International Trade Patterns and Trends in International Trade Gains from trade Absolute and comparative advantage revisited Tariffs Quotas Welfare loss from trade restrictions Arguments for trade restrictions

Source: www.bls.gov

Foreign sector as a percent of GDP has grown

The U.S. trade deficit

Composition of U.S. Imports and Exports Composition of US merchandise exports and imports in 2006

U. S. production as a percentage of U. S U.S. production as a percentage of U.S. consumption for various commodities Percent If U.S. production is <100% of consumption, imports make up the difference. If U.S. production exceeds U.S. consumption, then the difference is exported.

Win-win? Ricardo’s principle of comparative advantage shows how trade between nations can be mutually beneficial

Production possibilities for United States and Izodia (a) United States Production possibilities with 100 million workers (millions of units per day) U1 U2 U3 U4 U5 U6 Food Clothing 600 480 60 360 120 240 180 300 (b) Izodia Production possibilities with 200 million workers I1 I2 I3 I4 I5 I6 200 160 80 40 320 400

Production possibilities frontiers for the United States and Izodia without trade (millions of units per day) (a) United States (b) Izodia 100 200 300 400 500 600 Food 100 200 300 400 500 600 Food U1 U2 U3 U4 I1 I2 U5 I3 I4 I5 U6 I6 100 200 300 400 Clothing 100 200 300 400 Clothing Slope: opportunity cost of an additional unit of food is ½ unit of clothing An additional unit of food costs 2 units of clothing. Food is produced at a lower opportunity cost in the United States.

Comparative advantage Measuring opportunity cost: For the United States Food: 60 clothing/120 food = ½ clothing per food. Clothing: 120 food/60 clothing = 2 food per clothing For Izodia Food: 80 clothing/40food = 2 clothing per food Clothing: 40 food/80 clothing = ½ food per clothing Thus the Unites States has the comparative advantage in food and Izodia has the comparative advantage in clothing.

Terms of trade How much of one good exchanges for a unit of another good. As long as the Americans can get more than ½ unit of clothing for each unit of food , and as long as the Izodians can get more than ½ unit of food for a unit of clothing, both sides benefit from specialization and trade

1 unit of clothing = 1 unit of food These terms work for both sides

Production (and consumption) possibility frontiers with trade (millions of units per day) (a) United States (b) Izodia 100 200 300 400 500 600 Food 100 200 300 400 500 600 Food U U4 I I3 100 200 300 400 Clothing 100 200 300 400 Clothing Trade: 1 unit of clothing for 1 unit of food. Both countries are better off as a result of international trade.

Gains from trade United States Izodia Clothing (units) Food (units) No Trade 180 240 160 120 Trade 200 400 Gain 20 40 80

Trade restrictions Trade embargos: Prohibitions on the importation (or exportation) of goods and services. Examples: 1973 Oil embargo, trade embargo with Iraq, embargo on imported sugar from Cuba. Tariffs: Taxes imposed on imported goods. Quotas: Limits on the quantity or value of goods or services that can be imported or exported. Examples: The textile quota, the sugar quota, export quota on raw timber. Subsidies: payments by government to exporters. These stimulate trade by allowing the exporter to charge a lower price.

Non-tariff trade barriers Health and safety standards—such as European ban on genetically-modified soybeans and hormone-treated beef. Product design standards Licensing requirements Bureaucratic red tape The Japanese trade ministry (MITI) decided that snow skis made in the U.S. were not safe enough for Japanese ski enthusiasts

Consumer and producer surplus from market exchange $0.50 0.25 Price per pound D = marginal benefit Consumer surplus S = marginal cost Producer surplus 60 Chicken (pounds per day)

Effect of a tariff At a world P=$0.10 per pound, US consumers demand 70 mill. pounds of sugar per month, and US producers supply 20 mill. pounds per month; the difference is imported. $0.15 0.10 per pound Price S D Tariff= $0.05 per pound; P=$0.15 per pound. US producers increase production to 30 mill. pounds; US consumers cut back to 60 mill. pounds. Imports fall to 30 mill. pounds. a c b d a = increase in producer surplus f c = government revenue from the tariff 30 Sugar millions of pounds per month) 20 60 70 b = higher marginal cost of domestically producing sugar that could have been produced more cheaply abroad. d = loss of consumer surplus from the drop in consumption Consumers are worse off. Loss of consumer surplus: areas a, b, c, and d. b+d = Net welfare loss to the US economy

Effect of a quota $0.15 0.10 per pound Price S $0.15 0.10 per pound b d Sugar (millions of pounds per month) 20 50 70 30 Sugar (millions of pounds per month) 20 60 70 Quota=30 mill., world price=$0.10. S’=supply curve (imports and US production; new price $0.15: intersection of D and S’. Loss of consumer surplus: a+b+c+d; a = transfer from US consumers to US producers; b+d = net loss; c = gain for sellers of foreign-grown sugar

Trade restrictions are welfare-reducing Given the preceding analysis , why are trade restrictions so pervasive?

Arguments for trade restrictions National security Save domestic jobs Anti-dumping Infant industry