Mehdi Arzandeh, University of Manitoba

Mehdi Arzandeh, University of Manitoba
PowerPoint Presentation by Mehdi Arzandeh, University of Manitoba

© 2016 McGraw‐Hill Education Limited
International Trade 17 LEARNING OBJECTIVES LO17.1 List and discuss several key facts about Canada’s international trade. LO17.2 Define comparative advantage, and demonstrate how specialization and trade add to a nation’s output. LO17.3 Describe how differences between world prices prompt exports and imports. LO17.4 Analyze the economic effects of tariffs and quotas. LO17.5 Analyze the validity of the most frequently presented arguments for protectionism. LO17.6 Identify and explain the objectives of GATT, WTO, EU, Euro Zone, and NAFTA, and discuss offshoring and those hurt by free trade. © 2016 McGraw‐Hill Education Limited

Other National Economies
LO4.1 FIGURE 17-1 International Linkages Canadian Economy Other National Economies Goods & Services Capital & Labour Info & Technology Money LO1 © 2016 McGraw‐Hill Education Limited

Canada, International Linkages, and Globalization 17.1 Canada and World Trade Volume Exports are about 28% of Canadian GDP Imports are about 29% of Canadian GDP LO1 © 2016 McGraw‐Hill Education Limited

17.1 GLOBAL PERSPECTIVE China has the largest share of world exports, followed by the United States and Germany. The eight largest export nations account for over 40 percent of world exports. LO1 © 2016 McGraw‐Hill Education Limited

Canada, International Linkages, and Globalization 17.1 Dependence Canada almost entirely dependent on other countries for bananas, cocoa, coffee, spices, tea, raw silk, tin, and natural rubber. Many Canadian industries rely on sales abroad: agricultural products, computers, chemicals, aircraft, automobiles, etc. LO1 © 2016 McGraw‐Hill Education Limited

Canada, International Linkages, and Globalization 17.1 Trade Patterns A trade surplus occurs when exports exceed imports. Canada had a trade surplus in goods in 2014. A trade deficit occurs when imports exceed exports. Canada had a trade deficit in services in 2014. Canada imports some of the same categories of goods that it exports, called intra-industry trade. Canada’s export and import trade is mainly with other industrially advanced nations. LO1 © 2016 McGraw‐Hill Education Limited

LO4.1 Principal Canadian Exports and Imports of Goods, 2014 TABLE 17-1 Exports % of total Imports Machinery and equipment 16 10 Automotive products 22 17 Industrial goods and materials 18 Forestry products 7 Consumer goods 20 Energy products 24 Agricultural and fishing products 3 8 Table 17-1 may be updated. Source: Statistics Canada. At: and Accessed May 28, 2015 LO1 © 2016 McGraw‐Hill Education Limited

LO4.1 Canadian Exports and Imports of Goods by Area, 2014 TABLE 17-2 Exports to % of total Imports from United States 76 67 United Kingdom 8 9 European Union 3 2 Japan Other countries 11 20 Table 17-2 may be updated. Source: Accessed May 28, 2015 LO1 © 2016 McGraw‐Hill Education Limited

Canada, International Linkages, and Globalization 17.1 Participants in International Trade Germany, the United States, China, and Germany had combined exports of over five trillion in 2014. Along with Germany, other western European nations such as France, Britain, and Italy are major exporters. Southeast Asian countries of South Korea, Taiwan, and Singapore have combined exports which exceed those of France, Britain, or Italy. China with its increased reliance on the market system and reintegration of Hong Kong, has quickly emerged as a major international trader. LO1 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Why do nations trade? The distribution of resources is uneven. Efficient production requires different technologies or resource combinations. Products are differentiated as to quality and other non-price attributes. LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Absolute Advantage A country is said to have an absolute advantage over other producers for a product if it is the most efficient producer of that product Comparative Advantage A country is said to have a comparative advantage over other producers of a product if it can produce the product at a lower opportunity cost LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 The Basic Principle Specialization according to comparative advantage reduces costs This is true even if a nation has an absolute advantage LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Specialization and Comparative Advantage Two isolated nations (Canada and Brazil) Constant Costs straight-line production possibilities curves Different Costs different technology & resources Canada has absolute advantage in both steel and soybeans LO2 © 2016 McGraw‐Hill Education Limited

LO4.1 FIGURE 17-3 Production Possibilities Curve (a) Canada (b) Brazil Soybean s(Tonnes) 30 25 20 15 10 5 35 40 45 Steel (Tonnes) Soybeans (Tonnes) 30 25 20 15 10 5 35 40 45 Steel (Tonnes) 12 A 4 Z 18 8 LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Specialization Based on Comparative Advantage Self-sufficiency output mix Specialization and trade Produce the good with the lowest domestic opportunity cost Opportunity cost of 1 tonnes of steel: 1 tonnes of soybeans in Canada (1St = 1Soy). 2 tonnes of soybeans in Brazil (1St = 2Soy) LO2 © 2016 McGraw‐Hill Education Limited

TABLE 17-3 Country (1) Outputs before specialization
LO4.1 International Specialization According to Comparative Advantage and the Gains from Trade (in tonnes) TABLE 17-3 Country (1) Outputs before specialization (2) Outputs after specialization (3) Amounts exported (–) and imported (+) (4) Outputs available after trade (5) Gains from specialization and trade(4) – (1) Canada 18 steel 30 steel –10 steel 20 steel 2 steel 12 soybeans 0 soybeans +15 soybeans 15 soybeans 3 soybeans Brazil 8 steel 0 steel +10 steel 10 steel 4 soybeans 20 soybeans –15 soybeans 5 soybeans 1 soybeans Total output (steel and soybeans) 42 50 8 LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Terms of Trade What will the terms of trade be? Canada 1St = 1Soy Canada will sell 1St for more than 1Soy Brazil 1St = 2Soy Brazil will pay less than 2Soy for 1St For trade to be mutually beneficial the terms of trade must be between each nation’s opportunity costs. Settle between the two, depends on supply/demand factors (assume trade 1St for 1.5Soy). LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Gains from Trade Trading possibilities line Slope equals terms of trade Improved options Complete specialization More of both goods More efficient resource allocation The trading possibilities line shows that both countries end up better off with trade. With comparative advantage, the nations have complete specialization in which each nation only produces the good that it has the comparative advantage in and then imports all of the good for which it has a comparative disadvantage. Each country ends up with more of both goods. Both the Canada and Brazil made more efficient use of their resources by specializing in production of the good for which they have a comparative advantage. LO2 © 2016 McGraw‐Hill Education Limited

LO4.1 KEY GRAPH - Trading Possibilities Lines and the Gains from Trade FIGURE 17-4 (a) Canada (b) Brazil Soybeans (Tonnes) 30 25 20 15 10 5 35 40 45 Steel (Tonnes) Soybeans (Tonnes) 30 25 20 15 10 5 35 40 45 Steel (Tonnes) V’ Trading Possibilities Line V Trading Possibilities Line v A’ As we can see in these graphs, the maximum production line for each country has rotated outwards to provide each with a higher level of output under trade. In the long run, all parties benefit from trade, at any level. The slope of the trading possibilities line reflects the terms of trade between the two countries. 12 A Z’ 4 Z B W b b’ 18 8 LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 Trade with Increasing Costs Concave production curve Resources not perfectly substitutable Incomplete specialization While we were using a very simple example of two products and two countries, the analysis would be the same for any number of products and countries. In the real world we are also faced with a concave production possibilities curve instead of the linear one from our analysis. This means there are increasing opportunity costs in the real world and, at some point, the underlying basis for further specialization and trade disappears so both countries end up producing some of both products. This is why we end up with domestically-produced products competing with similar imported products. However the numbers come out, everyone ends up benefitting somehow from trade. In addition to promoting efficiency and competition among firms, nations benefit as they build relationships with their trading partners that can help to prevent disagreements that might lead to wars. LO2 © 2016 McGraw‐Hill Education Limited

The Economic Basis for Trade 17.2 The Case for Free Trade Restated Through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well- being than without free trade. Side benefits: Promotion of competition, deterrence of monopoly Linking of national interests, reduction of national animosities LO2 © 2016 McGraw‐Hill Education Limited

Supply and Demand Analysis of Exports and Imports 17.3 When world prices increase relative to domestic prices, domestic exports will increase, resulting in an upward sloping export supply curve When world prices decrease relative to domestic prices, domestic imports will increase, resulting in a downward sloping import demand curve LO3 © 2016 McGraw‐Hill Education Limited

(Millions of Kilograms) (Millions of Kilograms)
FIGURE 17-5 Canadian Export Supply and Import Demand Canada Domestic Aluminum Market (b) Canada Export Supply and Import Demand Price (Per Kilogram; Canadian Dollars) 1.50 1.25 1.00 .75 .50 50 75 100 125 150 Quantity of Aluminum (Millions of Kilograms) Surplus = 100 1.50 1.25 1.00 .75 .50 50 100 Quantity of Aluminum (Millions of Kilograms) Price (Per kilogram; Canadian. Dollars) Sd c Surplus = 50 Canadian Export Supply b a Canadian Import Demand x Shortage = 50 Here in these graphs we see the effects of differences between the world price and the domestic equilibrium price. The domestic equilibrium price is $1.00/kilogram. If the world price is above that point, say at $1.25/kilogram, domestic producers will produce 125 million pounds, which creates a surplus of 25 million pounds over the domestic demand. The surplus will be exported and sold at the higher price. For each price above the domestic equilibrium price, there will be surplus and the Canadian will export that surplus at that price, creating the Canadian export supply. For each price below the domestic equilibrium price, the U.S. will have a shortage and will import aluminum equivalent to the size of the shortage. Doing this for each price creates the U.S. import demand. y Shortage = 100 Dd LO3 © 2016 McGraw‐Hill Education Limited

(Millions of Kilograms) (Millions of Kilograms)
FIGURE 17-6 U.S. Export Supply and Import Demand U.S. Domestic Aluminum Market (b) U.S. Export Supply and Import Demand Price (Per kilogram, Canadian Dollars) 1.50 1.25 1.00 .75 .50 50 75 100 125 150 Quantity of Aluminum (Millions of Kilograms) 1.50 1.25 1.00 .75 .50 50 100 Quantity of Aluminum (Millions of Kilograms) Price (Per kilogram, Canadian Dollars) Surplus = 100 Sd s Surplus = 50 U.S. Export Supply r q U.S. Import Demand Here we switch our viewpoint to U.S. for illustration purposes. We can see their domestic equilibrium price is $.75/kilogram, and we see the surpluses and shortages that occur when the world price is higher or lower than that. t Shortage = 50 Dd LO3 © 2016 McGraw‐Hill Education Limited

(Millions of Kilograms)
Equilibrium World Price and Quantity of Exports and Imports FIGURE 17-7 1.25 1.00 1.125 50 100 Quantity of Aluminum (Millions of Kilograms) Price (Per Kilogram; Canadian Dollars) Canadian Export Supply U.S. Export Supply e Equilibrium Canadian Import Demand U.S. Import Demand Now we can combine the two countries into one analysis to determine a world equilibrium price. If we combine the U.S. export supply curve and import demand curve with the Canadian export supply curve and import demand curve, we find the equilibrium point where one country’s export supply curve intersects the other country’s import demand curve. In this example that occurs at a price of $1.125/pound. After trade, this would be the price found in both countries. 25 LO3 © 2016 McGraw‐Hill Education Limited

Supply and Demand Analysis of Exports and Imports 17.3 Equilibrium World Price, Exports and Imports, Two-Nation Model International equilibrium occurs when one nation’s demand curve intersects another nation’s export supply curve. Americans will pay more for aluminum with trade than without it. Americans are willing to export aluminum to Canada because they can gain from the trade (to import other goods). Canadians pay less for aluminum with trade. Canadians gain from the trade. LO3 © 2016 McGraw‐Hill Education Limited

Trade Barriers and Export Subsidies 17.4 Tariffs Revenue tariffs Protective tariffs Nontariff Barriers (NTB) Import Quotas Voluntary Export Restrictions (VER) Export Subsidy LO4 © 2016 McGraw‐Hill Education Limited

Trade Barriers and Export Subsidies 17.4 Economic Impact of Tariffs Direct effects Decline in consumption Increase in domestic production Decline in imports Tariff revenue Indirect effects Because tariffs are the most commonly used trade barrier, we will look closer at their effect on the economy. The direct impact of tariffs includes a decline in domestic consumption as the desired goods are now at a higher price than consumers are willing to pay, an increase in domestic production as suppliers will be able to receive a higher price for the goods, a decline in imports which was the whole point of the tariff, and tariff revenue accruing to the domestic government. Tariffs also have an indirect effect beyond just basic supply and demand concepts. Since the foreign country supplying the import will sell less, their economy will decline. If they imported any products from the domestic country, those would decline as well. Tariffs also to some extent subsidize inefficient producers which can be a drain on the economy. LO4 © 2016 McGraw‐Hill Education Limited

Trade Barriers and Export Subsidies 17.4 Economic Impact of Quotas Decline in consumption Increase in domestic production Decline in imports Quotas do not provide for any government revenue but instead transfer it to foreign producers Quotas have much the same effect as tariffs with the major difference being that quotas do not provide any government revenue. With a tariff, the government could theoretically use the revenue to compensate firms and individuals who have been adversely affected by the international trade. With quotas, the excess revenue provided accrues to the foreign producer, not the domestic government. LO4 © 2016 McGraw‐Hill Education Limited

LO4.1 The Economic Effects of a Protective Tariff or an Import Quota FIGURE 17-8 Quantity Price Sd Sd + Q Pd Pt Pw This graph illustrates the effects of a tariff or quota on domestic supply and demand. At the world price, there is a shortage in the market equivalent to ad. This shortage will be solved with imports equivalent to ad. When a tariff is placed on the good, the price increases, and the quantity produced by domestic firms will rise while the quantity demanded by domestic consumers falls. The shortage shrinks from ad to bc. The foreign producers will continue to receive the world price. The quota has essentially the same effects except that the higher price is now received by foreign and domestic producers. Note that the yellow area reflects the additional revenue that under a tariff will go to the government but with a quota will go to the foreign producer. Dd a b q c d LO4 © 2016 McGraw‐Hill Education Limited

Trade Barriers and Export Subsidies 17.4 Net Costs of Tariffs and Quotas Consumer costs price of imported product goes up some consumers shift purchases from imports to higher-priced domestic goods prices of domestic goods rise Gains to protected industries and workers come at the expense of much greater losses for the entire economy. LO4 © 2016 McGraw‐Hill Education Limited

The Case for Protection: A Critical Review 17.5 Military Self-Sufficiency Argument Diversification for Stability Argument Infant Industry Argument Counter-arguments: which industries? how long? other methods which are better LO5 © 2016 McGraw‐Hill Education Limited

The Case for Protection: A Critical Review 17.5 Protection Against Dumping Argument Driving Out Competitors Price Discrimination Increased Domestic Employment Argument Job creation from imports Fallacy of composition Possibility of retaliation Long-run feedbacks Cheap Foreign Labour Argument What actually matters is labour costs per unit, not per hour Differences in productivity typically mean that labour costs per unit are often nearly identical despite huge differences in labour costs per hour LO5 © 2016 McGraw‐Hill Education Limited

The Case for Protection: A Critical Review 17.5 Summing Up The arguments for protection are not convincing. There is compelling historical evidence that free trade has led to prosperity and protectionism has led to the opposite. LO5 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 High tariffs a contributing cause of the Great Depression Reciprocal Trade Agreements Most-favoured-nation clauses LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 General Agreement on Tariffs and Trade (GATT) First signed in 1947 equal, non-discriminatory trade treatment for all member nations reduction of tariffs by multilateral negotiation elimination of import quotas Eight rounds of negotiations Uruguay Round took effect in 1995 LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 World Trade Organization (WTO) Successor to the GATT 155 member organization Oversees trade agreements Rules on trade disputes Forum for further rounds of negotiations Doha Round launched in 2001 LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 World Trade Organization (WTO) Trade liberalizations implemented by 2005: tariff reductions new rules for trade in services reductions in agricultural subsidies new protections for intellectual property phasing out quotas on textiles, apparel, and replacing them with tariffs LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 World Trade Organization (WTO) GATT and WTO have been positive forces for liberalized trade WTO is highly controversial LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 The European Union (EU) Free-trade zones, trade blocs EU initiated in 1958 as the Common Market Expanded to 27 countries in 2007, then to 28 nations in 2013 Nearly all internal tariffs & import quotas abolished Common system of tariffs on non-EU goods Liberalized movements of capital and labour within the EU Common internal economic policies Euro-zone LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 North American Free Trade Agreement (NAFTA) Canada, Mexico, United States formed a trade bloc in 1993. Concerns about job losses not realized. Standard of living has been enhanced in all three countries. In 2008, Canada signed a free-trade agreement with Colombia. LO6 © 2016 McGraw‐Hill Education Limited

Multilateral Trade Agreements and Free-Trade Zones 17.6 Recognizing Those Hurt by Free Trade OFFSHORING OF JOBS Job losses because of international trade and globalization of factor markets Offshoring reflects growing specialization and international trade in services or “tasks.” Offshoring may encourage domestic investment and the expansion of firms in Canada by reducing their production costs and keeping them competitive worldwide Offshoring also increases the demand for complementary jobs in Canada LO6 © 2016 McGraw‐Hill Education Limited

LO4.1 The LAST WORD Petition of the Candlemakers, 1845 French economist Frédéric Bastiat (1801–1850) devastated the proponents of protectionism by satirically extending their reasoning to its logical and absurd conclusions. Petition of candlemakers asking for protection from natural light producers such as the sun Tongue-in-cheek argument supporting the idea of free trade © 2016 McGraw‐Hill Education Limited

LO4.1 Chapter Summary LO17.1 List and discuss several key facts about Canada’s international trade. LO17.2 Define comparative advantage, and demonstrate how specialization and trade add to a nation’s output. LO17.3 Describe how differences between world prices prompt exports and imports. LO17.4 Analyze the economic effects of tariffs and quotas. LO17.5 Analyze the validity of the most frequently presented arguments for protectionism. LO17.6 Identify and explain the objectives of GATT, WTO, EU, Euro Zone, and NAFTA, and discuss offshoring and those hurt by free trade. © 2016 McGraw‐Hill Education Limited

Mehdi Arzandeh, University of Manitoba

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