May 02 2007

Does free trade really mean lower prices? A debate between two economists much smarter than me

Dani Rodrik’s weblog: Does Free Trade Bring Lower Prices?

Greg Mankiw’s Blog: Does free trade lower prices?

Here’s a very interesting discussion between two Harvard professors (a “diablog” as my IB students and I call it). Greg Mankiw (author of a widely used AP Econ textbook) takes Dani Rodrik to task on his view that countries producing the products for which they have comparative advantage, and trading in a free global market, may actually face higher prices as a result of free trade. This seems to defy what AP Econ students learn about the impact of free trade on domestic product prices.

In our text, we learned that in a particular market in which free trade exists, the world supply curve lies beyond the domestic supply curve, resulting in a lower world price, meaning domestic firms produce less output and sell it at a lower price than they would without trade. This of course would represent an industry in which the country in question is at a comparative disadvantage, and thus is a net importer of the product. Assuming that a particular country will be net importers of certain goods (those for which they have a comparative disadvantage) and a net exporter of other goods (those for which they have a comparative advantage), we may infer that the net result will be lower prices faced by consumers due to all the relatively cheap imports that trade affords. Rodrik, however, argues that in some cases, when a country is a net exporter (as the US is for agricultural products, given its huge comparative advantage in the farming industry), the foreign demand for its domestic output may in fact drive prices paid by domestic consumers up, as foreigners demand more and more of the country’s output in those markets. If the increase in price that results from exporting large quantities of output outweigh the price decreases that consumers enjoy due to cheap imports (think Walmart, folks) then perhaps free trade would result in an overall increase in the price level.

The theory brought forth in the Mankiw/Rodrik discussion goes way beyond AP Economics, but if you’re like me and enjoy pushing your understanding of economics to the edge, these articles just may be within the realm of an AP Econ student’s grasp of the subject! And if this stuff interests you as much as it does me, then you may just consider studying Econ in college! Which reminds me, for those of you who promise to major in Econ in college, I promise to have a pleasant surprise for you the day after our AP exams on the 17th! Stay tuned!

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

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