Chapter 16 Microeconomics International Trade

Some International Trade Facts The U.S. is the largest international trader in the world. Trade is a large part of our ever expanding economy. In recent years, the U.S. has had large trade deficits. A trade deficit occurs when a nation’s imports exceed its exports. In 2013, our trade deficit was billion lowest since 2009.

Why Nations Trade? Just like people in the US trade with each other, different nations trade with each other to benefit themselves and each other. The US had a trade deficit of 28 billion in 2013 with Saudi Arabia. However, we use oil to make so many other things. Ultimately, both nations benefit.

The Law of Comparative Advantage The law of comparative advantage states that trade between nations is beneficial to both if there is a difference in “opportunity costs”. Video: XZY XZY

Finding Comparative Advantage In a free market, profit-seeking will lead to the most mutually beneficial production and trade according to comparative advantage. To ensure that trade follows comparative advantage, governments simply need to allow free trade free of barriers and restrictions.

Other Benefits of Free International Trade Free international trade… (1) Extends markets, which allows for economies of scale and greater returns to innovation. (2) Increases competition. (better products and innovation) (3) Speeds the flow of technological advances. (sends it around the world…cell phones)

(4) Gives consumers access to more variety of goods – greater quality of life comes with choices (5) Improves international relations – strong incentives to avoid war and conflicts

Trade Restrictions Though nations benefit overall from free international trade, domestic producers who face increased competition from imports may suffer losses. Domestic producers may seek governmentally imposed restrictions on trade. Called Protectionist Policies

Trade Restrictions Tariff – a tax on an imported good. Quota – a legal limit on the quantity of a good that may be imported. QxN1OBghttp:// QxN1OBg

Gain from Trade Restrictions Both tariffs and quotas will reduce the supply of imports. Domestic producers will sell a greater quantity at a higher price, thus receiving more producer’s surplus. The increase in producer’s surplus is the gain to domestic producers from trade restrictions. See the Graphs on the next two slides.

Free Trade

Quota of Zero

Loss from Trade Restrictions Domestic consumers will buy a lesser quantity at a higher price, thus receiving less consumer’s surplus. The decrease in consumer’s surplus is the loss to domestic consumers from trade restrictions. See the Graphs on the next two slides.

Free Trade

Quota of Zero

Net Loss from Trade Restrictions The loss to domestic consumers exceeds the gain to domestic producers. A trade restriction causes a net economic loss to the nation imposing the restriction. Trade restrictions are an economically inefficient way to redistribute income from domestic consumers to domestic producers.

Free Trade

Net Loss

Loss to Foreign Producers A trade restriction will also impose a loss on foreign producers. The nation of the injured foreign producers may retaliate with trade restrictions of its own.

Politics of Trade Restrictions There is a political reason that trade restrictions are imposed: The benefits of trade restrictions are concentrated on a few producers, while the costs of trade restrictions are dispersed over many consumers. See Example 6 on page 16-6.

Arguments for Trade Restrictions 1. National defense argument – National defense concerns may require certain trade restrictions. See Example 7 on page The national defense argument has been misused.

2. Infant industry argument – new industries need temporary protection from foreign competition. However, investors are willing to suffer short run losses in hopes of long run profits. If “temporary” protection is granted, the domestic producers may never become competitive. Arguments for Trade Restrictions

3. Unfair foreign competition argument. a. Dumping. b. Foreign export subsidies. Both dumping and foreign export subsidies will mean lower prices for U.S. consumers and a net gain to the U.S. economy. Arguments for Trade Restrictions

4. Low foreign wages argument – If domestic producers are not protected from imports, American wages will be driven down to low levels. But high wages overall are made possible by high productivity. Restricting trade reduces a nation’s overall productivity. Arguments for Trade Restrictions

5. Saving domestic jobs argument – Restricting imports can save specific domestic jobs. But protecting noncompetitive jobs interferes with the allocation of labor to its most productive use. And the cost to save the jobs will be greater than the jobs are worth. See Example 9 on page Arguments for Trade Restrictions

Movement Toward Freer Trade Reason 1 – Economic Growth Nations that practice free international trade experience more economic growth than nations that restrict trade. Example 11: According to the “Economic Freedom of the World, 2010 Annual Report”, the twenty-five percent of nations with the most free economies had a per capita Real GDP over 8 times as high as the twenty-five percent of nations with the least free economies.

Movement Toward Freer Trade Reason 2 – Lower Tariff Rates In recent years, there has been a movement toward freer international trade. The mean tariff rate worldwide was decreased from 26.3 percent in 1986 to 8.6 percent in Between 1986 and 2009, exports as a share of worldwide GDP increased from 17% to 32%.

In 1932, the average tariff rate in the U.S. was almost 60%. Today it is less than 4%. The increased international trade has greatly benefited the U.S. economy. See Example 13 on page Movement Toward Freer Trade Reason 3 – Domestic Tariffs dropping

Bonus Stuff

Comparative Advantage versus Absolute Advantage A country can be at an absolute disadvantage in producing all goods and still have a comparative advantage in producing some goods. See the example on page 16-9.

Exchange Rates The exchange rate is the value of one nation’s currency in terms of another nation’s currency. The exchange rate for a nation’s currency will change relative to another nation’s currency due to the determinants of exchange rates.

Determinants of Exchange Rates 1. Differences in inflation rates. The currency of the higher-inflation nation will depreciate versus the currency of the lower-inflation nation. See Example 15 on page

2. Differences in economic growth rates. The currency of the higher-growth nation will depreciate versus the currency of the lower-growth nation. See Example 16 on page Determinants of Exchange Rates

3. Changes in real interest rates. The currency of the increasing-real interest rates nation will appreciate versus the currency of the decreasing-real interest rates nation. See Example 17 on page Determinants of Exchange Rates

4. Changes in foreign investment attractiveness. The currency of the increasing- attractiveness nation will appreciate versus the currency of the decreasing- attractiveness nation. See Example 18 on page Determinants of Exchange Rates

“The Wealth of Nations, Book 4” According to Adam Smith, every individual attempts to employ his resources to produce the greatest possible value, thus promoting the best interest of society. See the quotation on page

Smith was skeptical of government attempts to redirect resource use. See the first quotation on page Instead of restraining trade, Smith asserted that nations should behave like prudent householders. See the second quotation on page “The Wealth of Nations, Book 4”

Smith wrote that consumer interests should prevail over producer interests. “Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.” “The Wealth of Nations, Book 4”