1. Chapter 9: International Trade

2. Argument Against Free Trade Foreign goods crowd out our markets, reducing employment and sales Trade deficit increases demand for $, whose appreciation increases imports and decreases exports, causing the deficit to grow Protect our vital industries (auto, aircraft) against foreign competition in case of war

3. Argument For Free Trade Principle of Comparative Advantage states: Free trade is mutually beneficial if countries specialize in production of low cost goods and exchange those for high cost goods

4. Simple Demonstration Two countries: Alpha, Omega Two goods: milk, bread Equal terms of trade: 1 bread = 1 milk

5. Labor Costs One day of work will produce in –Alpha: 1 bread, but 2 milk –Omega: 2 bread, but 1 milk Comparative advantage: –Alpha: milk –Omega: bread

6. Alpha’s Trade Sheet GoodPre- trade PPC Specialization PPC TradePost- trade CPC Gains from Trade Milk 100200-1001000 Bread 500+10010050

7. Alpha’s PPC/CPC Bread Milk 100 200 100200 50 Pre-trade CPC Post-trade CPC Trade gain=50 bread

8. Omega’s Trade Sheet GoodPre- trade PPC Specialization PPC TradePost- trade CPC Gains from Trade Milk 250+505025 Bread 50100-50500

9. Omega’s PPC/CPC Bread Milk 50 100 50100 Pre-trade CPC Post-trade CPC Trade gain=25 milk 25

10. Balance of Trade Current Account-- Flow of traded goods and services: exports less imports Capital Account-- Flow of investment: change in U.S. assets abroad less change in foreign assets in U.S. Balance of Payments = Current plus Capital

11. International Finance Two trading countries: U.S. & U.K. U.S. exports supply dollars for U.S. U.S. imports require pounds to pay to U.K. U.S. converts its dollars to pounds to pay U.K.

12. Market for Foreign Exchange Dollar/Pound ratio Pound per month D D S S 1.60 1 pound = $1.60 $1 = 0.625 pounds

13. Effects of Exchange Control May improve the balance of trade: –exports become less costly to foreign buyers –imports become more costly to domestic buyers Cause a shortage and develops a black market

14. Exchange Control Dollar/Pound ratio Pound per month D D S S 1.60 1.50 1.70 Shortage 1.60=market rate 1.50=controlled rate 1.70=black market rate

15. Import Tariff Tax imposed on imported goods to: –Reduce the supply of imports –Increase the price to domestic consumers –Decrease the volume of imports –Generate revenues for the government

16. Tariff on Japanese Automobiles Price Quantity S’ 20,000 22,500 8,00010,000 S S D D 17,500 Consumers pay $2,500 more Dealers receive $2,500 less Government makes $40 million

17. Import Quota Quantity restriction on imported goods: –Reduce the volume of imports –Increase the price to domestic buyers –Reduce the price to foreign supplies –Create profits to holders of import licenses

18. Quota on Sugar Imports Price ($/ton) tons/year D D 35 30 7501,000 S’ S S 25 Consumer pay $5 more Producers receive $5 less Exporters make $7,500 profit

19. Common Markets Free trade within the market, restrictions against outsiders –European Union (EU): 15 countries –North American Free Trade Agreement (NAFTA): U.S., Canada, Mexico