1 Ch. 31: International Trade James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University ©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning

2 What Does the U.S. Export and Import? Exports: automobiles, computers, aircraft, corn, wheat, soybeans, scientific instruments, coal, and plastics. Exports: automobiles, computers, aircraft, corn, wheat, soybeans, scientific instruments, coal, and plastics. Imports: petroleum, automobiles, clothing, iron and steel, office machines, footwear, fish, coffee, and diamonds. Imports: petroleum, automobiles, clothing, iron and steel, office machines, footwear, fish, coffee, and diamonds.

3 Why Do People In Different Countries Trade with One Another? International trade exists for the same reasons that trade at any level exists: individuals trade to make themselves better off. International trade exists for the same reasons that trade at any level exists: individuals trade to make themselves better off. Some countries will be able to produce some goods that other countries cannot produce or can produce only at extremely high costs. Some countries will be able to produce some goods that other countries cannot produce or can produce only at extremely high costs.

4 Comparative Advantage Comparative Advantage: situation where a country can produce a good at a lower opportunity cost than another country. Comparative Advantage: situation where a country can produce a good at a lower opportunity cost than another country. Countries specialize in the production of the good in which they have a comparative advantage Countries specialize in the production of the good in which they have a comparative advantage

5 Comparative Advantages After specializing in production, countries must negotiate the terms of trade. After specializing in production, countries must negotiate the terms of trade. The profit motive determines the pattern of international trade. The profit motive is consistent with comparative advantage. The profit motive determines the pattern of international trade. The profit motive is consistent with comparative advantage.

6 Exhibit 1: Production Possibilities in Two Countries

7 Exhibit 2: Both Countries Gain from Specialization and Trade

8 Self-Test Suppose the United States can produce 120 units of X at an opportunity cost of 20 units of Y, and Great Britain can produce 40 units of X at an opportunity cost of 80 units of Y. Identify favorable terms of trade for the two countries. Suppose the United States can produce 120 units of X at an opportunity cost of 20 units of Y, and Great Britain can produce 40 units of X at an opportunity cost of 80 units of Y. Identify favorable terms of trade for the two countries. If a country can produce more of all goods than any other country, would it benefit from specializing and trading? Explain your answer. If a country can produce more of all goods than any other country, would it benefit from specializing and trading? Explain your answer. Do government officials analyze data to determine what their country can produce at a comparative advantage? Do government officials analyze data to determine what their country can produce at a comparative advantage?

9 Trade Restrictions Specialization and international trade benefit individuals in different countries. But, every person may not gain. Specialization and international trade benefit individuals in different countries. But, every person may not gain. Consumers’ Surplus = Maximum Buying Price – the Price Paid. Consumers’ Surplus = Maximum Buying Price – the Price Paid. Producers’ Surplus = Price Received – Minimum Selling Price Producers’ Surplus = Price Received – Minimum Selling Price

10 Exhibit 3: Consumers’ and Producers’ Surplus

11 Tariffs Tariff: a tax on imports. Tariff: a tax on imports. Consumers receive more consumers’ surplus when tariffs do not exist and less when they do. Consumers receive more consumers’ surplus when tariffs do not exist and less when they do. Producers receive less producers’ surplus when tariffs do not exist and more when they do exist. Producers receive less producers’ surplus when tariffs do not exist and more when they do exist. The effects of the tariff are a decrease in consumers’ surplus, an increase in producers’ surplus, and an increase in tariff revenues for government. The effects of the tariff are a decrease in consumers’ surplus, an increase in producers’ surplus, and an increase in tariff revenues for government.

12 Exhibit 4: The Effects of a Tariff

13 Quotas Quota: a legal limit on the amount of a good that may be imported. Quota: a legal limit on the amount of a good that may be imported. A quota reduces the supply of a good and raises the price of imported goods to domestic consumers. A quota reduces the supply of a good and raises the price of imported goods to domestic consumers. The effects of a quota are a decrease in consumers’ surplus, an increase in producers’ surplus, and an increase in total revenue to the importers who sell the allowed number of imported units. The effects of a quota are a decrease in consumers’ surplus, an increase in producers’ surplus, and an increase in total revenue to the importers who sell the allowed number of imported units. Because the loss to consumers is greater than the increase in producers’ surplus plus the gain to importers, there is a net loss as a result of the quota. Because the loss to consumers is greater than the increase in producers’ surplus plus the gain to importers, there is a net loss as a result of the quota.

14 Exhibit 5: The Effects of a Quota

15 Why Nations Restrict Trade National Defense Argument: certain industries should remain based in our country, especially if they manufacture items vital to our defense. Items this argument has been used for for include: pens, pottery, peanuts, papers, candles, thumbtacks, tuna fishing, and pencils. National Defense Argument: certain industries should remain based in our country, especially if they manufacture items vital to our defense. Items this argument has been used for for include: pens, pottery, peanuts, papers, candles, thumbtacks, tuna fishing, and pencils. Infant Industry Argument: new industries must be protected from older, established foreign competitors until they are mature enough to compete. However, removing protection is almost impossible. Infant Industry Argument: new industries must be protected from older, established foreign competitors until they are mature enough to compete. However, removing protection is almost impossible.

16 Why Nations Restrict Trade (cont.) Antidumping Argument: domestic industries need to be protected from foreign dumping. Dumping is the sale of goods abroad at a price below cost and the price charged in the domestic market. But, domestic consumers benefit from dumping. Antidumping Argument: domestic industries need to be protected from foreign dumping. Dumping is the sale of goods abroad at a price below cost and the price charged in the domestic market. But, domestic consumers benefit from dumping. Foreign–Export–Subsidies Argument: Some governments subsidize the firms that export goods. Firms hold that this forces them to compete with both the firm and the government in question. Foreign–Export–Subsidies Argument: Some governments subsidize the firms that export goods. Firms hold that this forces them to compete with both the firm and the government in question.

17 Why Nations Restrict Trade (cont) Low Foreign Wages Argument: A country’s low wage advantage may be offset by its productivity disadvantage. High wages means high productivity. Low wages mean low productivity. Low Foreign Wages Argument: A country’s low wage advantage may be offset by its productivity disadvantage. High wages means high productivity. Low wages mean low productivity. Saving Domestic Jobs Argument: This argument is actually most of the previous arguments but in disguise. Saving Domestic Jobs Argument: This argument is actually most of the previous arguments but in disguise.

18 What Price Jobs? Important Questions to ask about “Saving Jobs”: 1. How many domestic jobs in the firms that produce good X are being saved because of the tariff? 2. How much do consumers have to pay in higher prices to save those jobs?

19 What Price Jobs? ”Voluntary” Export Restraint (VER): an agreement between two countries in which the exporting country “voluntarily” agrees to limit its exports to the importing country.

20 World Trade Organization “[The WTO’s] overriding objective is to help trade flow smoothly, freely, fairly, and predictably.” “[The WTO’s] overriding objective is to help trade flow smoothly, freely, fairly, and predictably.” Functions include: administering trade agreements, acting as a forum for trade negotiation, settling trade disputes, reviewing national trade policies, assisting developing countries in trade policy issues, and cooperating with other international organizations. Functions include: administering trade agreements, acting as a forum for trade negotiation, settling trade disputes, reviewing national trade policies, assisting developing countries in trade policy issues, and cooperating with other international organizations. The WTO, in theory, is supposed to lead to freer international trade, and there is some evidence that is has done just this. The WTO, in theory, is supposed to lead to freer international trade, and there is some evidence that is has done just this. Critics often say that it has achieved this objective at some cost to a nation’s sovereignty. Critics often say that it has achieved this objective at some cost to a nation’s sovereignty.

21 Self-Test Who benefits and who loses from tariffs? Explain your answer. Who benefits and who loses from tariffs? Explain your answer. Identify the directional change in consumers’ surplus and producers’ surplus when we move from free trade to tariffs. Is the change in consumers’ surplus greater than, less than, or equal to the change in producers’ surplus? Identify the directional change in consumers’ surplus and producers’ surplus when we move from free trade to tariffs. Is the change in consumers’ surplus greater than, less than, or equal to the change in producers’ surplus?

22 Self-Test What is a major difference between the effects of a quota and the effects of a tariff? What is a major difference between the effects of a quota and the effects of a tariff? Outline the details of the infant industry argument for trade restriction. Outline the details of the infant industry argument for trade restriction.

23 Coming Up (Ch. 32): International Finance