Chapter 9: International Trade

Argument Against Free Trade Foreign goods crowd out our markets, reducing employment and sales Trade deficit increases demand for $, whose appreciation increases imports and decreases exports, causing the deficit to grow Protect our vital industries (auto, aircraft) against foreign competition in case of war

Argument For Free Trade Principle of Comparative Advantage states: Free trade is mutually beneficial if countries specialize in production of low cost goods and exchange those for high cost goods

Simple Demonstration Two countries: Alpha, Omega Two goods: milk, bread Equal terms of trade: 1 bread = 1 milk

Labor Costs One day of work will produce in –Alpha: 1 bread, but 2 milk –Omega: 2 bread, but 1 milk Comparative advantage: –Alpha: milk –Omega: bread

Alpha’s Trade Sheet GoodPre- trade PPC Specialization PPC TradePost- trade CPC Gains from Trade Milk Bread

Alpha’s PPC/CPC Bread Milk Pre-trade CPC Post-trade CPC Trade gain=50 bread

Omega’s Trade Sheet GoodPre- trade PPC Specialization PPC TradePost- trade CPC Gains from Trade Milk Bread

Omega’s PPC/CPC Bread Milk Pre-trade CPC Post-trade CPC Trade gain=25 milk 25

Balance of Trade Current Account-- Flow of traded goods and services: exports less imports Capital Account-- Flow of investment: change in U.S. assets abroad less change in foreign assets in U.S. Balance of Payments = Current plus Capital

International Finance Two trading countries: U.S. & U.K. U.S. exports supply dollars for U.S. U.S. imports require pounds to pay to U.K. U.S. converts its dollars to pounds to pay U.K.

Market for Foreign Exchange Dollar/Pound ratio Pound per month D D S S pound = $1.60 $1 = pounds

Effects of Exchange Control May improve the balance of trade: –exports become less costly to foreign buyers –imports become more costly to domestic buyers Cause a shortage and develops a black market

Exchange Control Dollar/Pound ratio Pound per month D D S S Shortage 1.60=market rate 1.50=controlled rate 1.70=black market rate

Import Tariff Tax imposed on imported goods to: –Reduce the supply of imports –Increase the price to domestic consumers –Decrease the volume of imports –Generate revenues for the government

Tariff on Japanese Automobiles Price Quantity S’ 20,000 22,500 8,00010,000 S S D D 17,500 Consumers pay $2,500 more Dealers receive $2,500 less Government makes $40 million

Import Quota Quantity restriction on imported goods: –Reduce the volume of imports –Increase the price to domestic buyers –Reduce the price to foreign supplies –Create profits to holders of import licenses

Quota on Sugar Imports Price ($/ton) tons/year D D ,000 S’ S S 25 Consumer pay $5 more Producers receive $5 less Exporters make $7,500 profit

Common Markets Free trade within the market, restrictions against outsiders –European Union (EU): 15 countries –North American Free Trade Agreement (NAFTA): U.S., Canada, Mexico