International Trade MB MC Chapter 16 International Trade

International Trade MB MC Chapter 16: International Trade and Trade Policy

MB MC Introduction n Understanding the Economic Issues of International Trade The benefits of trade l The costs of trade l The economic impact of trade restrictions l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 2

MB MC n Comparative Advantage as a Basis for Trade The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 3

MB MC n Closed Economy l n Production and Consumption Possibilities and the Benefits of Trade An economy that does not trade with the rest of the world Open Economy l An economy that trades with other countries Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 4

MB MC Production Possibilities Curve for a Many-Worker Economy A Coffee (pounds/year) 100, 000 Observations • The OC of producing an additional unit = the slope of the line that touches the point • OC will increase as output of on good increases C D 40, 000 B 1, 000 2, 000 Computers (number/year) Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 5

MB MC Production and Consumption Possibilities and the Benefits of Trade n A country’s PPC shows the quantities of different goods that its economy can produce. n Consumption Possibilities l The combinations of goods and services that a country’s citizens might feasibly consume Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 6

MB MC n Production and Consumption Possibilities and the Benefits of Trade In a closed economy: Society’s production possibilities = consumption possibilities. l If a country is self-sufficient, it is called autarky. l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 7

MB MC n Production and Consumption Possibilities and the Benefits of Trade In an open economy: l The society’s consumption possibilities are typically greater than its production possibilities. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 8

MB MC Buying and Selling in World Markets 150, 000 Coffee (pounds/year) 120, 000 A C Assume: • Producing at D • Closed economy • World price of coffee = $10/lb and computer = $500 100, 000 D 50, 000 B 1, 000 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 2, 000 2, 400 Computers/year Chapter 9: International Trade 3, 000 9

MB MC Buying and Selling in World Markets 150, 000 Coffee (pounds/year) 120, 000 E Consumption possibilities A C 100, 000 Observation: • Sell 2, 000 computers @ $500 • Take the $1 million and buy 100, 000 pounds of coffee • Consumption possibilities of 150, 000 is greater than PPC without trade D 50, 000 Production possibilities B 1, 000 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 2, 000 2, 400 Computers/year Chapter 9: International Trade F 3, 000 10

MB MC Buying and Selling in World Markets 150, 000 Coffee (pounds/year) 120, 000 E Consumption possibilities A C Observation: • Start at D • Sell 50, 000 lbs of coffee • Buy 1, 000 computers with the $500, 000 • Pt F is possible with trade but not on the PPC 100, 000 D 50, 000 Production possibilities B 1, 000 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 2, 000 2, 400 Computers/year Chapter 9: International Trade F 3, 000 11

MB MC Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy 160, 000 150, 000 L E Coffee (pounds/year) 120, 000 100, 000 Consumption possibilities • 50 lbs of coffee trades for 1 computer • LM = consumption possibilities • G is the optimal combination for Costa Rica • Costa Rica can use trade to locate anywhere along LM A C G 50, 000 D Production possibilities B 1, 000 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 2, 000 2, 400 Computers/year Chapter 9: International Trade F M 3, 000 3, 200 12

MB MC Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy 160, 000 150, 000 L E Coffee (pounds/year) 120, 000 100, 000 Consumption possibilities Why produce at G? • Slope of the PPC = LM • Domestic and international opportunity costs of acquiring an extra computer (in terms of forgone coffee) are equal A C G 50, 000 D Production possibilities B 1, 000 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 2, 000 2, 400 Computers/year Chapter 9: International Trade F M 3, 000 3, 200 13

MB MC A Straight-Line Production Possibilities Curve Coffee (pounds/year) 800 600 A B Observation • The tradeoff between coffee and tea is constant at any point on the PPC C 200 D 200 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 600 Tea (pounds/year Chapter 9: International Trade 800 14

MB MC Two Consumption Possibilities Curves Consumption possibilities curve when the world price of coffee is twice the world price of tea Coffee (pounds/year) 800 600 A • Islandia produces at A • Islandia can use the money earned from selling 800 lbs of coffee to choose any combination on AD’ B C 200 D 200 Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 600 800 Tea (pounds/year Chapter 9: International Trade D’ 1, 600 15

MB MC Two Consumption Possibilities Curves Coffee (pounds/year) 1, 600 A’ Consumption possibilities curve when the world price of tea is twice the world price of coffee 800 600 200 A • Islandia produces at D • Islandia can choose any combination on A’D B C D 200 600 800 Tea (pounds/year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 16

MB MC n Consumption Possibilities With and Without International Trade What Do You Think? l Where should Islandia produce if the price of coffee and tea were the same? Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 17

MB MC n Consumption Possibilities With and Without International Trade Observations With a bow-shaped PPC consumption possibilities is typically maximized by producing where the PPC is tangent to the consumption possibilities line. l With a straight-line PPC production is completely specialized. l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 18

MB MC n Production and Consumption Possibilities and the Benefits of Trade Economic Naturalist l Does “cheap” foreign labor pose a danger to high-wage economies? Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 19

MB MC n Production and Consumption Possibilities and the Benefits of Trade Economic Naturalist l Scenario u U. S. and Fredonia produce software and beef. u Real wages in Fredonia are lower than in the U. S. u Fredonia is half as productive as the U. S. in beef production. u Fredonia is one-tenth as productive in software production. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 20

MB MC n Production and Consumption Possibilities and the Benefits of Trade Economic Naturalist l Outcome u Fredonia has a comparative advantage in beef. u U. S. has a comparative advantage in software. u The U. S. will trade software for beef and increase its consumption of both. u Employment in the software industry in the U. S. increases and employment in the beef industry will decrease. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 21

MB MC The Market for Computers in Costa Rica Consumer surplus without trade = $1 mil/yr 2, 400 Domestic supply Consumer surplus with trade = $1. 96 mil/yr 2, 400 E Producer surplus with trade = $360 K/yr E 1, 400 Producer surplus without trade = $1 mil/yr Domestic supply F 1, 000 World price Computer Imports 400 Domestic demand 2, 000 Computer per year Without Trade Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 4, 800 400 Domestic demand 1, 200 Chapter 9: International Trade 2, 000 2, 800 Computer per year With Trade 4, 800 22

MB MC n A Supply and Demand Perspective on Trade If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 23

MB MC The Market for Coffee in Costa Rica Consumer surplus without trade = $250 K/yr Consumer surplus with trade = $40 K/yr Domestic supply 12 10 F E World price E 7 7 Producer surplus with trade = $600 K/yr Producer surplus without trade = $150 K/yr 4 4 Coffee exports Domestic demand 100, 000 Coffee (pounds/year) Without Trade Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. 240, 000 Domestic demand 40, 000 100, 000 240, 000 Coffee (pounds/year) With Trade Chapter 9: International Trade 24

MB MC n A Supply and Demand Perspective on Trade If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 25

MB MC n A Supply and Demand Perspective on Trade Observations of the Mutually Beneficial Gains from Trade Countries will profit by exporting the goods and services for which they have a comparative advantage. l The revenue from the exports are used to import goods and services for which they do not have a comparative advantage. l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 26

MB MC n A Supply and Demand Perspective on Trade Observations of the Mutually Beneficial Gains from Trade The markets will ensure that goods will be produced where opportunity cost is lowest. l The consumption possibilities will be maximized. l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 27

MB MC Exercise 9. 4 Domestic supply Price of computers ($/computer) 2, 400 Question • Given the graph shown, what impact would trade have on producer and consumer surplus? 2, 100 World price 1, 200 600 Domestic demand 200 500 800 1, 200 Computers per year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 28

MB MC n A Supply and Demand Perspective on Trade Winners and Losers from Trade l Winners u Consumers of imported goods u Producers of exported goods l Losers u Consumers of exported goods u Producers of imported goods Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 29

MB MC n Protectionism l n The view that free trade is injurious and should be restricted Tariff l n A Supply and Demand Perspective on Trade A tax imposed on an imported good Quota l A legal limit on the quantity of a good that may be imported Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 30

MB MC The Market for Computers after the Imposition of an Import Tariff Domestic supply Price of computers ($/computer) 2, 400 E 1, 200 World price + tariff 1, 000 World price 400 Imports without tariff 1, 200 1, 600 2, 400 2, 800 Domestic demand 4, 800 Computers per year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 31

MB MC The Market for Computers after the Imposition of an Import Tariff Price of computers ($/computer) 2, 400 Consumer surplus with tariff = 1. 44 K/yr Domestic supply Tariff revenue = $160 K/yr E 1, 200 World price + tariff 1, 000 World price 400 Producer surplus with tariff = 640 K/yr Imports with tariff 1, 200 1, 600 2, 400 2, 800 Domestic demand 4, 800 Computers per year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 32

MB MC Exercise 9. 5 Domestic supply Price of computers ($/computer) 3, 600 Question • Given the graph shown, how will a tariff of $300 per computer affect total economic surplus? 2, 100 1, 500 World price 1, 200 600 Domestic demand 200 300 500 700 800 1, 200 Computers per year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 33

MB MC n Protectionist Policies: Tariffs and Quotas What do you think? l Why did President George W. Bush support the imposition of tariffs on steel imported into the United States? Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 34

MB MC n Protectionist Policies: Tariffs and Quotas Legal limit on the number or value of foreign goods that can be imported l Can be enforced by issuing permits l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 35

MB MC The Market for Computers after the Imposition of an Import Quota Domestic supply Price of computers ($/computer) 2, 400 Domestic supply + quota E 1, 400 F 1, 200 Imports with free trade = 1, 600 computers/yr World price 1, 000 400 Domestic demand 1, 200 1, 600 2, 400 2, 800 2, 000 4, 800 Computers per year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 36

MB MC The Market for Computers after the Imposition of an Import Quota Price of computers ($/computer) 2, 400 Domestic supply Consumer surplus with quota = $1, 440 K/yr Domestic supply + quota E 1, 400 F Economic rent to holders of import licenses = $80 K/year 1, 200 World price 1, 000 Imports = 800 computers/year 400 Producer surplus with quota = $640 K/yr Domestic demand 1, 200 1, 600 2, 400 2, 800 2, 000 4, 800 Computers per year Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 37

MB MC n A Supply and Demand Perspective on Trade Quotas & Tariffs Market effects of tariffs are the same. l Tariffs generate tax revenue. l Quotas generate revenue for the firms that hold an import license. l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 38

MB MC n A Supply and Demand Perspective on Trade Question l Why would the government ever impose a quota rather than a tariff? Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 39

MB MC n A Supply and Demand Perspective on Trade Economic Naturalist l Who benefited from and who was hurt by voluntary export restraints on Japanese automobiles in the 1980 s? Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 40

MB MC n A Supply and Demand Perspective on Trade Other Barriers to Trade Red-tape barriers l Regulations l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 41

MB MC n A Supply and Demand Perspective on Trade The Inefficiency of Protectionism Trade barriers are inefficient and reduce the size of the economic pie. l Because trade barriers benefit certain groups, and these groups may be well organized, they may be successful in lobbying for trade barriers. l The gains from trade could be used to assist groups that have been hurt by trade. l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 42

MB MC Outsourcing n Outsourcing l A term increasingly used to connote having services performed by low-wage workers overseas Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 43

MB MC Outsourcing n Outsourcing l Outsourcing of services to low-wage foreign workers is exactly analogous to the importation of goods manufactured by lowwage foreign workers. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 44

MB MC Outsourcing n Economic Naturalist Paul Solman and his associate Lee Koromvokis produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program, The News. Hour with Jim Lehrer. l Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderbad? l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 45

MB MC Outsourcing n Characteristics of Jobs that are Less Susceptible to Outsourcing Less rules-based jobs l “Face-to-Face” complex communication jobs l Jobs that require the worker to be physically present l Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 46

MB MC Outsourcing n Responding to changing economic conditions requires the ability to adapt quickly to new circumstances. n Education provides the means to develop a comparative advantage that is not rules -based and does require complex face-to -face communication. Copyright c 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Chapter 9: International Trade 47

End of Chapter MB MC Chapter 16: International Trade and Trade Policy