INTRODUCTION TO ECONOMICS Beata Łopaciuk-Gonczaryk Lecture 11 International Trade

Outline Facts of International Trade The Economic Basis for Trade The Principle of Comparative Advantage Trade Barriers The Case for Protection: A Critical Review The World Trade Organization

Facts of International Trade: Highlights Exports as a share of total output Trade deficit Free trade agreements (EU, NAFTA, etc.) Improved transportation and communication has contributed to international trade since WWII. U.S., Japan, Western Europe and China dominate world trade, but substantial international trade form South Korea, Taiwan, and Singapore.

Shares of World Exports, 2001 GLOBAL PERSPECTIVE Shares of World Exports, 2001 0 2 4 6 8 10 12 United States Germany Japan France United Kingdom China Canada Italy Source: World Trade Organization

Shares of World Exports, 2009 GLOBAL PERSPECTIVE Shares of World Exports, 2009 Source: World Trade Organization, http://stat.wto.org

The Economic Basis for Trade The rationale for trade: uneven distribution of economic resources among nations efficient production of various goods requires different technologies or combinations of resources products are differentiated among nations and some people prefer imported goods

The Economic Basis for Trade Examples: Japan: has a large, well‑educated labor force can specialize in labor‑intensive commodities Australia: has an abundance of land relative to human and capital resources and can cheaply produce land‑intensive agricultural products Industrially advanced nations: are in a position to produce capital‑intensive goods.

Production Possibilities Curve For Each Country United States Brazil Coffee (tons) 45 40 35 30 25 20 15 10 5 5 10 15 20 25 30 5 10 15 20 Wheat (tons) constant cost industries (18, 12) A (8, 4) B

Comparative Advantage Differing opportunity costs of producing various goods and services Total output will be greatest when each good is produced by the nation that has the lowest opportunity cost for that good Example U.S has comparative advantage in wheat and Brazil has comparative advantage in coffee after specialization there will be more coffee and more wheat in total than the totals before specialization

Comparative Advantage Terms of trade The rate at which units of one product can be exchanged for units of another product The amount of one good or service that must be given up to obtain 1 unit of another good or service in the U.S. 1 wheat = 1 coffee in Brazil 1 wheat = 2 coffee, so Brazil will not trade more than 2 coffee for 1 wheat. the rate of exchange will be somewhere between 1 and 2 coffees for each wheat The actual TOT - country’s negotiating power and world demand and supply conditions.

Trading Possibilities Lines – the Gains From Trade United States Brazil 45 40 35 30 25 20 15 10 5 If the U.S. chooses to trade 10 tons of wheat for 15 tons of coffee Trading possibilities line 30 25 20 15 10 5 Coffee (tons) Coffee (tons) Trading possibilities line A B 5 10 15 20 25 30 5 10 15 20 Wheat (tons) Wheat (tons)

Trading Possibilities Lines – the Gains From Trade United States Brazil 45 40 35 30 25 20 15 10 5 Trading possibilities line 30 25 20 15 10 5 Coffee (tons) Coffee (tons) Trading possibilities line A’ (20,15) A B’ (10, 5) B 5 10 15 20 25 30 5 10 15 20 Wheat (tons) Wheat (tons)

Comparative Advantage The gains from trade Improved productivity of resources Added output Remark In reality increasing costs Complete specialization will probably not occur with many products

Comparative Advantage Through free trade, based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well‑being Free trade: promotes competition and deters monopoly power specialization increases the production possibility curve by raising the productivity of the resources devoted to producing certain goods

Trade Barriers Types of barriers: Tariffs Import quotas taxes raising import prices Import quotas maximum amounts of imports allowed Nontariff barriers licensing requirements, unreasonable standards, or bureaucratic red tape in customs procedures Voluntary export restrictions agreements by foreign firms to “voluntarily” limit their exports to a particular country

Economic Impact of Tariff or Quota Source: McConell and Brue 2005

Economic Impact of Tariffs Direct effects when tariff is imposed: Domestic consumption declines as the price rises to Pt Domestic production rises because the price has risen Imports fall Government tariff revenue represents a transfer of income from consumers to government Indirect effect Relatively inefficient industries are expanding Relatively efficient industries abroad have been made to contract

Economic Impact of Quotas Similar to tariffs, but No revenue is generated for the government Price rises to pt as with the tariff, but Revenue generated by the higher price goes to foreign and domestic producers No possibility for consumers to obtain more than the allowed quota Even at higher prices

The Case for Protection Military self‑sufficiency National defense argument but It is difficult to select strategic industries to protect Increasing domestic employment Imports may eliminate some jobs, but they create others in the sales and service industries for these products The trading partner may be made weaker and less able to buy the protectionist nation’s products Trade wars

The Case for Protection Diversification for stability protecting certain industries until they become viable does not apply to diversified economies economic costs of diversification may be great and not worth the protection The infant‑industry argument new industries may need “temporary” protection to gain productive efficiency but difficult to determine which industries protection may persist direct subsidies may be preferable to international protection Viable = profitable

The Case for Protection Protection against “dumping” the below‑cost sales - a form of price discrimination antidumping duties (tariffs) Protection against competition from cheap foreign labor not valid it is mutually beneficial for rich and poor to trade with one another The infant‑industry argument and the military self‑sufficiency argument may be justifiable on political grounds

World Trade Organization Inefficiencies of protectionism - seeking ways to promote free trade World Trade Organization GATT (1948-1994) 153 nations China from 2001 Poland from 1995 oversees provisions of agreement and resolves disputes a protest target of groups who are against various aspects of globalization

Key Terms labor-intensive goods land-intensive goods capital-intensive goods cost ratio principle of comparative advantage terms of trade trading possibilities line gains from trade world price domestic price export supply curve import demand curve equilibrium world price tariffs revenue tariff protective tariff import quota nontariff barrier (NTB) voluntary export restriction (VER) strategic trade policy dumping World Trade Organization (WTO)