© 2001 J. Douglass Klein 5. Explain some of the differences between the northern and southern American Colonies. “…our northern settlements, we have found, are full of farmers, fisherman, seamen; -but no planters. This is precisely the case with Britain herself; consequently a rivalry between them must inevitably take place.” (p. 96) “American corn cannot come to an European market without doing mischief to the corn trade of England” (p. 97) Under what circumstances will there be the greatest gains from trade?

© 2001 J. Douglass Klein Gains from Trade Specialize and trade If countries specialize in those goods in which they have a comparative advantage, and then trade with countries specializing in other goods, all countries can consume outside their individual production possibilities. This kind of trade is Pareto Optimal -- EVERYONE GAINS Can you suggest a way that trade between the two economies could clearly make consumers in both economies better off? Link to: Gains from Trade worksheetGains from Trade worksheet

© 2001 J. Douglass Klein Gains from Trade Corn Woolens Britain A Corn Woolens North America C Can you suggest a way that trade between the two economies could clearly make consumers in both economies better off? Specialize and trade -- Who should specialize in what? A’ C’ The exchange rate should be between the two MRTs (between 2.5 and.5)

© 2001 J. Douglass Klein Freedom to Choose “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.” (424) “By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be bought from foreign countries.” (425)

© 2001 J. Douglass Klein Justifications for Protection??? GENERALLY 1. In the interest of national defense. (429) 2. When the same domestic product is taxed. (431) SOMETIMES 3. Retaliation for other countries’ tariffs. (434) 4. Where a tariff has long been in force, and people’s livelihood depends on it. (435) Note the importance of factor mobility.

© 2001 J. Douglass Klein Effects of a Tariff Economics 24 Effects of ProtectionCONNECT TO ECO 24 WEB SITECONNECT TO ECO 24 WEB SITE Consider the British corn industry, and suppose, initially, that there is free trade in corn. The situation for the British corn market and a typical British corn farmer are shown in figure 1, below. The world price of corn is PW. SB is the British domestic supply curve, and DB is British demand for corn. The typical farmer produces qf1, and earns zero economic profit, and British consumers import an amount of corn equal to QD1 - QS1.

© 2001 J. Douglass Klein Smith - final words (for now) Adam Smith also wrote The Theory of Moral Sentiments Smith’s view on tariffs and getting rid of them: “The legislature, were it possible that its deliberations could be always directed, not by the clamorous importunity of partial interests, but by an extensive view of the general good, ought... to be particularly careful neither to establish any new monopolies of this kind, nor to extend further those which are already established. Every such regulation introduces some degree of real disorder into the constitution of the state, which it will be difficult afterwards to cure without occasioning another disorder.” (p. 369)

© 2001 J. Douglass Klein The Declaration of Independence and the Constitution To propose that Great Britain should voluntarily give up all authority over her colonies, and leave them to elect their own magistrates, to enact their own laws, and to make peace and war as they might think proper … If it was adopted … Great Britain would not only be immediately freed from the whole annual expence of [governing] the colonies, but might … secure to her [Britain] a free trade, more advantageous to the great body of the people, though less so to the merchants, than the monopoly which she at present enjoys. (111)THESE ARE THE WORDS OF ADAM SMITH!

© 2001 J. Douglass Klein When you are finished, in groups of 2 navigate your way to: 1 Schaffer Library 2 Reference Room 3 WWW Research (also through our LINKS page) 4 Finding Information on the Internet: A Tutorial (2 nd item) 5 Can you TRUST the Web? Evaluating Web Pages 6 Powerpoint POST your two web addresses related to the D of I & Constitution to the CONSTITUTION discussion list.

© 2001 J. Douglass Klein Evaluate your sites Using the worksheet, and in your group of 2 - Evaluate the quality and reliability of each site you found - Post a brief review of each site as a Reply to your

© 2001 J. Douglass Klein The Constitution of the United States Article I Article II Article III Article IV Article V Article VI Article VII Amendments Legislative - See sections 8 and 10 Executive Judicial Relationships among the states Process of amendment Assumption of prior debts Procedure for ratification Bill of Rights Income Tax Women’s Suffrage

© 2001 J. Douglass Klein Hamilton’s Reports on Public Credit Makes the case for good public credit for the federal government. on Manufacturers Makes the case for promoting manufacturing in the US by means of protection (tariffs) and other means.

© 2001 J. Douglass Klein Federalist Policies of the New Nation The Constitution Hamilton’s reports on Public Credit Manufacturing What is Federalism? What is Anti-federalism? Name some prominent Federalists. Name some prominent Anti-federalists. Federalist documents we will look at:

© 2001 J. Douglass Klein Public Credit 1. Define public credit. 2. Why should the public credit of the U.S. be of concern? 3. What embarrassments is Hamilton referring to at the top of page 3?

© 2001 J. Douglass Klein Money Amount of paper money issued (in $ millions)

© 2001 J. Douglass Klein Money Value of paper money issued (exchange rate of paper to gold coin)

© 2001 J. Douglass Klein Money and Prices One way of describing the relationship between money and prices is called the equation of exchange MV = PY Quantityof money (M) times velocity of money (V) = Price level (P) times level of real output (Y) If M rises with V and Y roughly fixed, P will rise.

© 2001 J. Douglass Klein Gresham’s Law Bad money drives out good money.

© 2001 J. Douglass Klein What is the controversy? The US had bad credit. Hamilton wanted to pay off the debt to restore our credit. Who can complain? Who did complain? Why? How was the issue resolved?

© 2001 J. Douglass Klein Early Federalist v. Anti-federalist Debate Proposals for a “federal town” for the deliberations of the Continental Congress were made in 1783, 4 years before the adoption of the Constitution. Rivalry between Northern and Southern delegates over the site appeared in the First Congress, The Virginia members of the House wanted a capital on the eastern bank of the Potomac; they were defeated by the Northerners, while the Southerners defeated the Northern attempt to have the nation assume the war debts of the 13 original states, the Assumption Bill fathered by Alexander Hamilton. Hamilton and Jefferson arranged a compromise: the Virginia men voted for the Assumption Bill, and the Northerners conceded the capital to the Potomac. The World Almanac® and Book of Facts 1995 is licensed from Funk & Wagnalls Corporation. Copyright © 1994 by Funk & Wagnalls Corporation. All rights reserved. The World Almanac and The World Almanac Book of Facts are registered trademarks of Funk & Wagnalls Corporation.

© 2001 J. Douglass Klein Effects of a Tariff Economics 24 Effects of ProtectionCONNECT TO ECO 24 WEB SITECONNECT TO ECO 24 WEB SITE Consider the British corn industry, and suppose, initially, that there is free trade in corn. The situation for the British corn market and a typical British corn farmer are shown in figure 1, below. The world price of corn is PW. SB is the British domestic supply curve, and DB is British demand for corn. The typical farmer produces qf1, and earns zero economic profit, and British consumers import an amount of corn equal to QD1 - QS1. Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 T Pw + T P

© 2001 J. Douglass Klein Effects of a Tariff Consider the effects of a tariff on the British corn industry. World-wide, the price of corn is Pw. British farmers can produce corn along the supply curve S B. Why is the world supply curve flat? Why does S B have a positive slope? How much corn does Britain import? Why don’t British farmers grow more corn? Q P SBSB DBDB World Supply PWPW Entire British corn market Q S1 Q D1

© 2001 J. Douglass Klein Effects of a Tariff P Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 Suppose the British government imposes a tariff T on imported corn. What happens in the SHORT RUN? What happens in the LONG RUN? Define SHORT RUN and LONG RUN. T Pw + T

© 2001 J. Douglass Klein Effects of a Tariff Q P SBSB DBDB q P Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 NO TARIFF. LONG RUN EQUILIBRIUM. With no trade barriers, British consumers import Q D1 - Q S1 corn. British farmers sell Q S1 units of corn. Typical farmers earn zero excess profit. What does it mean to say that farmers are earning zero profit? Price = Average Cost IMPORTS

© 2001 J. Douglass Klein Effects of a Tariff P What happens in the SHORT RUN? T Pw + T Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 PROFIT q f2 Q S2 Q D2 At the new higher price, British corn farmers make a profit. At the new higher price, British consumers import less corn.

© 2001 J. Douglass Klein Effects of a Tariff P What happens in the LONG RUN? T Pw + T Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 In the LONG RUN, entry can occur. So long as profits exist, entry will continue. How do we show entry on the graph? How far will the British Supply curve shift? S’ S’’ S’’’

© 2001 J. Douglass Klein Effects of a Tariff P T Pw + T Q P SBSB DBDB q MC AC World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 S’’ If Average Costs rise as the industry expands, for example if poorer farm land is put into corn production, then profits of the newest (and least productive) farms will fall to zero at a price higher than Pw. AC’ The more productive farms may still earn the kind of profit called economic rent, profit which cannot be eliminated by entry. P2P2

© 2001 J. Douglass Klein Effects of a Tariff - SUMMARY A tariff raises the price of a good. With higher prices, domestic firms make a greater profit in the short run. The higher profits provide an incentive for domestic entry. As entry occurs, price begins to fall. Whether price will eventually fall to (or below) the world price is hotly debated. One thing is clear. A tariff helps domestic producers, and at least in the short run hurts domestic consumers.