1. 1 CHAPTER 7 LECTURE - GLOBAL MARKETS IN ACTION

2. 2  Because we trade with people in other countries, the goods and services that we can buy and consume are not limited by what we can produce.  Imports (M) are the good and services that we buy from people in other countries.  Exports (X) are the goods and services we sell to people in other countries.  If X - M > 0 Trade Surplus  If X - M < 0 Trade Deficit  If X = M Trade Balance How Global Markets Work

3. 3 United States Trade Over Time

4. 4 https://www.cia.gov/library/publications/the- world-factbook/fields/2050.html http://useconomy.about.com/od/tradepolicy/p/I mports-Exports-Components.htm http://www.census.gov/foreign-trade Look at data Looking at the Data

5. 5 International trade occurs because it makes people better off than they would be if they could consume only domestically produced products. Trade between industrial countries accounts for the majority of international trade. Absolute Advantage –An absolute advantage is derived from one country having a lower absolute input cost of producing a particular good than another country. Comparative Advantage –An advantage derived from comparing the opportunity costs of production in two countries. –Countries export goods in which they have a comparative advantage. The terms of trade are the amount of an exported good that must be given up to obtain one unit of the imported good. What Determines What Goods a Nation Will Export?

6. 6 Productivity Differences: productivity differences account for comparative advantage. This theory is often referred to as the Ricardian model after David Ricardo of the early 19 th century. Factor Abundance: comparative advantage is based on the relative abundance of factors of production. This is sometimes called the Heckscher-Ohlin model after two Swedish economists. Human Skills emphasizes differences across countries in the availability of skilled and unskilled labor. Since different consumers have different preferences, some consumers will prefer goods produced by foreign firms. The product-life-cycle theory asserts that as the product matures, comparative advantage shifts away from the country of origin if other countries have lower manufacturing costs using the now-standardized technology. Sources of Comparative Advantage

7. 7 Why the United States Imports T-Shirts Figure 7.1(a) shows U.S. demand and U.S. supply with no international trade. The price of a T-shirt is $8. U.S. firms produce 40 million T-shirts a year and U.S. consumers buy 40 million T-shirts a year. How Global Markets Work

8. 8 Figure 7.1(b) shows the market in the United States with international trade. World demand and world supply of T-shirts determine the world price of a T-shirt at $5. The world price is less than $8, so the rest of the world has a comparative advantage in producing T-shirts. How Global Markets Work

9. 9 With international trade, the price of a T-shirt in the United States falls to $5. At $5 a T-shirt, U.S. garment makers produce 2 million T-shirts a year. At $5 a T-shirt, U.S. consumers buy 60 million T-shirts a year. The United States imports 40 million T-shirts a year. How Global Markets Work

10. 10 Why the United States Exports Airplanes Figure 7.2(a) shows U.S. demand and U.S. supply with no international trade. The price of an airplane is $100 million. Boeing produces 400 airplanes a year and U.S. airlines buy 400 a year. How Global Markets Work

11. 11 Figure 7.2(b) shows the market in the United States with international trade. World demand and world supply of airplanes determine the world price of a airplane at $150 million. The world price exceeds $100 million, so the United States has a comparative advantage in producing airplanes. How Global Markets Work

12. 12 With international trade, the price of an airplane in the United States rises to $150 million. At $150 million, U.S. airlines buy 200 jets a year. At $150 million, Boeing produces 700 airplanes a year. The United States exports 500 airplanes a year. How Global Markets Work

13. 13 –International trade lowers the price of an imported good and raises the price of an exported good. –Buyers of imported goods benefit from lower prices and sellers of exported goods benefit from higher prices. –But some people complain about international competition: not everyone gains. –Who wins and who loses from free international trade? Winners, Losers, and the Net Gain from Trade

14. 14 Governments often find political reasons to favor policies that restrict trade. Government policy aimed at influencing international trade flows is called commercial policy. Protection from foreign competition generally benefits domestic producers at the expense of domestic consumers. Governments and Trade

15. 15 Governments restrict international trade to protect domestic producers from competition. Governments use four sets of tools: Tariff - a tax on a good that is imposed by the importing country when an imported good crosses its international boundary. Import Quotas - restriction that limits the maximum quantity of a good that may be imported in a given period. May also be placed on value. Other import barriers Export subsidies – Some arguments for protectionism are presented on the next three slides International Trade Restrictions

16. 16 Assumes that domestic producers will produce the goods that otherwise would have been produced abroad, giving jobs to domestic workers instead of foreign workers. Unfortunately, only the single industry involved is helped. Domestic consumers will pay higher prices for the good involved, thereby having less income to spend on other goods. Saving domestic jobs from foreign competition may ultimately cost domestic consumers more than it benefits the protected industries. Argument 1 - Creation of Domestic Jobs Argument 2 - “Level Playing Field” Government should offset perceived advantages of foreign producers: cheaper labor, lower taxes, less stringent regulations “Fair trade” typically aimed at imposing restrictions to match those imposed by other nations. Elimination of the comparative advantage of another country makes domestic consumers worse off, and undermines the basis for specialization and trade.

17. 17 Tariffs on trade generate government revenue. In many developing countries income taxes are difficult to levy and collect, while tariffs are easy to collect. Argument 3 - Government Revenue Creation Argument 4 - National Defense Industries that are critical to the national defense (certain metals, food, transportation) should be protected from foreign competition if that is the only way to ensure their existence. An alternative is to store up the critical product in peacetime.

18. 18 New industries need time to: –Establish efficient relationships with other firms –Overcome Learning curves –Increase the scale of production until economies occur Countries sometimes justify protecting new industries that need time to become competitive with the rest of the world. An alternative is to subsidize the industry, making it possible for them to charge lower prices relative to their production costs. Should be temporary, but often it is hard to remove. Argument 5 - Infant Industries Argument 6 - Strategic Trade Policy STP: The use of trade restrictions or subsidies to allow domestic firms with decreasing costs to gain a greater share of the world market. Increasing returns to scale industries: costs of production per unit of output fall with levels of output.

19. 19 Effect of a Tariff Figure 7.5(b) shows the effect of a tariff on imports. The tariff of $2 raises the price in the United States to $7. U.S. imports decrease to 10 million a year. U.S. government collects the tax revenue of $20 million a year.

20. 20 Consumer surplus shrinks to the green area. Producer surplus expands to the blue area. Area B is a transfer from consumer surplus to producer surplus. Imports decrease. Tariff revenue equals area D: Imports of T-shirts multiplied by $2. The tariff creates a social loss (deadweight loss) equal to area C + E. International Trade Restrictions

21. 21 The Effects of an Import Quota Figure 7.7(a) shows the market before the government imposes an import quota on T-shirts. The world price is $5. The United States imports 40 million T-shirts a year. International Trade Restrictions

22. 22 Figure 7.7(b) shows the market with an import quota of 10 million T-shirts. With the quota, the supply of T-shirts in the United States becomes S + quota. The price rises to $7. The quantity produced in the United States increases and the quantity bought decreases. Imports decrease. International Trade Restrictions

23. 23 Other Import Barriers Thousands of detailed health, safety, and other regulations restrict international trade. Export Subsidies An export subsidy is a payment made by the government to a domestic producer of an exported good. Export subsidies bring gains to domestic producers, but they result in overproduction in the domestic economy and underproduction in the rest of the world and so create a deadweight loss. International Trade Restrictions

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