MBMC International Trade and Trade Policy

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 2 Introduction Understanding the Economic Issues of International Trade The benefits of trade The costs of trade The economic impact of trade restrictions

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 3 Comparative Advantage as a Basis for Trade The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 4 Production and Consumption Possibilities and the Benefits of Trade Closed Economy An economy that does not trade with the rest of the world Open Economy An economy that trades with other countries

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 5 Production and Consumption Possibilities and the Benefits of Trade Example Two good economy (Brazil) -- computers and coffee Two workers who work 50 weeks/year  Carlos oCan produce 100 pounds/week or 1 computer  Maria oCan produce 100 pounds/week or or 2 computers

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 6 Production and Consumption Possibilities and the Benefits of Trade Example Slope of PPC (Maria) Slope of PPC (Carlos)

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 7 10, B 150 5,000 Slope AC = Maria’s OC computers = - 50 pounds coffee/computer C A Slope CB = Carlos’ OC computers = pounds coffee/computer Production Possibilities Curve for a Two-Worker Economy Computers (number/year) Coffee (pounds/year)

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 8 B C A D Maria produces computers Maria and Pedro produces computers All three workers produce computers Production Possibilities Curve for a Three-Worker Economy Computers (number/year) Coffee (pounds/year)

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 9 Production Possibilities Curve for a Many-Worker Economy Computers (number/year) Coffee (pounds/year) B C A D Observations The OC of producing an additional unit = the slope of the line that touches the point OC will increase as output of on good increases

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 10 A country’s PPC shows the quantities of different goods that its economy can produce. Consumption Possibilities The combinations of goods and services that a country’s citizens might feasibly consume Production and Consumption Possibilities and the Benefits of Trade

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 11 In a closed economy: Society’s production possibilities = consumption possibilities. If a country is self-sufficient, it is called autarky. Production and Consumption Possibilities and the Benefits of Trade

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 12 In an open economy: The society’s consumption possibilities are typically greater than its production possibilities. Production and Consumption Possibilities and the Benefits of Trade

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 13 Brazil’s Consumption Possibilities with Trade Computers (number/year) Coffee (pounds/year) 100 B ,000 C A 5,000 Production possibilities Slope = -50 pounds coffee/computer Production possibilities Slope = -100 pounds coffee/computer Without Trade Brazil’s consumption possibilities = ACB Assume production is at C The OC of 50 lbs coffee = 1 computer The OC of 1 computer = 100 lbs coffee

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 14 Brazil’s Consumption Possibilities with Trade Computers (number/year) Coffee (pounds/year) 13, C G F 5, Consumption possibilities with trade Slope = -80 pounds coffee/computer With Trade World market: 80 lbs coffee for 1 computer Trade 100 computers for 8,000 lbs coffee + 5,000 lbs from Carlos = 13,000 lbs Trade 80 lbs coffee for 1 computer or 5,000 lbs of coffee for 62.5 computers computers from Maria = computers Consumption Possibilities = FCG

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 15 Brazil’s Consumption Possibilities with Trade Computers (number/year) Coffee (pounds/year) 13, B ,000 C A G F 5, Consumption possibilities with trade Slope = -80 pounds coffee/computer Production possibilities Slope = -50 pounds coffee/computer Production possibilities Slope = -100 pounds coffee/computer

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 16 Consumption Possibilities Curve for a Many-Worker Economy Computers (number/year) Coffee (pounds/year) B C A G F Consumption possibilities Production possibilities Slope of FG = relative prices of coffee & computers on the world market Maximum consumption by producing at C (slope of PPC = FG) and trading for the desired combination on FG

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 17 Economic Naturalist Does “cheap” foreign labor pose a danger to high-wage economies? Production and Consumption Possibilities and the Benefits of Trade

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 18 Economic Naturalist Scenario  U.S. and Fredonia produce software and beef.  Real wages in Fredonia are lower than in the U.S.  Fredonia is half as productive as the U.S. in beef production.  Fredonia is one-tenth as productive in software production. Production and Consumption Possibilities and the Benefits of Trade

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 19 Economic Naturalist Outcome  Fredonia has a comparative advantage in beef.  U.S. has a comparative advantage in software.  The U.S. will trade software for beef and increase its consumption of both.  Employment in the software industry in the U.S. increases and employment in the beef industry will decrease. Production and Consumption Possibilities and the Benefits of Trade

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 20 The Market for Computers in Brazil Quantity of computers Price of computers p E q Domestic supply Domestic demand Closed economy equilibrium qSqS qDqD World price Imports

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 21 A Supply and Demand Perspective on Trade If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 22 The Market for Coffee in Brazil Quantity of coffee Price of coffee p E q Domestic supply Domestic demand Closed economy equilibrium qSqS qDqD World price Exports

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 23 A Supply and Demand Perspective on Trade If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 24 A Supply and Demand Perspective on Trade Observations of the Mutually Beneficial Gains from Trade Countries will profit by exporting the goods and services for which they have a comparative advantage. The revenue from the exports are used to import goods and services for which they do not have a comparative advantage.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 25 A Supply and Demand Perspective on Trade Observations of the Mutually Beneficial Gains from Trade The markets will ensure that goods will be produced where opportunity cost is lowest. The consumption possibilities will be maximized.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 26 A Supply and Demand Perspective on Trade Winners and Losers from Trade Winners  Consumers of imported goods  Producers of exported goods Losers  Consumers of exported goods  Producers of imported goods

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 27 A Supply and Demand Perspective on Trade Protectionism The view that free trade is injurious and should be restricted Tariff A tax imposed on an imported good Quota A legal limit on the quantity of a good that may be imported

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 28 The Market for Computers after the Imposition of an Import Tariff Quantity of computers Price of computers E Domestic supply Domestic demand qSqS qDqD World price Imports before tariff Production w/o tariff

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 29 The Market for Computers after the Imposition of an Import Tariff Quantity of computers Price of computers qSqS pTpT E q’ S q’ D qDqD Domestic supply Domestic demand World price World price plus tariff Imports after tariff Production w/o tariff Tariff tax collection

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 30 A Supply and Demand Perspective on Trade Tariffs The market for computers in Brazil:  Demand = Q D = 3, P C  Supply = Q S = 1, P C

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 31 A Supply and Demand Perspective on Trade Tariffs Closed economy  Equilibrium price: o1, P C = 3, P C oP C = $2,000  Equilibrium quantity: o1, (2,000) = 2,000 computers

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 32 A Supply and Demand Perspective on Trade Tariffs Open economy  P = world price = $1,500  q S = 1, (1,500) = 1,750  q D = 3, (1,500) = 2,250  Imports = 2, ,750 = 500 computers/yr

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 33 A Supply and Demand Perspective on Trade Tariffs Tariff imposed  Tariff = $300/computer  P = world price + tariff = $1,500 + $300 = $1,800  q s = 1,000 + (0.5)(1,800) = 1,900 computers/yr  q d = 3,000 = (0.5)(1,800) = 2,100  Imports = 2, ,900 = 200  Tariff revenue = $300/computer x 200 computers/yr = $60,000/yr

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 34 The Market for Computers after the Imposition of an Import Quota Quantity of computers Price of computers qSqS qDqD Domestic supply World price Domestic demand Imports with open economy

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 35 The Market for Computers after the Imposition of an Import Quota Quantity of computers Price of computers qSqS pTpT F q’ S q’ D qDqD Domestic supply Domestic supply plus quota World price Domestic demand Import quota Impact of quota = impact of tariff Revenue from quota goes to the producer

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 36 A Supply and Demand Perspective on Trade Quotas & Tariffs Market effects of tariffs are the same. Tariffs generate tax revenue. Quotas generate revenue for the firms that hold an import license.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 37 A Supply and Demand Perspective on Trade Effects of an import Quota Without quota:  q S = 1, P C With a quota of 200 computers  q S = 1, P C = 1, P C  q D = 3, P C  Equilibrium = 1, P C = 3, P C  Equilibrium price = $1,800

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 38 A Supply and Demand Perspective on Trade Effects of an import Quota With a quota of 200 computers  Domestic quantity supplied o1, ($1,800) = 1,900 computers/yr  Domestic quantity demanded o3, ($1,800) = 2,100 computers/yr  Imports = 2, ,900 = 200  Revenue to the importers o($1,800 - $1,500) x 200 = $60,000

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 39 A Supply and Demand Perspective on Trade Economic Naturalist Who benefited from and who was hurt by voluntary export restraints on Japanese automobiles in the 1980s?

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 40 A Supply and Demand Perspective on Trade Other Barriers to Trade Red-tape barriers Regulations

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 41 A Supply and Demand Perspective on Trade The Inefficiency of Protectionism Trade barriers are inefficient and reduce the size of the economic pie. Because trade barriers benefit certain groups, and these groups may be well organized, they may be successful in lobbying for trade barriers. The gains from trade could be used to assist groups that have been hurt by trade.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade and Trade Policy Slide 42 A Supply and Demand Perspective on Trade Economic Naturalist What should Lula do about foreign trade?

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