1. Today: Winners and losers of various international trade policies

2. Previously, we talked about…
How trade can benefit people
Comparative advantage being the core of beneficial trade
An introduction of international trade

3. Today: More on international trade
Review of comparative advantage
Examining consumption possibilities
Without trade
With trade
Supply and demand analysis of trade
Tariffs and Quotas
“Outsourcing”

4. Review of comparative advantage
Recall the principle of comparative advantage
“Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.” (F/B p. 39)
Today, we will apply this concept on a countrywide scale

5. Comparative advantage: Same numbers, different names
Productivity in pizza production
Productivity in salad production
United States
20 pizzas cooked per hour
10 salads made per hour
Chile
16 pizzas cooked per hour
4 salads made per hour

6. Comparative advantage
Opportunity cost of cooking a pizza
Opportunity cost of making a salad
U.S.
½ salad
2 pizzas
Chile
¼ salad
4 pizzas
Recall: To find comparative advantage for each person, find the lowest number in each column

7. Recall increasing opportunity cost
Opportunity cost increases as production increases within each country
Each country uses its best pizza maker to make its first pizzas
Then, the next best pizza maker is used, etc.
The same applies to salads

8. Production possibilities curve
Recall from last lecture that all of the points along PGQ are the efficient points of the production possibilities curve
Recall that this shape occurs due to increasing opportunity costs as more is produced

9. Production possibilities curve
Without trade, only points along arc PGQ (or points between this arc and the origin) can be consumed
We will see that gains can be made by trade

10. The world market
In the world market, there is an equilibrium price (based on world supply and world demand)
Any one country that enters or exits the market usually does not change the market price much
For ease of discussion, assume that entry or exit by any one country does not change the world price

11. Consumption possibilities curve
If we produce at point G, we can trade goods at the given market price
Production at G (with trade)  Consumption anywhere along FGH

12. Which consumption possibility curve is best?
We could produce at one of the red dots before we start trading
However, note that there are fewer consumption sets possible than producing at G

13. Optimal production in an open economy
Since the red line is suboptimal, we will not utilize it
Similarly, any point except G will produce a similar result to the red line
Suboptimal consumption possibilities for any production except G

14. Optimal production in an open economy
Solution
Produce such that the “line of trade possibilities” is tangent to the production possibilities curve
In this case, point G is tangent to line FGH

15. Supply and demand analysis of trade
As we just analyzed, we saw that total surplus goes up when world trade is possible
However, we will see that there are winners and losers to trade
Note that the winners’ gain is larger than the losers’ loss

16. Market for cars, w/o trade
Suppose that without trade, 40,000 cars are sold at a price of $14,000

17. Market for cars, w/o trade
Consumer surplus is blue shaded area
Producer surplus is red shaded area

18. Market for cars, with trade
Notice that the world price for cars is $10,000
At this price, notice that 20,000 cars will be supplied and 60,000 cars will be demanded in this market

19. Market for cars, with trade
What will happen?
This is unlike the case of rent control, since the shortage is picked up by the world market
20,000 domestic cars will be purchased
40,000 foreign cars will be purchased
Imports

20. Surplus with trade Consumer surplus increases substantially
Producer surplus decreases, but does not change as much as consumer surplus does
Imports

21. Without imports (left) With imports (right)

22. Net gain
Imports

23. A similar exercise can be done for a country that is a net exporter
When a country is a net exporter, the world price is above what it would be if trade was not possible
Consumer surplus decreases when trade occurs
Producer surplus increases when trade occurs
Overall, total surplus increases

24. Tariffs, quotas, and bailouts
Even when trade is not prohibited, countries use other devices to control the amount of a particular good imported
Tariff
Tax that must be paid for each unit of the good imported
Quota
A binding limit set on the amount of a good that can be imported
Bailouts: An example with U.S. automakers
Subsidized loans
See additional reading on class website

25. What happens when we impose a tariff?
In this case, the tariff imposed is $1000 per ton of sugar imported
We will see that some potential economic surplus is lost when the tariff is imposed

26. What happens when we impose a tariff?
Total surplus without tariffs
Shaded area

27. What happens when we impose a tariff?
With a tariff, the price paid by consumers is the world price plus the amount of the tariff
Think of a tariff just like a tax
This increases the quantity supplied domestically and decreases the amount imported

28. What happens when we impose a tariff?
Quantity supplied domestically increases
Imports decrease
Before, 100 tons minus 20 tons, or 80 tons
After, 80 tons minus 40 tons, or 40 tons

29. Total surplus and tariff money collected
Consumer surplus (CS)
Producer surplus (PS)
Tariff revenue generated
What is missing?

30. Total surplus and tariff money collectedCS PS
Tariffs
What is missing?
Two triangles are lost with the imposition of tariffs

31. Total surplus and tariff money collected
The two triangles lost are potential surplus that could be gained
Notice that relative to open global trade, producer surplus is higher
Consumer surplus is lower with the tariff (relative to open global trade)

32. Voluntary export restraints (VERs)
Many American consumers bought fuel-efficient Japanese cars
1980s
VERs agreed to between US and Japan
U.S. auto makers benefited by decreased competition
Japanese auto makers benefited by being able to raise their prices
U.S. consumers lost by having to pay more for all cars purchased

33. VERs VERs are a type of quota
What does economic theory tell us about quotas?

34. Quotas Quotas are similar to tariffs, except:
Domestic supply plus quota determines supply available in a country’s market
Equilibrium in this example is price of 125, 80,000 TV’s

35. What else is different with quotas?
With quotas, no revenues are directly generated
Those with right to import and export gain economic rents

36. The U.S. automaker bailout
Bad decision making
CAFE standards
What did fuel economy standards lead to?
Minivans
SUVs
Bankruptcy for some U.S. automakers in the near future?
See

37. “Outsourcing”
“Outsourcing” has been a controversial term in the media in recent years
There are definitely short-run costs of outsourcing
Displaced workers
Buildings and machinery that gets unused

38. “Outsourcing” Long-run benefits of outsourcing
Each country can specialize what it has comparative advantage in
Technological improvements lower the costs of trade
Lower costs to consumers

39. How to make sure your job does not get outsourced
Make sure it requires a lot of face-to-face contact
Construction work
Automobile repair
Health care
Make sure that you have skills that nobody else has

40. Final thoughts about “outsourcing”
Trade policy can be formed such that those that are displaced are not any worse off
Some of the gains from “making the pie bigger” can be transferred to those that get displaced
Justification for re-training programs for displaced workers
Overall, the standard of living of a country improves with trade
Example: Think how much bananas would cost if we could not import them

41. Summary Trade improves overall surplus
Some people win, while others lose
Trade barriers, such as protectionism, quotas, and tariffs limit the gains from trade
Outsourcing has short-run costs but long-run benefits in a country’s economy

42. Upcoming attractions
For the next month, we will examine market failures and some economic fields
Market failures: Monopoly, oligopoly, monopolistic competition, externalities, cost of information, private provision of public goods
Fields
Some potential topics: Labor, Income distribution, Environment, Health/Safety, Public Good analysis

43. End of Unit 3 Starting next week, Unit 4
Monopoly, including profit maximization and inefficiencies
Game theoretical tools needed to analyze small groups of people or firms
Applications, including Prisoner’s Dilemma
Study of externalities