1. International Aspects
Lessons 4 & 5

2. Consider your typical day:
You wake up to an alarm clock made in South Korea.
You pour yourself orange juice made from Florida oranges and coffee from beans grown in Brazil.
You put on some clothes made of cotton grown in Egypt and sewn in factories in Thailand./Cambodia
You watch the morning news broadcast from New York on your TV made in China for a S Korean firm.
You drive to class in a car made of parts manufactured in a half-dozen different countries.
You see your messages on your Iphone made in ZZ for Apple Corp bought in UK

3. Interdependence and the Gains from Trade
Remember, economics is the study of how societise - state, countries, nations produce and distribute goods in an attempt to satisfy the wants and needs of its members/consumers/households 2 3

4. Interdependence and the Gains from Trade
How does a society satisfy its wants and needs in a global economy?
We can try to be economically self-sufficient. OR
We can specialize and trade with others, leading to economic interdependence. 3 4

5. Let’s review theories of international trade
Mercantilism
Jean-Baptiste Colbert
Absolute Advantage
Adam Smith
Comparative Advantage
David Ricardo
Factor Endowment Theory
Eli Heckscher and Bertil Ohlin

6. Mercantilism - Jean-Baptiste Colbert
Trade is seen as a zero-sum activity – with winners and losers
Wealth was seen as gold – there is only so much of it.
Aim to gain as much wealth as possible
Become wealthy at the expense of other countries
This thinking still exists today as protectionism

7. Absolute Advantage - Adam Smith
Adam Smith’s book “The Wealth of Nations” published 1776
Markets work without government intervention as if guided by an “Invisible hand”
A country could have an absolute advantage over other countries.
For example, Portugal had an absolute advantage over England in producing grapes and wine because of its better climate and soil. However, England had an absolute advantage over Portugal in producing sheep and wool because of its climate.
Portugal should sell wine to England and that England should sell wool to Portugal. By specialising in what they were good at, both countries could produce more.
Both countries become better off as a result.
Free trade can be win-win

8. Comparative Advantage - David Ricardo
An importing country can be better off importing goods it could easily produce itself, if by doing so it is able to concentrate its resources on other activities that produce more value.
Countries can benefit from a comparative advantage, even without an absolute advantage.

9. Factor Endowment Theory - Eli Heckscher and Bertil Ohlin
Countries derive comparative advantage from factor endowments.
Factors might be land, location, natural resources such as minerals or energy, labour or population size.
This theory suggests countries will export goods that make use of factors they have inherited in abundance, and import goods that make use of factors that they lack.
The Factor Endowment theory states that it is the relative abundance of these inherited factor endowments that counts.

10. New trade theory
Other forms of advantage:
Innovation creates advantage – by providing a first-mover advantage.
Learning effects provide an advantage – for example after you have built one airplane, the next one is easier.
Economies of scale provide an advantage – for example if you build most of the world’s airplanes, you can build them better and cheaper than your competitors.

11. Interdependence and the Gains from Trade
Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity.
But this gives rise to two questions:
Why is interdependence the norm?
What determines production and trade? 4 11

12. Interdependence and the Gains from Trade
Why is interdependence the norm?
Interdependence occurs because people are better off when they specialize and trade with others.
What determines the pattern of production and trade?
Patterns of production and trade are based upon differences in opportunity costs.
ECONOMIC PRINCIPLE #5 12

13. A PARABLE FOR THE MODERN ECONOMY
Imagine . . .
only two goods: potatoes and meat
only two people: a potato farmer and a cattle rancher
What should each produce?
Should they trade? 13

14. Table 1 The Production Opportunities of the Farmer and Rancher
Copyright © South-Western

15. Production Possibilities
Self-Sufficiency
By ignoring each other:
Each consumes what they each produce.
The production possibilities frontier is also the consumption possibilities frontier.
Without trade, economic gains are diminished. 8 15

16. Figure 1 The Production Possibilities Curve
(a) The Farmer ’
s Production Possibilities Frontier
Meat (ounces)
If there is no trade,
the farmer chooses
this production and
consumption. 8 32 A 4 16
Potatoes (ounces)
Copyright©2003 Southwestern/Thomson Learning

17. Figure 1 The Production Possibilities Curve
(b) The Rancher ’
s Production Possibilities Frontier
Meat (ounces) 48 24
If there is no trade,
the rancher chooses
this production and
consumption. B 12 24
Potatoes (ounces)
Copyright©2003 Southwestern/Thomson Learning

18. The farmer should produce potatoes. The rancher should produce meat.
Specialization and Trade
The Farmer and the Rancher Specialize and Trade
Each would be better off if they specialized in producing the product they are more suited to produce, and then trade with each other.
The farmer should produce potatoes.
The rancher should produce meat. 10 18

19. Table 2 The Gains from Trade: A Summary
Copyright © South-Western

20. Table 2 The Gains from Trade: A Summary
Copyright © South-Western

21. THE PRINCIPLE OF COMPARATIVE ADVANTAGE
Differences in the (input) costs of production determine the following:
Who should produce what?
How much should be traded for each product?
Who can produce potatoes at a lower cost--the farmer or the rancher? 11 21

22. THE PRINCIPLE OF COMPARATIVE ADVANTAGE
Differences in Costs of Production
Two ways to measure differences in costs of production:
The number of hours required to produce a unit of output (for example, one pound of potatoes).
The opportunity cost of sacrificing one good for another. 22

23. Absolute Advantage
The comparison among producers of a good according to their productivity—absolute advantage
Describes the productivity of one person, firm, or nation compared to that of another.
The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. 13 23

24. Absolute Advantage
The Rancher needs only 10 minutes to produce an ounce of potatoes, whereas the Farmer needs 15 minutes.
The Rancher needs only 20 minutes to produce an ounce of meat, whereas the Farmer needs 60 minutes.
The Rancher has an absolute advantage in the production of both meat and potatoes.

25. Opportunity Cost and Comparative Advantage
Compares producers of a good according to their opportunity cost.
Whatever must be given up to obtain some item
The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. 14 25

26. Comparative Advantage and Trade
Who has the absolute advantage?
The farmer or the rancher?
Who has the comparative advantage? 15 26

27. Table 3 The Opportunity Cost of Meat and Potatoes

28. Comparative Advantage and Trade
The Farmer’s opportunity cost of an ounce of potatoes is ¼ an ounce of meat, whereas the Rancher’s opportunity cost of an ounce of potatoes is ½ an ounce of meat.
The Rancher’s opportunity cost of a pound of meat is only 2 ounces of potatoes, while the Farmer’s opportunity cost of an ounce of meat is only 4 ounces of potatoes...

29. Comparative Advantage and Trade
…so, the Rancher has a comparative advantage in the production of meat but the Farmer has a comparative advantage in the production of potatoes.

30. Comparative Advantage and Trade
Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.
Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade. 16 30

31. Comparative Advantage and Trade
Benefits of Trade
Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.
AND to become better at it and hence more productive and therefore achieve a better S O L 17 31

32. APPLICATIONS OF COMPARATIVE ADVANTAGE
Should China Trade with Other Countries?
Each country has many citizens with different interests. International trade can make some individuals worse off, even as it makes the country as a whole better off.
Imports—goods produced abroad and sold domestically
Exports—goods produced domestically and sold abroad

33. Comparative Advantage and Trade
The Farmer’s opportunity cost of an ounce of potatoes is ¼ an ounce of meat, whereas the Rancher’s opportunity cost of an ounce of potatoes is ½ an ounce of meat.
The Rancher’s opportunity cost of a pound of meat is only 2 ounces of potatoes, while the Farmer’s opportunity cost of an ounce of meat is only 4 ounces of potatoes...

34. Summary
Each person consumes goods and services produced by many other people both in our country and around the world.
Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services. 34

35. Summary
There are two ways to compare the ability of two people producing a good.
The person who can produce a good with a smaller quantity of inputs has an absolute advantage.
The person with a smaller opportunity cost has a comparative advantage. 35

36. Summary
The gains from trade are based on comparative advantage, not absolute advantage.
Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage.
The principle of comparative advantage applies to countries as well as people. 36

37. What determines whether a country imports or exports a good?

38. Who gains and who loses from free trade among countries?

39. What are the arguments that people use to advocate trade restrictions?

40. THE DETERMINANTS OF TRADE
Equilibrium Without Trade
Assume:
A country is isolated from rest of the world and produces steel.
The market for steel consists of the buyers and sellers in the country.
No one in the country is allowed to import or export steel.

41. The Equilibrium Without International Trade
Equilibrium Without Trade
Results:
Domestic price adjusts to balance demand and supply.
The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.

42. The World Price and Comparative Advantage
If the country decides to engage in international trade, will it be an importer or exporter of steel?

43. The World Price and Comparative Advantage
The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good.

44. The World Price and Comparative Advantage
If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporter of the good.

45. The World Price and Comparative Advantage
If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good.

46. Figure 2 International Trade in an Exporting Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Domestic
quantity
demanded
Domestic
quantity
supplied
Price
before
trade
Exports
Quantity
of Steel
Copyright © South-Western

47. Figure 3 How Free Trade Affects Welfare in an Exporting Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Exports D C B A
Price
before
trade
Quantity
of Steel
Copyright © South-Western

48. Figure 3 How Free Trade Affects Welfare in an Exporting Country
Price
of Steel
Domestic
demand
Consumer surplus
before trade
Domestic
supply
Price
after
trade
World
price
Exports D C B A
Price
before
trade
Producer surplus
before trade
Quantity
of Steel
Copyright © South-Western

49. How Free Trade Affects Welfare in an Exporting Country

50. THE WINNERS AND LOSERS FROM TRADE
The analysis of an exporting country yields two conclusions:
Domestic producers of the good are better off, and domestic consumers of the good are worse off.
Trade raises the economic well-being of the nation as a whole.

51. The Gains and Losses of an Importing Country
International Trade in an Importing Country
If the world price of steel is lower than the domestic price, the country will be an importer of steel when trade is permitted.
Domestic consumers will want to buy steel at the lower world price.
Domestic producers of steel will have to lower their output because the domestic price moves to the world price.

52. Figure 4 International Trade in an Importing Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
before
trade
Price
after
trade
World
price
Domestic
quantity
supplied
Domestic
quantity
demanded
Imports
Quantity
of Steel
Copyright © South-Western

53. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price
Domestic
demand
of Steel
Domestic
supply C B D A
Price
before trade
Price
after trade
World
price
Imports
Quantity
of Steel
Copyright © South-Western

54. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price A
Domestic
demand
of Steel
Consumer surplus
before trade
Domestic
supply
Price
before trade C B
Producer surplus
before trade
Price
after trade
World
price
Quantity
of Steel
Copyright © South-Western

55. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price
Domestic
demand
of Steel
Consumer surplus
after trade
Domestic
supply C B D A
Price
before trade
Price
after trade
World
price
Imports
Producer surplus
after trade
Quantity
of Steel
Copyright © South-Western

56. How Free Trade Affects Welfare in an Importing Country

57. THE WINNERS AND LOSERS FROM TRADE
How Free Trade Affects Welfare in an Importing Country
The analysis of an importing country yields two conclusions:
Domestic producers of the good are worse off, and domestic consumers of the good are better off.
Trade raises the economic well-being of the nation as a whole because the gains of consumers exceed the losses of producers.

58. THE WINNERS AND LOSERS FROM TRADE
The gains of the winners exceed the losses of the losers.
The net change in total surplus is positive.

59. Losers sometimes want to restrict trade
Why
How
Who benefits

60. WHY - THE ARGUMENTS FOR RESTRICTING TRADE
Jobs
National Security
Infant Industry
Unfair Competition
Protection-as-a-Bargaining Chip

61. HOW
Tariffs
Quotas
Other means – Non Tariff barriers

62. The Effects of a Tariff
A tariff is a tax on goods produced abroad and sold domestically.
Tariffs raise the price of imported goods above the world price by the amount of the tariff.

63. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Equilibrium
without trade
Price
with tariff Q S Q D
Tariff
Price
without tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
without tariff
of Steel
Copyright © South-Western

64. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Consumer surplus
before tariff
Domestic
supply
Producer surplus
before tariff
Equilibrium
without trade
Price
without tariff
World
price Q S Q D
Quantity
Imports
without tariff
of Steel
Copyright © South-Western

65. Figure 6 The Effects of a Tariff
Price
of Steel A B
Domestic
demand
Consumer surplus
with tariff
Domestic
supply
Equilibrium
without trade
Price
with tariff Q S Q D
Tariff
Price
without tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
without tariff
of Steel
Copyright © South-Western

66. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Producer surplus
after tariff
Equilibrium
without trade
Price
with tariff C G
Imports
with tariff Q S D
Tariff
Price
without tariff
World
price Q S Q D
Quantity
Imports
without tariff
of Steel
Copyright © South-Western

67. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Tariff Revenue
Price
with tariff
Imports
with tariff Q S D E
Tariff
Price
without tariff
World Q S Q D
price
Quantity
Imports
without tariff
of Steel
Copyright © South-Western

68. Figure 6 The Effects of a Tariff
Price
of Steel A
Domestic
demand
Domestic
supply
Deadweight Loss B
Price
with tariff C G D F Q S E Q D
Tariff
Price
without tariff
World Q S Q D
Imports
with tariff
price
Quantity
Imports
without tariff
of Steel
Copyright © South-Western

69. The Effects of a Tariff

70. The Effects of a Tariff
A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.
With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.

71. The Effects of an Import Quota
An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

72. Figure 7 The Effects of an Import Quota
Price
of Steel
Domestic
demand
Domestic
supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota
Isolandian
price with
quota
Equilibrium
with quota Q S Q D
World
price
Price
without
quota = Q S Q D
Imports
with quota
Quantity
Imports
without quota
of Steel
Copyright © South-Western

73. Figure 7 The Effects of an Import Quota
Price
of Steel A
Domestic
demand
Domestic
supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota B
Isolandian
price with
quota
Equilibrium
with quota D Q S E' Q D C F
World
price
Price
without
quota =
E" Q S Q D G
Imports
with quota
Quantity
Imports
without quota
of Steel
Copyright © South-Western

74. The Effects of an Import Quota

75. The Effects of an Import Quota
Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off.
License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.

76. The Effects of an Import Quota

77. The Effects of an Import Quota
With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss.
The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.

78. Non Tariff Barriers
Administrative Bureaucracy
Government Purchasing Policies
Safety and technical standards/conditions- testing..

79. The Lessons for Trade Policy
All Barriers to Trade
raise domestic prices.
reduce the welfare of domestic consumers.
increase the welfare of domestic producers.
cause deadweight losses.

80. The Lessons for Trade Policy
Other Benefits of International Trade
Increased variety of goods
Lower costs through economies of scale
Increased competition
Enhanced flow of ideas

81. THE ARGUMENTS FOR RESTRICTING TRADE
Jobs
National Security
Infant Industry
Unfair Competition
Protection-as-a-Bargaining Chip

82. Trade Agreements and the World Trade Organization
Unilateral: when a country removes its trade restrictions on its own.
Multilateral: a country reduces its trade restrictions while other countries do the same.
World Trade Organisation

83. Trade Agreements/Areas
The North American Free Trade Agreement (NAFTA) is an example of a multilateral trade agreement.
In 1993, NAFTA lowered the trade barriers among the United States, Mexico, and Canada.
The EU is similar, also known as the Single market

84. Types of Trading Blocks
Free Trade Area
Customs Union
Common Market
Economic Union .

85. Types of Trading Blocks
Free Trade Area no barriers to trade
Customs Union common external barriers set up
Common Market no internal barriers to the free movement of labour and capital
Economic Union development of common policies on key aspects such as Agriculture, Regional Aid, Central Banking leading to monetary union. .

86. Homework for Monday
Describe the following terms in the context of the international macro environment
The World Trade Organisation
The BRIC Nations
The MIST Nations.
G8 and G20 Nations.

87. Summary
The effects of free trade can be determined by comparing the domestic price without trade to the world price.
A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter.
A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.

88. Summary
When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off.
When a country allows trade and becomes an importer of a good, consumers of the good are better off, and producers are worse off.

89. Summary
A tariff—a tax on imports—moves a market closer to the equilibrium than would exist without trade, and therefore reduces the gains from trade.
Import quotas will have effects similar to those of tariffs.

90. Summary
There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
Economists, however, believe that free trade is usually the better policy.

91. Summary
There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
Economists, however, believe that free trade is usually the better policy.