Comparative advantage refers to an economic situation to produce a good at the lowest opportunity cost. Here the trade exchange between China and USA shows how the Law of Comparative holds in real world. With the amount of trade taking place between two countries, the law holds that these trading partners are promoting their self interests by producing the goods for which they have low opportunity cost and trading another good for which they have high opportunity cost(CFA Institute 376).
Since USA and China have low opportunity cost to produce agricultural goods and machinery respectively. These countries are involved in consumption possibilities from international trade by specializing in the production of a good for which they have a comparative advantage and trades with the other for those goods for which it does not.
Although the gains from global trade are clear, many countries to protect and promote interests of domestic producers, impose tariffs on the imported goods (Schweser 291).
Tariff is the tax imposed on imported goods to protect the domestic producers by fixing a tariff rate of an amount equivalent that brings the price of foreign goods and domestic goods at least at par, so the domestic producers can compete on their own.
The figure below shows how the tariff will affect the USA economy by forcing dead weight loss in the economy.
In the above figure, without imposition of tariff, the equilibrium price of Machinery and Equipment was $45/unit and the equilibrium quantity was 90 million units. Now if the American government imposes a tariff of $20/unit to protect their domestic industry of Machinery and Equipments, the supply curve shifts up to S+ Tariff.
As a result, Equilibrium price paid by domestic consumers now rises to $60/unit and the imported quantity of machinery and equipment now decreases to 75 units.
The amount of tariff revenue generated by USA Government is ($20*75) = $1500.
However the gains from trade in the form of consumer and producer surplus is reduced by imposition of tariff revenue by the government and brings the dead weight loss in the economy in the form of under production(Shah 120).
The vice-versa situation also applies if China imposes tariff on import of Agricultural goods from USA as the tariff revenue collected will not be enough to compensate loss in consumer surplus and dead weight loss will arise in the economy.
References:
Kaplan SchweserR. SchweserNotesTM for the CFA Exam. USA: Kaplan, 2012. Print.
Shah, Niranjan. Advanced Economic Theory. Mumbai: Sharma Publications, 2011. Print.
Chartered Financial Analyst(CFA) Institute. Trading With the World. Boston: Custom Publishers, 2012. Print.
