International Trade

U.S. Trade Patterns Imports and Exports Imports are goods and services purchased from foreign sources. Exports are goods and services sold to foreign buyers.

Imports The U.S. imports over $1 trillion worth of goods and services. Total imports represent 12% of total GDP.

Exports Exports were just under $700 billion in 2000. Exports account for about 11% of total output.

Exports in Relation to GDP 10 20 30 40 50 60 70 80 90 100 EXPORTS (percentage of GDP) Exports in 1999 Myanmar 1 10 Brazil 11 Japan 12 United States 27 Germany 29 Great Britain 31 Mexico 41 Canada 44 Sweden 47 Kuwait 57 Thailand Belgium 73

Trade balance = exports – imports Trade Balances Imports and exports are seldom equal. The trade balance is the difference between exports and imports. Trade balance = exports – imports

Trade Balances Trade deficit — the amount by which the value of imports exceeds the value of exports in a given time period.

Trade Balances Trade surplus — the amount by which the value of exports exceeds the value of imports in a given time period.

Trade Balances Any imbalance in trade in the world must be offset by reverse balances elsewhere in the world.

Trade Balances The U.S. typically has merchandise deficit, a services surplus, and an overall trade deficit.

Trade Balances

Bilateral Trade Balances Top Deficit Countries

Bilateral Trade Balances Top Surplus Countries

Motivation to Trade Specialization increases total world output.

Gains From Trade Increased world output. A higher standard of living in both countries.

Production and Consumption Without Trade The gains from trade may be illustrated using a production possibilities curve. The production-possibilities curve defines the limits to what a country can produce.

Production and Consumption Without Trade In the absence of trade, a country cannot consume more than it produces.

Consumption Possibilities Without trade, a country’s consumption possibilities equals its production possibilities. Consumption possibilities are the alternative combinations of goods and services that a country could consume in a given time period.

Consumption Possibilities Without Trade

Consumption Possibilities Without Trade (a) U.S. production possibilities (zillions of loaves per year) OUTPUT OF BREAD OUTPUT OF WINE (zillions of barrels per year) 60 10 20 30 40 50 80 100 A B C D E F

Consumption Possibilities Without Trade (b) French production possibilities 25 20 G 15 (zillions of loaves per year) OUTPUT OF BREAD H 10 I J 5 K L 10 20 30 40 50 60 OUTPUT OF WINE(zillions of barrels per year)

Production and Consumption With Trade Changing the mix of output results in a higher total level of output. International trade allows each country to focus on what it does best.

Trade Possibilities When a country engages in international trade, its consumption possibilities exceed its production possibilities.

Consumption Combination Before Trade

Consumption Combination After Trade

Consumption Combination After Trade (a) U.S. production and consumption 120 A Production with trade 100 Consumption with trade 80 QUANTITY OF BREAD (zillions of loaves per year) C 60 N D 40 Production and consumption without trade 20 10 20 30 40 50 60 QUANTITY OF WINE (zillions of barrels per year)

Consumption Combination After Trade (b) French production and consumption 20 15 Consumption with trade I M 10 Production with trade QUANTITY OF BREAD (zillions of loaves per year) Production and consumption without trade 5 K 10 20 30 40 50 60 QUANTITY OF WINE (zillions of barrels per year)

Gains from Specialization

Comparative Advantage The ability of a country to produce a specific good or service at a lower opportunity cost than its trading partners. Opportunity cost is the most desired goods or services that are forgone in order to obtain something else.

Comparative Advantage A country should specialize in what it is relatively efficient at producing. That is, goods for which it has the lowest opportunity costs.

Comparative Advantage Comparative advantage refers to the relative (opportunity) cost of producing particular goods.

Comparative Advantage World output and, thus, the potential gains from trade are maximized when each country pursues comparative advantage.

Absolute Costs Don’t Count Absolute Advantage The ability of a country to produce a specific good with fewer resources (per unit of output) than other countries.

Absolute Costs Don’t Count It is not the absolute monetary cost of production that determines a nation’s comparative advantage. It is the opportunity costs.

Terms of Trade The rate at which goods are exchanged The amount of good A given up for good B in trade.

Limits to Terms of Trade A country will not trade unless terms of trade are superior to domestic opportunity costs.

Limits to Terms of Trade The terms of trade between any two countries will lie somewhere between their respective opportunity costs in production.

The Market Mechanism Import/export decisions are left up to the market decisions of consumers and producers.

The Market Mechanism Market participants tend to focus on prices.

The Market Mechanism The terms of trade depend on the willingness of market participants to buy or sell at various prices.

Protectionist Pressures Not everyone supports free trade.

Microeconomic Losers Workers and producers who work in import-competing industries have an economic interest in restricting trade.

Microeconomic Losers Trade redistributes income from import-competing industries to export industries.

Microeconomic Losers Trade not only alters the mix of output but also redistributes income from competing industries to export industries.

The Net Gain Microeconomic gains from trade are greater than the microeconomic losses.

The Net Gain Trade restrictions designed to protect special microeconomic interests reduce the total gain from trade.

Barriers to Trade The microeconomic losses caused by imports give rise to a constant clamor for trade restrictions.

Barriers to Trade Tariff Quota A tax (duty) imposed on imported goods. A limit on the quantity of a good that may be imported in a given time period.

Barriers to Trade Nontariff Barrier Protectionist measures designed to restrict trade.

Tariffs 50% of all U.S. imports – over 9,000 different products – are subject to tariffs. Although individual tariffs vary widely, average tariff is 4%.

Tariffs A tariff on imported goods makes them more expensive to domestic consumers. It makes them less competitive with domestically produced goods.

Tariffs Tariffs raise domestic prices and reduce quantity sold.

Quotas Like all trade barriers, they reduce world efficiency and invite retaliatory action.

Quotas Quotas put an absolute limit on imported sales – gives domestic producers opportunity to raise market price.

Quotas Quotas are a much greater threat to competition than tariffs because they preclude additional imports at any price.

Impact of Trade Restrictions (a) No-trade equilibrium D1 S1 p1 PRICE (dollars per unit) q1 QUANTITY (units per year)

Impact of Trade Restrictions (b) Free-trade equilibrium D1 S1 S2 p2 p1 PRICE (dollars per unit) B qd q2 q1 QUANTITY (units per year)

Impact of Trade Restrictions (c) Tariff-restricted trade D1 S1 p1 PRICE (dollars per unit) C p3 S3 p2 qt q3 S2 qd q1 q2 QUANTITY (units per year)

Impact of Trade Restrictions (d) Quota-restricted trade D1 S1 S4 Q p1 PRICE (dollars per unit) p4 q4 p2 q1 q2 QUANTITY (units per year)

Nontariff Barriers U.S. uses nontariff barriers to restrict roughly 15% of its imports. Examples include product standards, licensing restrictions, and restrictive procurement practices.

Nontariff Barriers In 1999-2000, the European Union banned imports of U.S. beef, arguing that the use of hormones on U.S. ranches created a health hazard for European consumers.

Nontariff Barriers Japan uses these to restrict nearly 30% of its imports.

Exchange Rates Every trade will require two different currencies as long as each nation has its own currency.

Exchange Rates The exchange rate is the price of one country’s currency expressed in terms of another country’s currency.

The Euro Market $1.15 1.10 Euros demanded by: Supply QUANTITY OF EUROS (euros per year) 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 $1.15 E Supply Demand Euros demanded by: U.S. travelers to Europe U.S. consumers buying European exports U.S. investors in European markets Euros supplied by: European consumers European travelers European investors in U.S. markets

Global Pricing The cost of a good depends on:

Appreciation/Depreciation Global prices of all imports and exports change whenever exchange rates change.

Currency Appreciation An increase in the value of one currency relative to another.

Currency Depreciation A decrease in the value of one currency relative to another.

Currency Depreciation If the value of a nation’s currency declines: Its exports become cheaper. Its imports become more expensive.

Foreign Exchange Markets Exchange rates change when either the supply or demand for a currency shift.

Currency Appreciation QUANTITY OF EUROS (euros per year) 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 $1.15 S An increase in euro demand causes it to appreciate. E2 E1 D1 D2

Policing World Trade Trade policy is a continuing conflict between the benefits of comparative advantage and protectionism.

GATT — General Agreement on Tariffs and Trade (1948) Purpose: Pursue free trade policies. Extend equal access – most favored nation status – to domestic markets for all GATT members.

GATT — General Agreement on Tariffs and Trade Tariff rates in developed countries averaged 40 percent when GATT was first signed.

GATT — General Agreement on Tariffs and Trade First seven GATT rounds lowered tariffs to an average of 6.3 percent.

GATT — General Agreement on Tariffs and Trade The Uruguay Round (1994) lowered tariffs to 3.9 percent.

WTO — World Trade Organization Created to replace GATT. The WTO is empowered to cite nations that violate trade agreements and to impose remedial action when violations persist.

WTO Protest Some believe freer trade is a mixed blessing.

WTO Protest Environmentalists Question the desirability of economic growth. Worry about depletion of resources, congestion and pollution, and social friction that growth often promotes.

WTO Protest Labor organizations worry that global competition will depress wages and working conditions.

WTO Protest Many third-world nations are concerned about playing by trade rules that seem to benefit rich nations.

International Trade End of Chapter 17