© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eO’Sullivan/Sheffrin Prepared by: Fernando Quijano and Yvonn Quijano CHAPTERCHAPTER 32 International Trade and Public Policy

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Benefits from Specialization and Trade If a nation produced everything it consumed, it would depend on any other nation for its livelihood.If a nation produced everything it consumed, it would depend on any other nation for its livelihood. Although self-sufficiency sounds appealing, countries are better off if they specialize in some products and trade some of those products with other nations for products that your nation doesn’t produce.Although self-sufficiency sounds appealing, countries are better off if they specialize in some products and trade some of those products with other nations for products that your nation doesn’t produce.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Benefits from Specialization and Trade Specialization and trade are concepts based on the principle of opportunity cost.Specialization and trade are concepts based on the principle of opportunity cost. PRINCIPLE of Opportunity Cost The opportunity cost of something is what you sacrifice to get it.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Output and Opportunity Cost The following table shows the daily output of two goods for two nations:The following table shows the daily output of two goods for two nations: ShirtlandChipland Shirts produced per day Chips produced per day Opportunity cost of shirts 1/3 chip 1 chip Opportunity cost of chips 3 shirts 1 shirt

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Production Possibilities Curve The production possibilities frontier shows the possible combinations of two goods that can be produced by an economy, assuming that all resources are fully employed.The production possibilities frontier shows the possible combinations of two goods that can be produced by an economy, assuming that all resources are fully employed.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Production Possibilities Curve For Shirtland, the trade-off is three shirts for every computer chip.For Shirtland, the trade-off is three shirts for every computer chip.ShirtlandPointShirtsChips r1080 h5418 s2428 t036

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Production Possibilities Curve For Chipland, there is a one-for-one trade- off between the two goods.For Chipland, there is a one-for-one trade- off between the two goods.ChiplandPointShirtsChips b1200 c6060 d0120

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Production Possibilities Curve Shirtland picks point s (28 chips and 24 shirts). Shirtland picks point s (28 chips and 24 shirts). Chipland picks point c (60 chips and 60 shirts).Chipland picks point c (60 chips and 60 shirts).ShirtlandPointShirtsChips r1080 h5418 s2428 t036ChiplandPointShirtsChips b1200 c6060 d0120ShirtlandPointShirtsChips r1080 h5418 s2428 t036ChiplandPointShirtsChips b1200 c6060 d0120 In the absence of trade, autarky, or self sufficiency:In the absence of trade, autarky, or self sufficiency:

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Comparative Advantage and the Terms of Trade The nation with the lower opportunity cost has a comparative advantage, which is the ability of one nation to produce a particular good at an opportunity cost that is lower than the opportunity cost of another nation in producing the same good.The nation with the lower opportunity cost has a comparative advantage, which is the ability of one nation to produce a particular good at an opportunity cost that is lower than the opportunity cost of another nation in producing the same good. The terms of trade are the rate at which two goods will be exchanged.The terms of trade are the rate at which two goods will be exchanged.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Consumption Possibilities Curve The consumption possibilities curve shows the combinations of two goods that a nation can consume when it specializes in producing one good and trades with another nation.The consumption possibilities curve shows the combinations of two goods that a nation can consume when it specializes in producing one good and trades with another nation.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Consumption Possibilities Curve In panel A, Chipland produces 120 chips and trades 40 of these chips to Shirtland for 80 shirts.In panel A, Chipland produces 120 chips and trades 40 of these chips to Shirtland for 80 shirts.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Consumption Possibilities Curve In panel B, Shirtland produces 108 shirts and trades 80 of these shirts to Chipland for 40 chips.In panel B, Shirtland produces 108 shirts and trades 80 of these shirts to Chipland for 40 chips.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Protectionist Policies Four common import-restriction policies are:Four common import-restriction policies are: An outright ban on imports.An outright ban on imports. An import quota, or a limit on the amount of a good that can be imported.An import quota, or a limit on the amount of a good that can be imported. Voluntary export restraints, where a nation voluntarily decreases its exports in an attempt to avoid more restrictive policies.Voluntary export restraints, where a nation voluntarily decreases its exports in an attempt to avoid more restrictive policies. A tariff, or a tax on imported goods.A tariff, or a tax on imported goods.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Effects of an Import Ban In the free-trade equilibrium, demand intersects the total supply curve at point x, with a price of $12 and a quantity of 80 shirts.In the free-trade equilibrium, demand intersects the total supply curve at point x, with a price of $12 and a quantity of 80 shirts.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Effects of an Import Ban If shirt imports are banned, the equilibrium is shown by the intersection of the demand curve and the domestic supply curve (point c ).If shirt imports are banned, the equilibrium is shown by the intersection of the demand curve and the domestic supply curve (point c ).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Quotas and Voluntary Export Restraints An import quota is a limit on the amount of a good that can be imported.An import quota is a limit on the amount of a good that can be imported. A scheme under which an exporting country voluntarily decreases its exports is a voluntary export restraint (VER).A scheme under which an exporting country voluntarily decreases its exports is a voluntary export restraint (VER).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Market Effects of a Quota, a VER, or a Tariff An import quota shifts the supply curve to the left. The market moves upward along the demand curve to point q, which is between point x (free trade) and c (an import ban).An import quota shifts the supply curve to the left. The market moves upward along the demand curve to point q, which is between point x (free trade) and c (an import ban).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Market Effects of a Quota, a VER, or a Tariff We can reach the same point with a tariff that shifts the total supply curve to the same position.We can reach the same point with a tariff that shifts the total supply curve to the same position.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Price Effects of VERs for Japanese Cars Many European nations use VERs to limit the number of Japanese cars imported. The VERs increase the price of Japanese cars.Many European nations use VERs to limit the number of Japanese cars imported. The VERs increase the price of Japanese cars.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Tariffs A tariff is a tax on imports which causes the supply curve to shift to the left. The effect of the tariff is the same as with the quota.A tariff is a tax on imports which causes the supply curve to shift to the left. The effect of the tariff is the same as with the quota.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin NAFTA and the Giant Sucking Sound The North American Free Trade Agreement (NAFTA) took effect in January 1999.The North American Free Trade Agreement (NAFTA) took effect in January NAFTA will gradually phase out tariffs and other trade barriers between the United States, Mexico, and Canada.NAFTA will gradually phase out tariffs and other trade barriers between the United States, Mexico, and Canada. Economists predicted that trade between the United States and Mexico would increase both imports from Mexico and exports to Mexico.Economists predicted that trade between the United States and Mexico would increase both imports from Mexico and exports to Mexico.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Trade Data for the United States and Mexico Year U.S. Imports from Mexico (billions) U.S. Exports to Mexico (billions) Exchange Rate: Pesos per Dollar U.S. Trade Surplus (+) or Deficit (-) with Mexico (billions) 1993$40$423.12$ $49$513.11$ $62$465.33$-16

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Rationales for Protectionist Policies Three possible motivations for policies that restrict trade are:Three possible motivations for policies that restrict trade are: To shield workers from foreign competition.To shield workers from foreign competition. To nurture “infant” industries until they mature.To nurture “infant” industries until they mature. Infant industry is a new industry that is protected from foreign competitors.Infant industry is a new industry that is protected from foreign competitors. Learning by doing is the knowledge gained during production, resulting in increases in productivity.Learning by doing is the knowledge gained during production, resulting in increases in productivity. To help domestic firms establish monopolies in world markets.To help domestic firms establish monopolies in world markets.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Are Foreign Producers Dumping Their Products? Dumping is a situation in which the price a firm charges for a product in a foreign market is lower than either the price it charges for that product in its home market or the product’s production cost.Dumping is a situation in which the price a firm charges for a product in a foreign market is lower than either the price it charges for that product in its home market or the product’s production cost. Why do firms dump?Why do firms dump? Price discrimination.Price discrimination. Predatory pricing: cutting prices in an attempt to drive rival firms out of business.Predatory pricing: cutting prices in an attempt to drive rival firms out of business.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Recent Trade Agreements North American Free Trade Agreement (NAFTA).North American Free Trade Agreement (NAFTA). World Trade Organization (WTO).World Trade Organization (WTO). European Union (EU).European Union (EU). Asian Pacific Economic Cooperation (APEC).Asian Pacific Economic Cooperation (APEC).