1. International Trade Chapter 37 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Comparative advantage and the gains from trade Exports and imports Economic effects of tariffs and quotas Arguments for protectionism 37-2

3. Some Key Facts U.S. trade deficit in goods –$815 billion in 2007 U.S. trade surplus in services –$107 billion in 2007 Canada largest U.S. trade partner Trade deficit with China –$257 billion in 2007 Exports are 12% U.S. output Dependence on oil 37-3

4. World Exports Germany United States China Japan France Netherlands United Kingdom Italy 0 2 4 6 8 10 12 9.20 8.59 8.02 5.38 4.06 3.83 3.71 3.40 Source: World Trade Organization Percentage Share of World Exports, Selected Nations, 2007 37-4

5. Economic Basis for Trade Nations have different resource endowments Labor-intensive goods Land-intensive goods Capital-intensive goods 37-5

6. Comparative Advantage Assumptions –Two nations –Same size labor force –Constant costs in each country –Different costs across countries –U.S. absolute advantage in both Opportunity cost ratio –Slope of the curve –Coffee sacrificed per ton of wheat 37-6

7. Coffee (Tons) 30 25 20 15 10 5 0 35 40 45 51015202530 Wheat (Tons) Coffee (Tons) 30 25 20 15 10 5 0 35 40 45 5101520 Wheat (Tons) (a) United States (b) Brazil 12 18 8 4 A B Comparative Advantage 37-7

8. Self-sufficiency output mix Specialization and trade Produce good with lowest domestic opportunity cost Opportunity cost 1 ton wheat –1 pound of coffee in U.S. –2 pounds of coffee in Brazil Comparative Advantage 37-8

9. Terms of trade –U.S. 1W = 1C –U.S. will sell 1W for more than 1C –Brazil 1W = 2C –Brazil will pay less than 2C for 1W –Settle between the two –Depends on supply/demand factors –Assume 1W = 1.5C Comparative Advantage 37-9

10. Gains from trade –Trade possibilities line –Slope equals terms of trade –Improved options Complete specialization More of both goods More efficient resource allocation Comparative Advantage 37-10

11. Economic Basis for Trade Coffee (Tons) 30 25 20 15 10 5 0 35 40 45 51015202530 Wheat (Tons) Coffee (Tons) 30 25 20 15 10 5 0 35 40 45 5101520 Wheat (Tons) (a) United States(b) Brazil 12 18 8 4 A B A’ B’ C C’ W c w w’ Trading Possibilities Line Trading Possibilities Line 37-11

12. Comparative Advantage Trade with increasing costs –Concave production curve –Resources not perfectly substitutable –Incomplete specialization The case for free trade –Promote efficiency –Promote competition 37-12

13. Supply and Demand Analysis World price Domestic price with no trade World price > domestic price –Export surplus –Export supply curve World price < domestic price –Import shortage –Import supply curve 37-13

14. Price (Per Pound; U.S. Dollars 1.50 1.25 1.00.75.50 0 5075100125150 Quantity of Aluminum (Millions of Pounds) 1.50 1.25 1.00.75.50 0 50100 Quantity of Aluminum (Millions of Pounds) Price (Per Pound; U.S. Dollars (a) U.S. Domestic Aluminum Market (b) U.S. Export Supply and Import Demand DdDd SdSd U.S. Export Supply U.S. Import Demand a b c x y Surplus = 50 Surplus = 100 Shortage = 50 Shortage = 100 Supply and Demand Analysis 37-14

15. Supply and Demand Analysis Price (Per Pound; U.S. Dollars 1.50 1.25 1.00.75.50 0 5075100125150 Quantity of Aluminum (Millions of Pounds) 1.50 1.25 1.00.75.50 0 50100 Quantity of Aluminum (Millions of Pounds) Price (Per Pound; U.S. Dollars (a) Canada’s Domestic Aluminum Market (b) Canada’s Export Supply and Import Demand DdDd SdSd Canadian Export Supply Canadian Import Demand q r s t Surplus = 50 Surplus = 100 Shortage = 50 37-15

16. International Equilibrium 1.00.75.88 0 50100 Quantity of Aluminum (Millions of Pounds) Price (Per Pound; U.S. Dollars Import demand = Export supply Canadian Export Supply Canadian Import Demand e U.S. Export Supply U.S. Import Demand Equilibrium 37-16

17. Trade Barriers Tariffs –Revenue tariff –Protective tariff Import quota Nontariff barrier (NTB) Voluntary export restriction (VER) 37-17

18. Trade Barriers Economic impact of tariffs Direct effects –Decline in domestic consumption –Increase in domestic production –Decline in imports –Tariff revenue Indirect effects 37-18

19. Trade Barriers Quantity Price 0 DdDd SdSd PdPd q S d + Q PtPt PwPw abcd Economic Effects of a Tariff or Quota 37-19

20. The Case for Protection Different arguments Military self-sufficiency Diversification for stability Infant industry Protection against dumping Increased domestic employment Cheap foreign labor 37-20

21. The WTO Protests World Trade Organization has 151 member nations –Liberalize trade through negotiation Protest groups –Labor unions, environmentalists, socialists, anarchists Key issues for the protestors –Labor protection and environmental standards 37-21

22. Key Terms labor-intensive goods land-intensive goods capital-intensive goods opportunity-cost ratio principle of comparative advantage terms of trade trading possibilities line gains from trade world price domestic price export supply curve import demand curve equilibrium world price tariffs revenue tariff protective tariff import quota nontariff barrier (NTB) voluntary export restriction (VER) strategic trade policy dumping Smoot-Hawley Tariff Act World Trade Organization (WTO) Doha Round 37-22

23. Next Chapter Preview… The Balance of Payments, Exchange Rates, and Trade Deficits 37-23