1 INTERNATIONAL TRADE Principles of Microeconomic Theory, ECO 284 John Eastwood CBA

2 Learning Objectives Describe the trends and patterns in international trade Explain comparative advantage and explain why all countries can gain from international trade Explain how economies of scale and diversity of taste lead to gains from trade

3 Learning Objectives (cont.) Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities Explain the arguments used to justify trade restrictions and show how they are flawed Explain why we have trade restrictions

4 Learning Objectives Describe the trends and patterns in international trade Explain comparative advantage and explain why all countries can gain from international trade Explain how economies of scale and diversity of taste lead to gains from trade

5 Patterns and Trends in International Trade Imports are the goods and services we buy from other countries. Exports are the goods and services we sell to people in other countries.

6 Patterns and Trends in International Trade Trade in Goods –50% of our exports and 60% of our imports are manufactured goods –Capital goods and autos are the leading export and import –Services make up 26% of our exports and 17% or our imports

7 Patterns and Trends in International Trade Trade in Services –The spending of a foreigner (students, vacationers) in a country is the importation of services. –Shipping and insurance charges paid to foreign firms on imported goods is the importation of services.

8 Patterns and Trends in International Trade Geographical Patterns –Canada is the Unites States’ leading trading partner for both imports and exports –45% of our imports are from Asian countries

9 Patterns and Trends in International Trade Trends in the Volume of Trade –In 1960, the U.S. exported less than 5% of total output and imported 4.5% of the goods and services consumed domestically. –Since, 1960 the composition of imports have changed dramatically food and raw material imports have fallen machinery comprise close to 50% of total imports

10 Patterns and Trends in International Trade Balance of Trade and International Borrowing –The balance of trade is the value of exports minus the value of imports –In 1996 the U.S. had a $95 billion deficit –We must either borrow from foreigners or sell some of our assets

11 Learning Objectives Describe the trends and patterns in international trade Explain comparative advantage and explain why all countries can gain from international trade Explain how economies of scale and diversity of taste lead to gains from trade

12 Opportunity Cost and Comparative Advantage A comparative advantage exists for a country if it can perform an activity at a lower opportunity cost than any other country. Recall Ricardo’s example using England and Portugal (Chapter 2 & notes).

13 Opportunity Cost and Comparative Advantage Countries can increase consumption if they produce only those goods in which they have a comparative advantage. Let’s look at Farmland and Mobilia

14 Opportunity Cost in Farmland Cars (millions per year) Grain(billions of bushels per year)

Opportunity Cost in Farmland Cars (millions per year) Grain(billions of bushels per year) Farmland’s PPF a 8

16 2 million cars Opportunity Cost in Farmland Cars (millions per year) Grain(billions of bushels per year) billion bushels of grain a Farmland’s PPF Opportunity cost of 1 car is 9,000 bushels of grain

17 Opportunity Cost in Mobilia Cars (millions per year) Grain(billions of bushels per year)

18 Opportunity Cost in Mobilia Cars (millions per year) Grain(billions of bushels per year) Mobilia’s PPF a'

19 Opportunity Cost in Mobilia Cars (millions per year) Grain(billions of bushels per year) Mobilia’s PPF 6 million cars 6 billion bushels of grain a' Opportunity cost of 1 car is 1,000 bushels of grain

20 Opportunity Cost and Comparative Advantage Mobilia has a comparative advantage in car production Farmland has a comparative advantage in grain production.

21 Gains from Trade Let’s see how two groups do business with each other.

22 International Trade in Cars Quantity (millions of cars per year) Price (thousands of bushels of grain per car)

23 International Trade in Cars Farmland’s import demand for cars Quantity (millions of cars per year) Price (thousands of bushels of grain per car) a

24 International Trade in Cars Farmland’s import demand for cars Mobilia’s export supply of cars a' Quantity (millions of cars per year) Price (thousands of bushels of grain per car) a

25 International Trade in Cars Farmland’s import demand for cars Mobilia’s export supply of cars Farmland’s no-trade point a a' Quantity (millions of cars per year) Price (thousands of bushels of grain per car) Mobilia’s no-trade point

26 Gains from Trade Balanced Trade –Farmland pays for its cars by exporting grain –They must export 12 billion bushels of grain for 4 million cars. –Mobilia is exporting 4 million cars for 12 billion bushels of grain. Trade is balanced

27 Gains from Trade Changes in Production and Consumption –How is it possible for everyone to gain? –With international trade economies can consume a different quantity than it produces.

28 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) Farmland

29 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) a No-trade production and consumption Farmland

30 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) a b No-trade production and consumption Production with trade Farmland

31 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) a c b Consumption with trade No-trade production and consumption Production with trade Farmland

32 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) Mobilia

33 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) a' No-trade production and consumption 9 21 Mobilia

34 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) a' b' No-trade production and consumption Production with trade 9 21 Mobilia

35 Expanding Consumption Possibilities Cars (millions per year) Grain(billions of bushels per year) a' c' b' Consumption with trade No-trade production and consumption Production with trade 9 21 Mobilia

36 Learning Objectives Describe the trends and patterns in international trade Explain comparative advantage and explain why all countries can gain from international trade Explain how economies of scale and diversity of taste lead to gains from trade

37 Gains from Trade in Reality The U.S. buys TVs and VCRs from Korea, machinery from Europe, and fashion goods from Hong Kong. We sell machinery, grain, and lumber, airplanes, computers and financial services. Why do we exchange manufactured goods?

38 Gains from Trade in Reality Diversity of Taste and Economies of Scale –Due to the large diversity in human tastes, people value diversity and are willing to pay for it. –The production of many manufactured goods are faced with economies of scale.

39 Learning Objectives (cont.) Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities Explain the arguments used to justify trade restrictions and show how they are flawed Explain why we have trade restrictions

40 Trade Restrictions Tariffs are a tax imposed by an importing country when an imported good crosses its international boundary. Nontariff barriers are actions other than a tariff that restricts international trade. –quantity restrictions, licensing requirements

41 U.S. Tariffs: 1930–1996 The Smoot-Hawley Act (1930) GATT (since 1947) Tariffs now as low as ever

42 Trade Restrictions The North American Free Trade Agreement (NAFTA) became effective January 1, –All trade barriers will virtually be eliminated between the U.S., Mexico, and Canada during a 15 year phasing-in period. European Union –Created the largest unified tariff-free market in the world

43 Trade Restrictions How Tariffs Work –What happens if Farmland places a tariff on the importation of cars. The supply of cars in Farmland decreases The price of a car in Farmland rises. The quantity of cars imported by Farmland decreases.

44 Trade Restrictions How Tariffs Work –What happens if Farmland places a tariff on the importation of cars. The government of Farmland collects the tariff revenue Resource use is inefficient The value of exports changes by the same amount as the value of imports and trade remains balanced.

45 The Effects of a Tariff Quantity (millions of cars per year) Price (thousands of bushels of grain per car) 2

46 The Effects of a Tariff Farmland’s import demand for cars Mobilia’s export supply of cars Quantity (millions of cars per year) Price (thousands of bushels of grain per car) 2

47 The Effects of a Tariff Farmland’s import demand for cars Mobilia’s export supply of cars Quantity (millions of cars per year) Price (thousands of bushels of grain per car) 2 Tariff revenue Mobilia’s export supply of cars plus tariff

48 Trade Restrictions Nontariff Barriers –Quotas are a quantitative restriction on the import of a particular good. –Voluntary export restraints (VER) are agreements between two governments in which the government of the exporting country agrees to restrain the volume of its own exports.

49 The Effects of a Quota Farmland’s import demand for cars Mobilia’s export supply of cars Quantity (millions of cars per year) Price (thousands of bushels of grain per car)

50 The Effects of a Quota Farmland’s import demand for cars Mobilia’s export supply of cars Quantity (millions of cars per year) Price (thousands of bushels of grain per car) 2 Quota Importer’s profit

51 Learning Objectives (cont.) Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities Explain the arguments used to justify trade restrictions and show how they are flawed Explain why we have trade restrictions

52 The Case Against Protection The National Security Argument –“A country must protect industries that produce defense equipment and armaments and those on which the defense industries rely for their raw materials and other intermediate inputs.”

53 The Case Against Protection The National Security Argument –This argument is false because: In a time of war, all industries contribute to national defense. It is more efficient to subsidize firms, financed from taxes, if a country wishes to increase the output of a strategic industry.

54 The Case Against Protection The Infant-Industry Argument –“It is necessary to protect a new industry to enable it to grow into a mature industry that can compete in world markets.”

55 The Case Against Protection The Infant-Industry Argument –This argument is false because: It only applies if the benefits of learning-by-doing not only accrue to the owners and workers of the firms in the infant industry but also spill over to other industries and parts of the economy. It is more efficient to protect an infant industry by using a subsidy financed from taxes.

56 The Case Against Protection The Dumping Argument –Dumping occurs when a foreign firm sells its exports at a lower price that its cost of production.

57 The Case Against Protection The Dumping Argument –The dumping argument should be resisted because: Dumping is virtually impossible to detect. A natural global monopoly is not likely. Regulation would be the best way of dealing with a natural global monopoly.

58 Other Arguments for Protection 1) Saves jobs 2) Allows us to compete with cheap foreign labor 3) Brings diversity and stability 4) Penalizes lax environmental standards

59 Other Arguments for Protection 5) Protect National Culture 6) Prevents rich countries from exploiting developing countries

60 Learning Objectives (cont.) Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities Explain the arguments used to justify trade restrictions and show how they are flawed Explain why we have trade restrictions

61 Why Is International Trade Restricted? Tariff Revenue Rent Seeking –Free trade brings benefits to some but imposes costs on others, with total benefits exceeding total costs

62 Why Is International Trade Restricted? Compensating Losers –Losers are compensated, to some degree, in reality: NAFTA and retraining workers Unemployment compensation

63 Why Is International Trade Restricted? Difficulties –Cost of identifying losers and estimating losses would be enormous. –Losers today, may be winners tomorrow.