1. McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 7: Global Markets in Action

2. 7-2 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Objectives After studying this chapter, you will be able to:  Explain how a country can gain from international trade  Explain how markets enable us to reap the gains from international trade and identify its winners and losers  Explain the effects of international trade barriers  Explain the arguments used to justify trade barriers and show how they are incorrect but also why some barriers are hard to remove

3. 7-3 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Big Macs and Cargo Jets  Globalisation is having a profound effect on the lives of Australians. Why do people go to such lengths to trade and communicate with others in different countries?  Australia—through the World Trade Organisation (WTO) and APEC—is committed to lowering barriers to international trade, encourage further globalisation and make the Australian economy more open to global competition  There are other people who oppose this view and want to restrict international trade

4. 7-4 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Imports are the goods and services that we buy from people in other countries.  Exports are the goods and services we sell to people in other countries.

5. 7-5 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Patterns and Trends in International Trade  Trade in goods  In 2003 Australia’s total exports were $141 billion, and total imports were $162 billion.  The largest exports of goods were coal, gold, and iron ore, and the largest imports of goods were motor vehicles, computers and aircraft parts  Major export markets were Japan, USA and China

6. 7-6 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Patterns and Trends in International Trade  Trade in services  International trade in services such as education and tourism is expanding rapidly.  Net exports and international borrowing  The value of exports minus imports is called net exports.  In 2003, net exports were -$21 billion.  When a country exports more than it imports, it lends to foreigners or buys some of their assets.  When a country imports more than it exports, it borrows from foreigners or sells them some of its assets.

7. 7-7 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  What drives international trade?  Comparative advantage is the fundamental force that generates trade between nations  The basis for comparative trade is divergent opportunity costs between countries.  Nations can increase the consumption of goods and services—when they allocate resources to the production of the goods and services for which they have a comparative advantage.

8. 7-8 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Australia’s PPF  Australia can produce coal or cars at any point inside or along the PPF as shown in Figure 7.1  The opportunity cost of a car is 500 tonnes of coal

9. 7-9 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Comparative advantage  A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country.

10. 7-10 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Cheaper to buy than to produce  If it costs 500 tonnes of coal to produce a car in Australia, while that same amount of coal costs 2.5 cars in the rest of the world, it makes sense for the rest of the world to buy coal from Australia and for Australians to buy cars from the rest of the world

11. 7-11 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Consumption possibilities  A country’s consumption possibilities frontier is the limit to what its citizens can consume  The consumption possibilities frontier is a boundary that separates attainable consumption levels from unattainable consumption levels  With international trade an economy can consume quantities of goods and services that differ from those that it produces

12. 7-12 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Gains from trade in reality  Gains from trade occur in the real global economy:  Comparative advantage today.  Australia buys cars made in Japan, clothing and household goods from China, and TV sets and DVD players from South Korea and Taiwan. In exchange Australia sell food, energy and services to these countries

13. 7-13 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Gains from International Trade  Trade in similar goods  Australia imports and at the same time exports cars. Australia has a comparative advantage in the production of some type of cars and not in other types  Diversity of taste and economies of scale  People have a large diversity of taste and there are economies of scale from producing a large quantity of each variety of a good

14. 7-14 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Markets and the Distribution of Gains and Losses  A country can gain by exporting a good in which it has a comparative advantage, and importing goods in which other countries have a comparative advantage  Who gets the gains from trade, consumers, producers of exports, or producers of imports, or all of these?  Examine these by looking at a market with imports and exports

15. 7-15 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Markets and the Distribution of Gains and Losses  An import  Australia is an importer in the market for cars  The market for cars without international trade is illustrated in figure 7.3(a)  The market for cars with international trade is illustrated in figure 7.3(b)

16. 7-16 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia 0 0.5 1.0 1.5 Quantity (millions of cars per year) Price (thousand of dollars per car) DADA SASA A Market With Imports 10 15 20 25 30 35 Quantity Produced and consumed Price with no trade Equilibrium without international trade Figure 7.3(a)

17. 7-17 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Quantity Consumed increases Quantity Produced decreases World Price 0 0.5 1.0 1.5 Quantity (millions of cars per year) Price (thousand of dollars per car) DADA SASA A Market With Imports 10 15 20 25 30 35 Imports Quantity produced Equilibrium in a market with imports Quantity consumed Price falls Figure 7.3(b)

18. 7-18 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Markets and the Distribution of Gains and Losses  Winners and losers in an import market  By comparing consumer surplus and producer surplus with imports and without imports, as shown in Fig 7.4, consumers gain and producers lose

19. 7-19 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Producer surplus Consumer surplus 0 0.5 1.0 1.5 Quantity (millions of cars per year) Price (thousand of dollars per car) DADA SASA Gains and Losses in a Market With Imports 10 15 20 25 30 35 Consumer and producer surplus without international trade Equilibrium with no international trade Figure 7.4(a)

20. 7-20 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Consumer Surplus expands Increase in total surplus from imports Producer Surplus shrinks World Price 0 0.5 1.0 1.5 Quantity (millions of cars per year) Price (thousand of dollars per car) DADA SASA Gains and losses in a Market With Imports 10 15 20 25 30 35 Gains and losses from imports Figure 7.4(b)

21. 7-21 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Markets and the Distribution of Gains and Losses  An Export  Australia is an exporter in the market for coal  Equilibrium without international trade is illustrated in figure 7.5(a)  Equilibrium with international trade is illustrated in figure 7.5(b)

22. 7-22 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia 0 100 200 300 Quantity (millions of tonnes per year) Price (dollars per tonne) DADA SASA A Market With Exports 25 40 50 75 100 Quantity Produced and consumed Price with no trade Equilibrium without international trade Figure 7.5(a)

23. 7-23 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Demand increases World Price 0 100 200 300 Quantity (millions of tonnes per year) Price (dollars per tonne) DADA SASA A Market With Exports 25 40 50 75 100 Equilibrium in a market with exports 125 DADA Exports Quantity consumed Consumption can increase Decrease, or remain the same - here it remains the same Price rises Quantity Produced Figure 7.5(b)

24. 7-24 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Markets and the Distribution of Gains and Losses  Winners and losers in an export market  We can see who gains and who loses by looking at the changes to consumer surplus and producer surplus  Consumer surplus remains the same while producer surplus increases  Producers gain because they receive higher price, sell more and receive a larger producer surplus

25. 7-25 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Consumer surplus Producer surplus 0 100 200 300 Quantity (millions of tonnes per year) Price (dollars per tonne) DADA SASA Gains and Losses in a Market With Exports 25 40 50 75 100 Equilibrium with no international trade Consumer and producer surplus without international trade Figure 7.6(a)

26. 7-26 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia World Price 0 100 200 300 Quantity (millions of tonnes per year) Price (dollars per tonne) DADA SASA Gains and Losses in a Market With Exports 25 40 50 75 100 The gains and losses from export 125 DADA Producer Surplus expands A B D E C F Consumer surplus can increase decrease, or remain the same - here it remains the same Increase in total surplus From exports = D+E+F Figure 7.6(b)

27. 7-27 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  Governments restrict international trade to protect domestic producers from competition by using three main tools: 1.Tariffs 2.Subsidies 3.Quotas  A tariff is a tax that is imposed by the importing country when an imported good crosses its international boundary.

28. 7-28 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  A subsidy is a payment made by a government to a domestic producer based on the quantity produced  A quota is a limit on the quantity of a good that may be imported

29. 7-29 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  The history of tariffs  Tariffs has been used as a source of government revenue for centuries.  The use of tariffs peaked during the 1930s  The General Agreement on Tariffs and Trade (GATT) was formed in 1947 to prevent tariff wars among countries

30. 7-30 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  The General Agreement on Tariffs and Trade (GATT) is an agreement between nations to have a series of trade negotiations, or “rounds,” to reduce tariffs on international trade.  Subsequent rounds of the GATT occurred in the 1960s, resulting in large tariff cuts on manufactured goods  The Uruguay round was the most ambitious, and led to the creation of the World Trade Organization (WTO).

31. 7-31 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  The North American Free Trade Agreement (NAFTA), between Canada, Mexico and the United States has lowered tariffs between these 3 countries  The European Union (EU) is an organisation of European countries that have agreed to eliminate trade barriers among them.  The Asia-Pacific Economic Cooperation (APEC) is another group aiming to lower trade barriers amongst its members, who include Australia, New Zealand, China, other economies of East Asia, the United States, Canada, Mexico, Peru, and Chile.  Australia has a long standing preferential agreement with New Zealand

32. 7-32 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  Australia had reduced its tariffs to low levels.  In 1970 the average tariffs on imports of manufactured products in Australia was 23 per cent  All tariffs were cut to 25 per cent in 1973.  Most tariffs were reduced to 5 per cent by July 1996  Tariffs on motor vehicle and parts, clothing, footwear and leather remain higher  Tariffs are predicted to fall to 3.5 per cent by 2015/16

33. 7-33 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Selected Australian Tariffs

34. 7-34 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  When Australia imposes a tariff on car imports:  The price of a car in rises.  The quantity of cars imported decreases.  The government collects the tariff revenue.  Producer surplus increases.  Consumer surplus decreases.  Total surplus decreases – a deadweight loss

35. 7-35 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia International Trade Restrictions  How subsidies work  A subsidy works just like a tax, but in the opposite direction.  A subsidy shifts the supply curve rightward, lowers the price, increase the quantity, and creates a deadweight loss from overproduction  If a subsidy is granted on an export or an import it changes the amount of international trade  The biggest subsidies today are those paid by the EU and US governments to farmers.

36. 7-36 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Effects of EU and US Farm Subsidies on a Small Economy Figure 7.9

37. 7-37 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Despite the fact that free trade promotes prosperity for all, trade is restricted.  Two classical arguments for restricting international trade are that protection is needed to:  Establish an infant industry  Counteract dumping

38. 7-38 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Infant industry argument  The infant-industry argument is that it is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets.  This argument is based on the concept of dynamic competitive advantage, which can arise from learning-by- doing.

39. 7-39 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Learning-by-doing is a powerful engine of productivity growth, but this fact does not justify protection from international competition  The argument is valid only if the benefits of learning-by- doing also spill over to other industries and parts of the economy  It is more efficient to protect an infant industry by a direct subsidy to the firms in the industry, with the subsidy financed out of taxes

40. 7-40 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  The dumping argument  Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production.  Dumping is seen as a justification for a tariff to prevent a foreign firm driving domestic firms out of business and then raising its price.  This argument is flawed because:  It is virtually impossible to determine a firm’s costs.  It is hard to find a good that is produced by a natural global monopoly  If there was a natural global monopoly, it would be more efficient to regulate it than to impose a tariff against it.

41. 7-41 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Four new arguments for protection are: 1.Saves jobs 2.Allows us to compete with cheap foreign labour 3.Penalises lax environmental standards 4.Prevents rich countries from exploiting developing countries

42. 7-42 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection 1.Saves Jobs  Free trade does cost some jobs, but it also creates other better-paying jobs  Free trade brings about a global rationalisation of labour and allocates scarce resources to their highest-value activities

43. 7-43 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection 2.Allows us to compete with cheap foreign labour  Relatively high wages don’t imply that an economy cannot compete.  Higher wages also result in higher productivity

44. 7-44 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection 3.Penalises lax environmental standards  It is not true that all lower-income economies have lower environmental protection than higher-income countries  Environmental standards tend to increase with higher incomes.  Free trade contributes to higher incomes in developing countries, which in turn will lead to better environmental standards.

45. 7-45 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection 4.Prevents rich countries from exploiting developing countries  Far from exploiting people in developing countries, free trade will increase the demand for their goods, leading to higher demand for labour and higher wages, improve their opportunities and increase their income.

46. 7-46 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Offshore outsourcing  Four ways of obtaining things to sell: 1.Hire Australian labour and produce in Australia 2.Hire foreign labour and produce in other countries 3.Buy finished good, components, or services from other firms in Australia 4.Buy finished goods, components, or services from other firms in other countries.  Activities 3 and 4 are outsourcing; 2 and 4 are offshoring. Activity 4 is offshore outsourcing.

47. 7-47 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Offshore outsourcing  Why did offshoring of services boom during the 1990s?  A dramatic fall in the cost of telecommunications  What are the benefits of offshoring?  Benefits identical to gains from trade in any other type of trade  Why is offshoring a concern?  Offshoring is taking jobs in services from Australia to overseas  Winners and losers

48. 7-48 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Avoiding trade wars  Protection invites retaliation and can trigger a trade war  Why is international trade restricted?  Two reasons: 1.A tariff is easier to collect than other types of government revenue 2.Tariffs benefit the domestic producers of import- competing goods and services

49. 7-49 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Case Against Protection  Compensating losers  If gains from free international trade exceed the losses, why don’t those who gain compensate those who lose so that everyone is in favour of free trade?  The cost of identifying the losers and estimating the value of their losses would be enormous  Difficult to identify the real victims of free trade  Some people who look like losers at one point in time may, in fact, end up gaining.

50. 7-50 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia END CHAPTER 7