1. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18 InternationalTrade 1

2. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Gains from Trade Law of comparative advantage –The individual with the lowest opportunity cost of producing a particular good –Should specialize in that good Each country specializes –In making goods with the lowest opportunity cost 2

3. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Gains from Trade U.S. exports –$1.8 trillion (13% of GDP) in 2010 –Services (31% of U.S. exports) U.S. imports –$2.3 trillion (16% of GDP) in 2010 –Industrial supply (27% of U.S. imports) 3

4. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 1 4 Composition of U.S. Exports and Imports in 2010

5. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Gains from Trade U.S. trading partners, 2010 –Top 10 destinations for merchandise exports Canada, Mexico, China, Japan, United Kingdom, Germany, South Korea, Brazil, Netherlands, and Singapore –Top 10 sources of merchandise imports China, Canada, Mexico, Japan, Germany, United Kingdom, South Korea, France, Taiwan, and Ireland 5

6. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Production Possibilities without Trade Production possibilities –With existing resources No trade –Production possibilities = consumption possibilities Production possibilities frontiers –Straight lines –Different slopes – different opportunity costs 6

7. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 2 7 Production Possibilities Schedules for the U.S. and Izodia

8. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 3 8 Production Possibilities Frontiers for the United States and Izodia Without Trade (millions of units per day) 100 200 300 400 500 600 Food (a) United States U1U1 U2U2 U3U3 U5U5 100200300400Clothing0 100 200 300 400 500 600 Food (b) Izodia I1I1 I2I2 I4I4 I5I5 100200300400Clothing0 Panel (a) shows the U.S. production possibilities frontier; its slope indicates that the opportunity cost of an additional unit of clothing is 2 units of food. Panel (b) shows production possibilities for Izodia; an additional unit of clothing costs 1/2 unit of food. Clothing has a lower opportunity cost in Izodia. U4U4 U6U6 I3I3 I6I6

9. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Consumption Possibilities Gains from specialization and trade –Each country should specialize Producing the good with the lower opportunity cost Terms of trade –How much of one good exchanges for a unit of another good 9

10. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Consumption Possibilities Consumption possibilities frontier –Possible combinations of goods As result of specialization and exchange –Depend on relative preferences For each good –World production must equal world consumption 10

11. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 4 11 Production (and Consumption) Possibilities Frontiers With Trade (millions of units per day) 100 200 300 400 500 600 Food (a) United States 100200300400Clothing0 100 200 300 400 500 600 Food (b) Izodia 100200300400Clothing0 U I If Izodia and the United States can specialize and trade at the rate of 1 unit of clothing for 1 unit of food, both can benefit as shown by the blue lines. By trading with Izodia, the U.S. can produce only food and still consume combination U, which has more food and more clothing than U 4. Likewise, Izodia can attain preferred combination I by trading some clothing for U.S. food. I3I3 U4U4

12. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reasons for Specialization Differences in resource endowments –Create differences in opportunity cost –Countries export goods Produce more cheaply –Countries import Products unavailable domestically Cheaper elsewhere 12

13. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 5 13 U.S. Production as a Percentage of U.S. Consumption for Various Resources If U.S. production is less than 100 percent of U.S. consumption, then imports make up the difference. If U.S. production exceeds U.S. consumption, then the amount by which production exceeds 100 percent of consumption is exported.

14. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reasons for Specialization Economies of scale –Firms produce more –Reducing average costs Differences in tastes –Differences in consumption patterns 14

15. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Consumer and Producer Surplus Demand: marginal benefit Consumer surplus –Difference between what consumer would pay and what they pay Supply: marginal cost Producer surplus –Difference between actual amount received and what they would accept 15

16. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 6 16 Consumer Surplus and Producer Surplus 0 60 Apples (pounds per day) S D Consumer surplus Producer surplus 1.00 0.50 Price per pound 2.00 $3.00 Consumer surplus, shown by the blue triangle, indicates the net benefits consumers reap from buying 60 pounds of apples at $1.00 per pound. Some consumers would have been willing to pay $3.00 or more per pound for the first few pounds. Consumer surplus measures the difference between the maximum sum of money consumers would pay for 60 pounds of apples and the actual sum they pay. Producer surplus, shown by the gold triangle, indicates the net benefits producers reap from selling 60 pounds at $1.00 per pound. Some producers would have supplied apples for $0.50 per pound or less. Producer surplus measures the difference between the actual sum of money producers receive for 60 pounds of apples and the minimum amount they would accept for this amount.

17. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Trade Restrictions Tariff: Tax on imports –Specific: $ amount per unit –Ad valorem: Percentage per unit –Effects Loss of consumer surplus Increase in producer surplus Increase in government revenue Net loss in domestic social welfare 17

18. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 7 18 Effect of a Tariff $0.15 0.10 Price per pound S D 030 Sugar (millions of pounds per month) 206070 a b c d f At a world price of $0.10 per pound, U.S. consumers demand 70 million pounds of sugar per month, and U.S. producers supply 20 million pounds per month; the difference is imported. After the imposition of a $0.05 per pound tariff, the U.S. price rises to $0.15 per pound. U.S. producers supply 30 million pounds, and U.S. consumers cut back to 60 million pounds. At the higher U.S. price, consumers are worse off; their loss of consumer surplus is the sum of areas a, b, c, and d. The net welfare loss to the U.S. economy consists of areas b and d.

19. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Trade Restrictions Import quotas: Legal limit on the amount of a commodity that can be imported –Target imports from certain countries –Effects Raise the US price above the world price Reduce quantity below the free-trade level Lower consumer surplus Increase in producer surplus Net loss in domestic social welfare 19

20. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 8 20 Effect of a Quota S’ $0.15 0.10 Price per pound S D 0 Sugar (millions of pounds per month) 205070 $0.15 0.10 Price per pound S D 030 Sugar (millions of pounds per month) 206070 a b c d S’ e In panel (a), D is the U.S. demand curve and S is the supply curve of U.S. producers. If the government establishes a sugar quota of 30 million pounds per month, the supply curve combining U.S. production and imports becomes horizontal at the world price of $0.10 per pound and remains horizontal until the quantity supplied reaches 50 million pounds. For higher prices, the new supply curve equals the horizontal sum of the U.S. supply curve, S, plus the quota of 30 million pounds. The new U.S. price, $0.15 per pound, is determined by the intersection of the new supply curve, S, with the U.S. demand curve, D. Panel (b) shows the welfare effect of the quota. As a result of the higher U.S. price, consumer surplus is cut by the shaded area. The blue-shaded areas illustrate the loss in consumer surplus that is captured by domestic producers and those who are permitted to fulfill the quota, and the pink-shaded triangles illustrate the net welfare cost of the quota on the U.S. economy. (a)(b)

21. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Trade Restrictions Quotas in practice –Rewards domestic and foreign producers with higher prices –Lobbyists for foreign producers Seek the right to export to U.S. –Auction off the quotas Increase federal revenue Reduce pressure to perpetuate quotas 21

22. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Trade Restrictions Comparison: Tariffs and Quotas –Similarities Higher price, Lower quantity demanded Loss of consumer surplus (U.S. consumers) Gain of producer surplus (U.S. producers) Lower economic welfare –Differences Revenue from tariff – to U.S. government Revenue from quota - to quota rights’ owner 22

23. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Trade Restrictions Export subsidies - to encourage exports Domestic content requirements –A certain portion of a final good must be produced domestically Other requirements –Health, Safety, Technical standards –Discriminate against foreign goods Trade restrictions –Slow economic progress 23

24. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Multilateral Agreement General Agreement on Tariffs and Trade, GATT: –1947, 23 countries Reduce tariffs Reduce import quotas Equal trade –1986, “Uruguay Round” Now exceeds 150 countries Successor: WTO 24

25. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The World Trade Organization Legal and institutional foundation for world trade 500 economists and lawyers Trade –Merchandise –Services –Intellectual property Phase out quotas, keep only tariffs 25

26. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Doha Round and Round 1999, WTO, Seattle –50,000 protesters Largest demonstration against free trade –Labor unions – feared losing jobs overseas –Environmentalists - feared that producers would seek out countries with lax regulations –Farmers – feared foreign competition –Labor and environmental standards Effort to block goods coming from poor countries –Failed to get off the ground 26

27. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Doha Round and Round 2001, Doha, Qatar “Doha Round” –Improve market access –Phase out export subsidies –Reduce subsidies in agriculture 2003, Cancun 2005, Hong Kong 2006, 2008, Geneva Round and round 27

28. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Common Markets U.S. economy –Free trade zone across 50 states European Union –27 countries in 2010 –Barrier-free European market –16 members: common currency – Euro North American Free Trade Agreement –United States, Canada, Mexico 28

29. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Common Markets DR-CAFTA –U.S, Dominican Republic, five Central American countries Mercosur –Latin American countries ASEAN –Southeast Asian nations Southern African Customs Union –South Africa and four neighbors 29

30. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Arguments for Trade Restrictions National defense argument –Domestic industry’s output is vital to national defense –More efficient Government subsidies Stockpile basic military hardware 30

31. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Arguments for Trade Restrictions Infant industry argument –Protect emerging domestic industries –Foster inefficiencies –Cost: net welfare loss from higher domestic prices –More efficient Temporary production subsidies 31

32. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Arguments for Trade Restrictions Antidumping argument –Dumping: sell a product abroad for less than in the home market Persistent –Consumers - pay less –Increase consumer surplus Predatory –Temporary; eliminate competitors Sporadic –“sales” 32

33. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Arguments for Trade Restrictions Jobs and income argument –Protect domestic jobs –Retaliation –Great Depression: high tariffs choked trade and jobs Declining industries argument –Help lessen shocks to the economy –Specific duration 33

34. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Problems with Trade Protection Protect one stage of production –Protect downstream stages Cost of protection –Welfare loss, Cost of rent seeking Transaction cost of enforcing restrictions –Black markets Less efficient, less innovative Retaliation 34