International Trade 4.1 and 4.2

Memory check Formula for GDP (aka AD) ? GDP = C +I+G+(X-M) Formula for rGDP? rGDP = C + I +G + (X-M) Adjusted for inflation (X-M) is aka Balance of Payments or Current Account Balance

Why trade What you have 4 factors of production AKA Endowments Not equal worldwide

Canada

Alaska

Saudi Arabia

Phillipines

India

California

Absolute vs Comparative Advantage Absolute Advantage Reciprocal Comparative Advantage Specialization

Cost per unit in man hours 100 110 90 80

So… England has 1:1.1 ratio of cloth to wine Portugal has 9:8 ratio of cloth to wine Assume 1000 man hours available

In England a unit of cloth costs 100 and a unit of wine 120 units of labour; in Portugal a unit of cloth costs 90 and a unit of wine 80 units of labour’. (Ricardo)

ENGLAND 9.09 Wine A B 10 Cloth

PORTUGAL 12.5 Wine A B 11.1 Cloth

Assumptions There are no transport costs. Costs are constant There are only two economies producing two goods. The theory assumes that traded goods are homogeneous (ie identical). Factors of production are assumed to be perfectly mobile. There are no tariffs or other trade barriers. There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.

X A A2 B B2 Y

X A A2 B B2 Y

How we measure trade X M If X > M then…. If inverse…. But not whole picture If X > M we assume C & I will grow BUT….

Grows when businesses spend on new Factories, machines, office products etc C + I + G + (X-M) Grows when consumers spend money Grows when Gov’t buys goods or services

So…. Could limiting M help C or I? Does limiting M always help C or I? What role does G play in offsetting decreases in C or I due to increase in M or decrease in X? What role does G play in facilitating X? (or M as the case may be?)

The Equilibrium without International Trade

International Trade in an Exporting Country

How Free Trade Affects an Exporting Country

International Trade in an Importing Country

How Free Trade Affects an Importing Country

II. Ways to approach trade 3 patterns Protectionism Free Trade Fair Trade And what is impact on GDP?

III. Protectionism Methods:

Main methods of trade barriers Tariffs (import duties) - import taxes Quotas – volume limits imports allowed Voluntary Export Restraint Agreements Embargoes - a total ban on imported goods Subsidies - a government payment to encourage domestic production by lowering their costs Export subsidies Import licensing systems Exchange controls - limiting the amount of foreign currency that can move between countries

Effects Domestic Supply Price World Price Pw Imports Domestic Demand Qs Qd Output (Q)

Embargo Domestic Supply Price P Domestic Demand Qs Output (Q)

Import Tariffs Domestic Supply Price Pw + Tariff World Price Pw Domestic Demand M Qs Qs2 Qd2 Qd Output (Q)

Tariffs Revenue Domestic Supply Price Pw + Tariff Revenue from Tariff World Price Pw Domestic Demand M Qs Qs2 Qd2 Qd Output (Q)

Effects of a quota Visualize: World Price intersection of D is cheaper than domestic (S & D). A Quota only allows in some products at World Price, rest goes back to Domestic prices (although slightly lower)

Summary of import control effects Intervention Type (domestic) quantity traded Effect on consumer surplus Effect on (domestic) producer surplus Effect on Budget Finances Production Quotas Falls; Excess Supply Falls Rise or Fall Zero Import Tariffs Rises Positive Import Quotas

Arguments for and against Infant Industry Senile Industry Balance of Payments(X-M) Anti dumping Protect employment To raise revenue for Gov’t (tariff=tax) Costs more Retaliation risk Improperly applied Less choice Inefficient

Non economic arguments Strategic (defense, retaliatory) Product standards Politically popular QUIZ

50 years of tariff reductions GATT/WTO: 50 years of tariff reductions Tariff reduction of industrial countries for industrial products, excluding petroleum Implementation period Round covered Weighted tariff reduction 1948–63 First five GATT rounds (1947–62)  –36 1968–72 Kennedy Round (1964–67)  –37 1980–87 Tokyo Round (1973–1979)  –33 1995–99 Uruguay Round (1986–94)  –38 Note: Tariff reductions for the first five trade rounds refer to US only

Figure 6 The Effects of a Tariff

Figure 7 The Effects of an Import Quota

Figure 8 The Effects of an Export Subsidy Without Subsidy With Subsidy CHANGE Consumer Surplus A+B Producer Surplus E+F+G B+C+E+F+G +(B+C) Government Revenue –(B+C+D) Total Surplus A+B+E+F+G A+B–D+E+F+G –D