countries lower the opportunity costs of the goods they are getting from the trade.
Why do countries have different opportunity costs? They have different endowments of productive resources -warmer climates and longer growing seasons; more plentiful natural resources such as oil, iron ore, and water; more highly educated and skilled workers; and larger quantities of more sophisticated machinery.
World trade is not static. It has been increasing both in amount and in significance. New supplies of natural resources can be discovered and developed while existing supplies are better managed. Human resources can be improved through better educational programs. Capital resources can be acquired to make the better trained workers even more productive. The increase in world trade should result in more efficient use of the world's scarce resources, and in higher standards of living.
Students read and discuss a narrative about international trade that focuses on opportunity cost and the principle of comparative advantage. Then the class is divided into four groups, each representing a different country. They engage in a simulation that assesses the skills available within their countries, and each country decides on an area of specialization. The lesson ends with a class discussion about the decisions made by the four countries and the economic benefits and/or costs of those decisions.
Middle School, average and above average students.
- Opportunity Cost
- Absolute Advantage
- Comparative Advantage
- Specialization Terms of Trade
Content Standards and Benchmarks
National Standard Number: 5
Voluntary exchange occurs only when all participating parties expect to gain. This is true for trade among individuals or organizations within a nation, and usually among individuals or organizations in different nations.
National Standard Number: 6
When individuals, regions, and nations specialize in what they can produce at the lowest cost and then trade with others, both production and consumption increase.
- Recognize that comparative advantage is the basis for trade.
- Engage in a comparative advantage simulation.
- Analyze the simulation results and use the comparative advantage model to make a decision about specialization.
- Predict the consequences of one's decisions.
Three class periods. (Two if the reading of Activity 1, Comparative Advantage assigned as homework.)
- Distribute Activity 1, Comparative Advantage. Allow students sufficient time to read the explanation of comparative advantage or assign the reading for homework. (This is a difficult concept for students at all levels to understand. You may choose to treat the activity as a text and read through it step by step with your students. Once you think the students understand the concept, use steps 2 through 9 as a review.)
- Copy TABLE A on the board. Ask the following questions:
What would be the total production of shoes and shirts without specialization and trade? (180 units of shoes and175 units of shirts.)
How many units of each good would the United States have? (100 units of shoes and 75 units of shirts.)
How many units of each good would Canada have? (80 units of shoes and 100 units of shirts.)
- Copy TABLE B on the board. Ask the following questions:
How did specialization affect world production? (Added 20 units of shoes and 25 units of shirts.)
How did specialization and trade affect the standard of living in the United States? In Canada? (The United States added 25 units of shirts. Canada added 20 units of shoes.)
- Copy TABLE C on the board. Ask the following questions:
What would be the total production of shoes and shirts without specialization and trade? (180 units of shoes and 155 units of shirts.)
How many units of each good would the United States have? (100 units of shoes and 80 units of shirts.)
How many units of each good would Canada have? (80 units of shoes and 75 units of shirts.)
- Copy TABLE D on the board. Ask the following question:
How did specialization affect world production? (Added 20 units of shoes and lost 5 units of shirts.)
- Copy TABLE E on the board. Ask the following questions:
How did this case of partial specialization increase total production from TABLE C? (Added 10 units of shoes and 3 units of shirts.)
Assume that the United States trades 85 units of shoes to Canada for 75 units of shirts as shown below:
How many units of each good would the United States have? (105 units of shoes and 83 units of shirts.)
How many units of each good would Canada have? (85 units of shoes and 75 units of shirts.)
Would this be an improvement over TABLE C? (The United States would add 5 units of shoes and 3 units of shirts; Canada would add 5 units of shoes.)
- Suppose that the United States trades 90 units of shoes to Canada for 75 units of shirts as shown below. Would both countries be better off than in TABLE C? (The United States would add 3 units of shirts and Canada would add 10 units of shoes.)
Why wouldn't the United States trade 95 units of shoes for 75 units of shirts?
(Without specialization the United States had 100 units of shoes and 80 units of shirts. The opportunity cost of one unit of shirts was 1.25 units of shoes. Three shirts would cost 3.75 units shoes. This trade would give up 5 units of shoes for 3 shirts.)
- Who benefits when countries trade? (Both countries benefit or no trade will take place.)
- Set up the classroom as described in Activity 2, Human Resources and Comparative Advantage. (Corner #1, SERVICE SKILLS; Corner #2, SALES SKILLS; Corner #3, BUREAUCRATIC SKILLS; Corner #4, COMPUTER SKILLS; Center of the Classroom, OTHER.)
- Provide someone to administer the tests in Corner #3 (Activity 3, Bureaucratic Skills Test) and Corner #4 (Activity 4, Computer Skills Test).
- Divide the remaining students into 4 approximately equal groups. Explain to the students that they should not be discouraged if they find one or more of the tests from Activity 2 to be difficult. If everyone got all the questions right, there would be no reason to specialize, and this activity is about specialization based on comparative advantage.
- Distribute Activity 2, Human Resources and Comparative Advantage. Have the groups meet, read over the activity, and decide what they have to do. Once they have indicated they are ready to begin their testing, signal them to begin. After 10, 20, and 30 minutes, remind them to move to another testing area; after 40 minutes, have them regroup in their countries to complete steps 4 through 7 of Activity 2.
1. 1 point for each word in correct position.
2. 2 points for each correct answer.
a. Yes b. Yes c. No
One point for each correct answer.
1. (28 days)
5. (Jane, 3, Jonas, 9, Juan)
10??. (100, 4, 4, 40)
- Put the chart under step 8 of Activity 2 on the board. Have each country fill in its information. Ask each country what it decided to produce and the reasoning behind the decision.
Have each student make a copy of the completed chart under step 8 of Activity 2.
Ask each student to write a one-page paper explaining why their country should or should not specialize and trade. They must discuss the opportunity costs involved and how com-parative advantage has influenced their decision. They should mention likely trading partners in their explanation.
Ask the students to write an original paragraph about two fictional countries and the products that they might exchange. Tell them to be sure to explain why these countries chose to produce these products, and what kind of trade will take place between these countries. Ask your most able students to define Absolute Advantage and Comparative Advantage and to explain how the two are different.
1. Ask each student to look for newspaper and periodical articles that discuss international trade. Have a committee of students develop a clipping file on such topics as NAFTA, Mexico's peso crisis, the impact of rising interest rates in the United States on investment in developing countries such as Mexico, the impact of middle-class Mexicans buying U.S.-made consumer goods, major trading partners of the United States, U.S. trade relations with Japan and other Pacific Rim countries, the return of Hong Kong to China, U.S. trade relations with Canada, GATT, widening NAFTA to include Latin American countries, U.S. trade relations with Russia and the other former Soviet states, and U.S. trade relations with the European Economic Community. (Give students credit for contributing to or organizing the file.)
2. Allow students to write short (one page) summaries of articles from the clipping file with at least one additional paragraph explaining how opportunity cost and comparative advantage help them to understand what is going on in the situation described in the article. (Students who submit thoughtful and perceptive analyses should be encouraged to present their papers to the class.)