1. Chapter 31 INTERNATIONAL TRADE Gottheil — Principles of Economics, 7e © 2013 Cengage Learning 1

2. Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 2 Absolute advantage Comparative advantage Free trade Tariffs

3. Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 3 Quotas Customs unions Free trade areas

4. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 4 EXHIBIT 1ILLINOIS PRODUCTION POSSIBILITIES CURVE

5. Exhibit 1: Illinois Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 5 1.What is the opportunity cost of producing an additional barrel of oil in Illinois? The opportunity cost of producing an additional barrel of oil is one bushel of corn.

6. Exhibit 1: Illinois Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 6 1.What is the opportunity cost of producing an additional barrel of oil in Illinois? The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 1.

7. Exhibit 1: Illinois Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 7 2.What is the opportunity cost of producing an additional bushel of corn in Illinois? The opportunity cost of producing an additional bushel of corn is one barrel of oil.

8. Intrastate Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 8 1.If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Illinois? We know that one barrel of oil must be given up to get one bushel of corn in Illinois. As a result one bushel of corn will trade for one barrel of oil in Illinois.

9. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 9 EXHIBIT 2OKLAHOMA PRODUCTION POSSIBILITIES CURVE

10. Exhibit 2: Oklahoma Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 10 1.What is the opportunity cost of producing an additional barrel of oil in Oklahoma? The opportunity cost of producing an additional barrel of oil is 0.0833 bushels of corn.

11. Exhibit 2: Oklahoma Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 11 1.What is the opportunity cost of producing an additional barrel of oil in Oklahoma? The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 2.

12. Exhibit 2: Oklahoma Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 12 2.What is the opportunity cost of producing an additional bushel of corn in Oklahoma? The opportunity cost of producing an additional bushel of corn is 12 barrels of oil.

13. Intrastate Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 13 2.If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Oklahoma? We know that 12 barrels of oil must be given up to get one bushel of corn in Oklahoma. As a result one bushel of corn will trade for 12 barrels of oil in Oklahoma.

14. Interstate Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 14 Since oil producers must give 12 barrels of oil for a bushel of corn in Oklahoma, but need only give one barrel of oil for a bushel of corn in Illinois, Oklahoma oil producers would seek out buyers in Illinois. 3.If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil?

15. Interstate Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 15 3.If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil? Likewise, since a bushel of corn trades for one barrel of oil in Illinois, but trades for 12 barrels of oil in Oklahoma, Illinois corn farmers would seek out buyers in Oklahoma.

16. Interstate Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 16 Free trade International trade that is not encumbered by protectionist government policies such as tariffs and quotas.

17. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 17 EXHIBIT 3PRODUCTION OF CORN AND OIL IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (bushels and barrels)

18. Exhibit 3: Production of Corn and Oil in Illinois and Oklahoma, before and after Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 18 What are the total gains from free trade between Oklahoma and Illinois? By having Illinois specialize in producing corn, and Oklahoma specialize in producing oil, an additional 75 bushels of corn and an extra 200 barrels of oil are produced.

19. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 19 EXHIBIT 4CORN AND OIL CONSUMPTION IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (bushels and barrels)

20. Exhibit 4: Corn and Oil Consumption in Illinois and Oklahoma, before and after Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 20 What relative price leads to Oklahoma and Illinois consuming the same quantity of oil after trade? A relative price of three barrels of oil for one bushel of corn will result in both states consuming 300 barrels of oil.

21. Interstate Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 21 4.If Illinois and Oklahoma engage in free trade, and if there are aggregate gains from trade, then is it true that nobody loses? No. Oil producers in Illinois are priced out by cheap imports of Oklahoma oil. Likewise corn growers in Oklahoma are priced out by cheap imports of Illinois corn.

22. International Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 22 International specialization The use of a country’s resources to produce specific goods and services, allowing other countries to focus on the production of other goods and services.

23. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 23 EXHIBIT 5PRODUCTION OF CORN AND OIL IN THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (bushels and barrels)

24. Exhibit 5: Production of Corn and Oil in the United States and Mexico, before and after Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 24 What does Mexico specialize in producing in Exhibit 5? Mexico specializes in producing oil.

25. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 25 EXHIBIT 6CORN AND OIL CONSUMPTION THE THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (bushels and barrels)

26. Exhibit 6: Corn and Oil Consumption in the United States and Mexico, before and after Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 26 What relative price leads to Mexico and the United States consuming the same quantity of corn after trade in Exhibit 6? Four barrels of oil for one bushel of corn.

27. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 27 Absolute advantage A country’s ability to produce a good using fewer resources than the country it trades with.

28. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 28 Comparative advantage A country’s ability to produce a good at a lower opportunity cost than the country with which it trades.

29. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 29 1.In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? The opportunity cost of producing one bushel of corn in the United States is three barrels of oil.

30. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 30 1.In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? The opportunity cost of producing one bushel of corn in Mexico is 12 barrels of oil.

31. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 31 1.In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? The U.S. has a comparative advantage in growing corn because it can do so at a lower opportunity cost than Mexico.

32. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 32 2.In the example of corn and oil trade between the United States and Mexico, what was Mexico’s comparative advantage? Using the same process as that used for the U.S., we find that Mexico has a lower opportunity cost for producing oil.

33. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 33 3. What determines how much each country gains from free trade? The relative price of the goods being traded.

34. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 34 EXHIBIT 7CORN AND OIL CONSUMPTION IN THE UNITED STATES AND MEXICO, UNDER CONDITIONS OF NO TRADE AND FREE TRADE

35. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 35 1.If a bushel of corn trades for four barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.? Mexico must trade 800 barrels of oil with the United States in order to get 200 bushels of corn.

36. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 36 2. If a bushel of corn now trades for five barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.? Mexico must trade 1000 barrels of oil with the United States in order to get 200 bushels of corn.

37. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 37 Mexico is worse off because it must trade an extra 200 barrels of oil just to keep getting 200 bushels of corn from the United States. 3.When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off?

38. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 38 3.When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off? The United States is better off because it gets an extra 200 barrels of oil for the same 200 bushels of corn it exports to Mexico.

39. Absolute and Comparative Advantage © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 39 During the colonial period, European colonial powers used their political power to manipulate trade prices so that most all of the gains from trade were shifted to them.

40. Calculating Terms of Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 40 Imports Good and services bought by people in one country that are produced in other countries.

41. Calculating Terms of Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 41 Exports Good and services produced by people in one country that are sold in other countries.

42. Calculating Terms of Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 42 Terms of trade The amount of a good or service (export) that must be given up to buy a unit of another good or service (import). A country’s terms of trade is measured by the ratio of the country’s export prices to its import prices.

43. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 43 EXHIBIT 8JAPANESE MOTORCYCLE AND BOLIVIAN TIN EXPORTS

44. Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 44 The price of Japanese motorcycles rises in panel a, while the price of Bolivian tin falls in panel b. What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?

45. Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 45 As a result, Bolivia’s terms of trade equation goes from (6,000/6000) × 100 = 100 in 1987, to (5,000/7,500) × 100 = 66.7 in 1995 What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?

46. Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 46 What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8? Bolivia’s terms of trade have deteriorated. Bolivia’s exports end up with only 67 percent of their former purchasing power.

47. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 47 EXHIBIT 9LDC TERMS OF TRADE FOR 2002 (1980 = 100) Source: Human Development Report, Oxford University Press, 2005.

48. Exhibit 9: LDC Terms of Trade for 2002 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 48 Which of the countries shown in Exhibit 9 has experienced the smallest deterioration in its terms of trade between 1980 and 2002? Pakistan’s terms of trade declined the least during this time period.

49. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 49 EXHIBIT 10INDUSTRIAL ECONOMIES’ TERMS OF TRADE FOR 2002 (1980 = 100) Source: Human Development Report, Oxford University Press, 2005.

50. Exhibit 10: Industrial Economies’ Terms of Trade for 2002 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 50 Which of the countries shown in Exhibit 10 has experienced the largest increase in its terms of trade between 1980 and 2002? Japan’s terms of trade increased the most during this time period.

51. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 51 EXHIBIT 11PERCENTAGE DISTRIBUTION OF EXPORTS TO DEVELOPED, LDCs, AND OTHER ECONOMIES: 2010 Source: Direction of Trade Statistics, Yearbook 2011 (Washington, D.C.: International Monetary Fund, 2011).

52. Exhibit 11: Percentage Distribution of Exports to Developed, LDCs, and Other Economies: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 52 What percentage of exports from LDCs actually went to other LDCs? a.59.0 percent b.41.0 percent c.36.0 percent

53. Exhibit 11: Percentage Distribution of Exports to Developed, LDCs, and Other Economies: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 53 What percentage of exports from LDCs actually went to other LDCs? a.59.0 percent b.41.0 percent c.36.0 percent

54. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 54 EXHIBIT 122010 EXPORTS AND IMPORTS OF THE MAJOR DEVELOPED ECONOMIES ($ billions) Source: Direction of Trade Statistics, Yearbook 2011 (Washington, D.C.: International Monetary Fund, June 2011).

55. Exhibit 12: 2010 Exports and Imports of the Major Developed Economies © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 55 True or false: The United States was the world’s leading importer among developed countries in 2010 (measured in $). True. The United States was also the world’s leading exporter.

56. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 56 EXHIBIT 132010 U.S. TRADE WITH ITS MAJOR TRADING PARTNERS ($ billions) Source: Direction of Trade Statistics, Yearbook 2011 (Washington, D.C.: International Monetary Fund, 2011).

57. Exhibit 13: 2010 U.S. Trade with Its Major Trading Partners © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 57 Complete the sentence: _____ was the United States’ largest trading partner in 2010 (measured in $).

58. Exhibit 13: 2010 U.S. Trade with Its Major Trading Partners © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 58 Complete the sentence: Canada was the United States’ largest trading partner in 2010 (measured in $).

59. Do We Need Protection Against Free Trade? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 59 1. What is the national security argument for against free trade? Key domestic industries need to be protected so that if war breaks out with our trading partners, we are still able to produce during a time of crisis.

60. Do We Need Protection Against Free Trade? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 60 2.What is the infant-industries argument against free trade? It takes time for new (“infant”) industries to gain expertise, and during that time it is fair and reasonable to protect those industries from international competition.

61. Do We Need Protection Against Free Trade? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 61 3. How long should infant-industries be protected from free trade? There is no clear answer, certainly not from the industries being protected. Infant industry protection is easily abused.

62. Do We Need Protection Against Free Trade? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 62 4.If domestic industry is not protected from imports from low-wage countries, who gains and who loses? Domestic producers and workers in this industry lose, while domestic consumers gain from lower prices.

63. Do We Need Protection Against Free Trade? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 63 Dumping Exporting a good or service at a price below its cost of production.

64. The Economics of Trade Protection? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 64 Tariff A tax on an imported good.

65. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 65 EXHIBIT 14TARIFF-RESTRICTED TRADE

66. Exhibit 14: Tariff-Restricted Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 66 Which of the following occur as a result of a tariff? a.Domestic prices rise b.The quantity imported falls c.Domestic production increases d.All of the above

67. Exhibit 14: Tariff-Restricted Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 67 Which of the following occur as a result of a tariff? a.Domestic prices rise b.The quantity imported falls c.Domestic production increases d.All of the above

68. The Economics of Trade Protection? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 68 Quota A limit on the quantity of a specific good that can be imported.

69. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 69 EXHIBIT 15QUOTA-RESTRICTED TRADE

70. Exhibit 15: Quota-Restricted Trade © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 70 True or false: Quota protection causes domestic prices to fall and increases the quantity of imported goods. False. Quota protection increases domestic prices and limits the quantity of imports.

71. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 71 Reciprocity An agreement between countries in which trading privileges granted by one to the others are the same as those granted to it by the others.

72. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 72 GATT (General Agreement on Tariffs and Trade) A trade agreement to negotiate reduction in tariffs and other trade barriers and to provide equal and nondiscriminating treatment among members of the agreement.

73. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 73 Most-favored-nation clause Any tariff reduction that one member grants to another must be extended on an equal basis to all other GATT members

74. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 74 World Trade Organization (WTO) The successor to GATT. The WTO is the only global international organization dealing with the rules of trade between nations. WTO agreements are ratified by member nations’ parliaments.

75. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 75 Customs union A set of countries that agree to free trade among themselves and a common trade policy with all other countries.

76. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 76 European Economic Community (EEC) A customs union consisting of France, Italy, Belgium, Holland, Luxembourg, Germany, Britain, Ireland, Denmark, Greece, Spain, Portugal, Iceland, Finland, Sweden, and Austria.

77. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 77 European Union (EU) An organization of European nations committed to economic and political integration without abandoning individual national sovereignty.

78. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 78 Free trade area A set of countries that agree to free trade among themselves but are free to pursue independent trade policies with other countries.

79. Negotiating Tariff Structures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 79 North American Free Trade Agreement (NAFTA) A free trade area consisting of Canada, the United States, and Mexico.

80. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 80 EXHIBIT 16AVERAGE U.S. TARIFF RATES ON IMPORTS Source: Economic Report of the President, January 1989 (Washington, D.C.: U.S. Government Printing Office, 1989), p. 152; and Economic Report of the President, January 2006 (Washington, D.C.: U.S. Government Printing Office, 2006), p. 154.

81. Exhibit 16: Average U.S. Tariff Rates on Imports © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 81 What was the average U.S. tariff rate in 1990–1993? a.45.9 percent b.25.3 percent c.4.0 percent

82. Exhibit 16: Average U.S. Tariff Rates on Imports © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 82 What was the average U.S. tariff rate in 1990–1993? a.45.9 percent b.25.3 percent c.4.0 percent