The Case for Free Trade

Tariffs, Comparative Advantage, and Opportunity Cost

To understand free trade we must first understand what a tariff really is. A tariff is a fancy name for a tax on imported goods across a nations borders. For example corporation Z. moves butter from country A. to country B. Country B. imposes a tax on country A’s butter produced by corporation Z.

In an ideal world, Countries would produce goods that they have a Comparative Advantage in. Comparative Advantage means that companies make goods that they can produce most efficiently or with the least opportunity cost to produce. Opportunity cost means that an individual has the choice between two different things: for example going to college or working full time. If they work full time, they can make 20k per year, if they go to college for 4 years; they can then make 40k per year with their college degree. So therefore going to college has an opportunity cost of 80k over 4 years, or the money that was lost by not working and going to school.

Therefore if a country has an comparative advantage, then they should produce what they can make most efficiently and export that good. This means that they should only produce comparative advantage goods and import everything else. For example, Honduras has a comparative advantage in producing bananas. This means that Honduras devotes most of their resources to producing bananas for export, and therefore imports everything else.

In our example with Honduras, lets say the United States places a tariff on Bananas. Bananas will now cost more in the United States, price will increase on bananas in the United States, and the quantity demanded in The United States will fall. If people in the United States demand less Bananas due to the tariff, Honduras will now sell less bananas to the United States, and depending on how large a buyer the United States is of bananas, this could potentially significantly lower Honduras exports of bananas. Therefore if Honduras sells less bananas, they are able to import fewer other goods needed in their economy.

In this simple example, it is clear that Honduras and the United States are significantly hurt by a tariff imposed by the United States on Bananas.