1 Chapter 15 International Trade

2 Chapter Outline WHAT WE TRADE AND WITH WHOM WHY TRADE IS GOOD WHY TRADE IS NOT ALWAYS GOOD FOR EVERYONE BARRIERS TO TRADE TRADE AS A DIPLOMATIC WEAPON 2

3 You Are Here 3

4 Exports and Imports As a percentage of GDP 4

5 What We Trade: Exports (2007) 5 GoodBillions of Dollars of Exports Industrial Eq198.5 Elec. Mach. Aud & Video148.4 Motor Vehicles107.0 Aerospace76.0 Optics66.3 Services ,645.7

6 What We Trade: Imports (2007) GoodBillions of Dollars of Imports Petroleum361.0 Industrial Eq250.2 Elec. Mach. Aud & Video248.9 Motor Vehicles214.5 Optics53.8 Services378.1 Total2,

7 With Whom We Trade 7

8 Why trade is good To understand why trade is good lets go back to an example we studied in Chapter 1 We had our little tribe (unfortunately since chapter 1 Jane got sick and died) but lets make it be hamburgers and buns to make the point extreme and clear 8 PersonHamburgersBuns Donna51 Bill32 Sally23 Carl15

99 If this is all one tribe we get the following Production Possibility Frontier Buns Burgers We like this point, 8 burgers and 8 buns

10 However now suppose that these are two different tribes that don’t interact and that Donna and Bill are in the same tribe Now the production possibilities: Now these are the two points We only have 2 actual hamburgers for each tribe Buns Burgers

11 Gains from Trade Now there are serious gains from trade Without trade: Donna and Bill have 5 burgers and 2 buns Sally and Carl have 2 burgers and 5 buns This suggests the following scenario: Donna and Bill only make burgers: 8 burgers Sally and Carl only make buns: 8 buns They trade 4 burgers for 4 buns Everybody can have 2 burgers Essentially the production possibilities frontier has expanded This is why economists think trade is good

12 CoffeeApples United States12 Brazil21 Suppose there are two countries, the United States and Brazil, and two goods, Apples and Coffee, and the production per unit of labor is shown in the table below. Clearly, there are benefits from trade. If the Americans focus on apples and the Brazilians focus on coffee and they trade with one another, more apples and more coffee is available to both countries. 12 Countries Lets think about this with countries now

13 Comparative and Absolute Advantage So Far I have been abstracting from something. The U.S. was better at apples and worse at coffee More generally you could be better at both things Absolute Advantage : the ability to produce a good better, faster, or more quickly than a competitor Comparative Advantage : the ability to produce a good at a lower opportunity cost of the resources used 13

14 The Benefits of Trade: When Comparative and Absolute Advantage are Not the same CoffeeApples United States32 Brazil21 Now suppose the Americans are better at producing both goods. The Americans have an absolute advantage in both but a comparative advantage in only Apples. 14

15 There are still benefits from trade. If the Americans focus on apple production and the Brazilians focus on coffee production and they trade with one another more apples and coffee is available to both countries. The Brazilians would be willing to trade 2 coffees for one apple, Americans would do that. Americans would give 2 apples for 3 coffees, Brazilians would do that Exactly where we end up depends on specific demand within the countries This is called the Terms of Trade: The amount of a good one country must give up in order to obtain another good from the other country, usually expressed as a ratio.

16 Per capita Consumption Possibilities Frontier Apples Coffee Consumption Possibilities Frontier 16 To set this up correctly assume that Brazil and the U.S. are the same size population Everyone within the countries are the same Terms of trade will be such that all Brazilians and Americans consume exactly the same amount of coffee and apples I want to figure out what that level could be with and without trade Brazilian Frontier without trade U.S. Possibilities without trade

17 Trade not good for everyone 17 I have been acting if everyone is identical, but of course that is not true Opening up trade markets in example above will not generally be good for Brazilian Apple tree owners and workers or American coffee growers and workers Lets see this in a supply and demand framework Think of a small country in a global economy so we just take the price of the good as given

18 Domestic Supply Domestic Demand Exports International Price Domestic Consumption Domestic Production Consumers are worse off, but producers are much better off Gains from trade:

19 Domestic Supply Domestic Demand Imports International Price Domestic Consumption Domestic Production Producers are worse off, but consumers are much better off Gains from trade:

20 Low Skill and High Skill Workers 20 Do we care about producers? It is not just owners but also workers in these sectors In the U.S. we often worry about trading with less developed countries The problem is We have comparative advantage in high skill workers They have a comparative advantage in low skill workers Thus generally when we trade with poorer countries Good for all consumers Good for high skill workers Probably bad for low skill workers in U.S. Probably good for low skill workers in other countries

21 Really two kinds of problems: More permanent: for workers who are not great at school, its not clear what they should be doing in the long run More temporary: for trained workers (say a welder) in industries that are moving overseas, not easy to find another job This is probably inevitable We can cushion the blow We can try to increase skills of these workers A lot of movement from manufacturing to services

22 Other Reasons For Limiting Trade National Security National Identity Both of the above can be overstated easily. Environmental Concerns Child-Labor Concerns Protect Industries from competition 22

23 Methods of Limiting Trade Tariffs: a tax on imports Quotas: a legal restriction on the amount of a good coming into the country Non-tariff barriers: barriers to trade that result from regulatory actions 23

24 Domestic Supply Domestic Demand International Price Domestic Consumption Domestic Production Tariff Government Revenue Deadweight Loss Tariffs

25 Domestic Supply Domestic Demand International Price Domestic Consumption Domestic Production Quota Quota rents Deadweight Loss Quotas

26 Trade as a Diplomatic Weapon Trade sanctions have failed To get Castro out of Cuba To get Iran to release our hostages in To get the Soviet Union out of Afghanistan. To get Iraq out of Kuwait in