International Trade

Analyzing Trade with Supply and Demand The Costs of Protectionism Arguments against International Trade For applications, click here To Try it! questions To Video

Analyzing Trade with Supply and Demand We can use the demand and supply model to determine: The effects of free trade on: Domestic equilibrium price and quantity Imports The effects of trade barriers on:

Analyzing Trade with Supply and Demand Price with free trade: World price prevails. Domestic consumption = Domestic production = Domestic supply imports = No trade equilibrium P no trade Free trade equilibrium Instructor Note: This is an animated diagram so you can explain as you “draw”. We are using the “small country” assumption which implies that semiconductors can be imported at a constant price. That is, our demand for semiconductors is small relative to the world market so we can import all be want without affecting the world price. The level of imports is determined by the difference between domestic demand and domestic production at the world price. The lower the world price relative to the domestic “no trade” price the greater will be imports. World price World supply Domestic consumption Domestic demand Imports Quantity of semiconductors Domestic production

Analyzing Trade with Supply and Demand Price With Tariff: World price + tariff prevails. Domestic consumption= Domestic production = Domestic supply imports = tariff revenue Equilibrium with tariff pno trade World price + tariff World supply + tariff tariff World price World Supply Instructor Note: This is an animated diagram so you can explain as you “draw”. With the tariff the world supply curve shifts up by the amount of the tariff per unit. The price domestic consumers pays goes up by the amount of the tariff and domestic consumption falls. The price domestic producers pay also goes up to domestic production rises. Results: Imports are less and domestic prices are higher Domestic producers win while domestic consumers lose. The government gains tariff revenue. Domestic consumption Imports w/ free trade Domestic demand Quantity of semiconductors Domestic production Imports w/tariff

A tariff results in a higher: I. consumer surplus. II. producer surplus. III. government revenue. I and II only II and III only I and III only I, II, and III To next Try it!

The Costs of Protectionism Protectionism = policy of restraining trade through quotas, tariffs, or other regulations which burden foreign (but not domestic) producers. Tariff = a tax on imports Trade Quota = a restriction on the quantity of goods that can be imported: imports greater than the quota amount are forbidden (or heavily taxed.) Instructor Note: Saving jobs through trade restrictions sounds good and is often politically rewarding. The problem is that the productive higher paying jobs that fail to be created are not always as visible as the jobs “saved”. This is one of the fundamental difficulties in debating trade politics. The gains from trade restrictions are seen and the losses are often not seen.

The Costs of Protectionism A tariff has two effects: ↑ domestic production, ↓ domestic consumption. More of the good is produced by the higher-cost domestic producers. Less is consumed → lower gains from trade. Measuring the losses and wasted resources Can we measure the value of wasted resources? Yes!

The Costs of Protectionism Price per pound (in cents) Domestic demand Domestic supply World supply + tariff 20 Tariff equilibrium U. S. costs Lost gains from trade or deadweight loss Wasted resources World price Instructor Note: This is an animated diagram so you can explain as you “draw”. Imposing a tariff on sugar raises the domestic price from 9 cents/lb. to 20 cents/lb.. Because domestic producers did not produce sugar at the world price of 9 cents/lb, the tariff increased producer surplus by the entire area under the world supply + tariff and above the domestic supply curve. With the tariff, consumer surplus is reduced by the amount of area below the domestic demand curve between world price and the world price + the tariff . Because the loss to consumers is greater than the gain to producers, there is a net loss to the economy. This loss is divided into two parts: The value of wasted resources resulting from producing sugar rather than other goods where the resources would be more productive. These costs are largely unseen and therefore often left out of the political debate. The lost gains from trade is lost consumer surplus resulting from consumers paying more for sugar. These costs are visible but spread among millions of consumers. Because the cost per consumer is small, these costs are not likely to get much political attention. These losses are quantified in the next diagram. World supply 9 Free trade equilibrium World costs 20 24 Quantity (in billions of pounds)

The Costs of Protectionism Price per pound (in cents) Domestic demand Domestic supply World supply + tariff 20 Value of wasted resources = [(.20 – .09) x 20]/2 = $1.1 billion Lost gains from trade = [(.20 - .09) x (24 – 20)]/2 = $.22 billion $1.1 billion World price Instructor Note: This is an animated diagram so you can explain as you “draw”. Imposing a tariff on sugar raises the domestic price from 9 cents/lb. to 20 cents/lb.. Because domestic producers did not produce sugar at the world price of 9 cents/lb, the tariff increased producer surplus by the entire area under the world supply + tariff and above the domestic supply curve. With the tariff, consumer surplus is reduced by the amount of area below the domestic demand curve between world price and the world price + the tariff . Because the loss to consumers is greater than the gain to producers, there is a net loss to the economy. This loss is divided into two parts: The value of wasted resources resulting from producing sugar rather than other goods where the resources would be more productive. These costs are largely unseen and therefore often left out of the political debate. The lost gains from trade is lost consumer surplus resulting from consumers paying more for sugar. These costs are visible but spread among millions of consumers. Because the cost per consumer is small, these costs are not likely to get much political attention. These losses are quantified in the next diagram. World supply 9 20 24 Quantity (in billions of pounds)

The Costs of Protectionism Conclusions: A tariff reduces economic efficiency: Low-cost producers are prevented from selling. Mutually profitable gains from trade are prevented by law. U.S. consumers pay more, and workers in other countries (many of whom are poor) lose income.

An increase in imports of 80 million units. A $1 tariff results in: An increase in imports of 80 million units. A decrease in imports of 80 million units. An increase in imports of 100 million units. A decrease in imports of 100 million units. To next Try it!

The Costs of Protectionism One final cost: lobbying The loss to domestic consumers is greater than the gains to domestic producers. Why does congress pass tariffs? Small number of producers → Benefit per producer is high. Large number of consumers → Loss per consumer is low.

Arguments Against International Trade Most Common Arguments Trade reduces the number of jobs in the U.S. It’s wrong to trade with countries that use child labor. We need to keep some industries for reasons of national security. We need to keep some “key” industries because of beneficial spillovers onto other sectors. We can increase U.S. well-being with strategic trade protectionism.

Which argument against trade is the strongest in your opinion? Trade reduces the number of jobs in the U.S. It’s wrong to trade with countries that use child labor. We need to keep some industries for reasons of national security. We need to keep some “key” industries because of beneficial spillovers onto other sectors. We can increase U.S. well-being with strategic trade protectionism. No right answer, just for discussion Back to

Trade and Jobs Rebuttals Tariffs raise the price of protected goods. Consumers have less money to spend on other goods. Jobs are lost in other industries—these lost jobs are hard to see. Trade creates jobs The U.S. dollars we spend on other country’s good are often used to buy our goods. Jobs are created in U.S. exporting industries.

Rebuttals Child Labor Restricting imports made by child labor may do more harm than good. Children work out of necessity—what else will they do? Often the alternative is worse. Prostitution Scrounging in refuse dumps Child labor is a poverty problem, not a trade problem.

Poverty and Child Labor Instructor Note: The size of the circles is proportional to the total number of child laborers. The vast majority of working children live in countries with a real GDP per capita less than $5,000. Countries with real GDP per capita less than $1,000 have more than thirty percent of their children in the labor force. Source: Edmonds, E. and N. Pavcnik, 2005. “Child Labor in the global economy” Journal of Economic Perspectives

iI think I am vital to your security. No kidding. Rebuttals Trade and National Security True: Some industries probably should be protected to protect National Security. BUT: This is subject to great abuse—almost every industry can make this argument for protection. Examples: Vaccine production?—probably a good idea. Angora Goat fleece?--are you kidding? No. This is protected. iI think I am vital to your security. No kidding.

Rebuttals Key Industries Some industries are characterized by large spillovers to other industries (and should be encouraged). Example: Computer chips have spillover benefits that go beyond the computer chip industry BUT: Subsidy (to chip makers) is a better option than a tariff. Tariff would be second-best. Hard to determine which industries are key.

Rebuttals Strategic Trade Protectionism = Government helps domestic firms act like a cartel when they sell to international buyers. May be able to grab up a larger share of the gains from trade than with free trade. This is done by forcing other countries to pay MORE for your goods, usually with an export tax. Will the exporting country see more revenue? Success depends on Price Elasticity of Demand. OPEC succeeds because oil has few substitutes. If the U.S. taxes car exports, it may just encourage foreigners to switch to a substitute good (Japanese cars, for instance). OPEC is an international agency, but it does practice the types of policy suggested in strategic trade protectionism.

At TEDIndia, TED favorite Hans Rosling gives another lively and humorous talk- and graphs global economic growth since 1858. He also predicts the exact date that India and China will outstrip the US. (15:50 minutes) http://www.ted.com/talks/hans_rosling_asia_s_rise_how_and_when.html

Globalization is not new Phoenicians: 1550 B.C. Traders Roman Empire: 753 B.C. Specialization and Trade Collapse of trade networks? 476 A.D. “Dark Ages” Revitalized trade routes? 1300s “European Renaissance” Periods of increased trade and the spread of ideas have been among the best for human progress.