1. MBMC International Trade

2. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Introduction Understanding the Economic Issues of International Trade The benefits of trade The costs of trade The economic impact of trade restrictions Chapter 9: International Trade Slide 2

3. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Comparative Advantage as a Basis for Trade The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries. Chapter 9: International Trade Slide 3

4. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade Closed Economy An economy that does not trade with the rest of the world Open Economy An economy that trades with other countries Chapter 9: International Trade Slide 4

5. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve for a Many-Worker Economy Chapter 9: International Trade Slide 5 Computers (number/year) Coffee (pounds/year) B C A D Observations The OC of producing an additional unit = the slope of the line that touches the point OC will increase as output of on good increases 100,000 40,000 1,0002,000

6. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade A country’s PPC shows the quantities of different goods that its economy can produce. Consumption Possibilities The combinations of goods and services that a country’s citizens might feasibly consume Chapter 9: International Trade Slide 6

7. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade In a closed economy: Society’s production possibilities = consumption possibilities. If a country is self-sufficient, it is called autarky. Chapter 9: International Trade Slide 7

8. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade In an open economy: The society’s consumption possibilities are typically greater than its production possibilities. Chapter 9: International Trade Slide 8

9. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Buying and Selling in World Markets Chapter 9: International Trade Slide 9 Computers/year Coffee (pounds/year) B C A D Assume: Producing at D Closed economy World price of coffee = $10/lb and computer = $500 120,000 100,000 1,000 50,000 2,0002,400 150,000 3,000

10. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Buying and Selling in World Markets Chapter 9: International Trade Slide 10 Computers/year Coffee (pounds/year) B C A D F Observation: Sell 2,000 computers @ $500 Take the $1million and buy 100,000 pounds of coffee Consumption possibilities of 150,000 is greater than PPC without trade E 150,000 120,000 100,000 1,000 50,000 2,0002,4003,000 Consumption possibilities Production possibilities

11. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Buying and Selling in World Markets Chapter 9: International Trade Slide 11 Computers/year Coffee (pounds/year) B C A D F Observation: Start at D Sell 50,000 lbs of coffee Buy 1,000 computers with the $500,000 Pt F is possible with trade but not on the PPC E 150,000 120,000 100,000 1,000 50,000 2,0002,4003,000 Consumption possibilities Production possibilities

12. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy Chapter 9: International Trade Slide 12 Computers/year Coffee (pounds/year) B C A D F 50 lbs of coffee trades for 1 computer LM = consumption possibilities G is the optimal combination for Costa Rica Costa Rica can use trade to locate anywhere along LM E 150,000 120,000 100,000 1,000 50,000 2,0002,4003,000 Consumption possibilities Production possibilities 160,000 3,200 G M L

13. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy Chapter 9: International Trade Slide 13 Computers/year Coffee (pounds/year) B C A D F Why produce at G? Slope of the PPC = LM Domestic and international opportunity costs of acquiring an extra computer (in terms of forgone coffee) are equal E 150,000 120,000 100,000 1,000 50,000 2,0002,4003,000 Consumption possibilities Production possibilities 160,000 3,200 G M L

14. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Straight-Line Production Possibilities Curve Chapter 9: International Trade Slide 14 Tea (pounds/year Coffee (pounds/year) B C A D Observation The tradeoff between coffee and tea is constant at any point on the PPC 200 600 800 600800

15. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Two Consumption Possibilities Curves Chapter 9: International Trade Slide 15 Tea (pounds/year Coffee (pounds/year) B C A D’ 600 200 600 800 1,600 D 200 Islandia produces at A Islandia can use the money earned from selling 800 lbs of coffee to choose any combination on AD’ Consumption possibilities curve when the world price of coffee is twice the world price of tea

16. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Two Consumption Possibilities Curves Chapter 9: International Trade Slide 16 Tea (pounds/year Coffee (pounds/year) B C A 600 200 600 800 1,600 D 200 Islandia produces at D Islandia can choose any combination on A’D Consumption possibilities curve when the world price of tea is twice the world price of coffee A’

17. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Consumption Possibilities With and Without International Trade What Do You Think? Where should Islandia produce if the price of coffee and tea were the same? Chapter 9: International Trade Slide 17

18. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Consumption Possibilities With and Without International Trade Observations With a bow-shaped PPC consumption possibilities is typically maximized by producing where the PPC is tangent to the consumption possibilities line. With a straight-line PPC production is completely specialized. Chapter 9: International Trade Slide 18

19. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade Economic Naturalist Does “cheap” foreign labor pose a danger to high-wage economies? Chapter 9: International Trade Slide 19

20. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade Economic Naturalist Scenario U.S. and Fredonia produce software and beef. Real wages in Fredonia are lower than in the U.S. Fredonia is half as productive as the U.S. in beef production. Fredonia is one-tenth as productive in software production. Chapter 9: International Trade Slide 20

21. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Production and Consumption Possibilities and the Benefits of Trade Economic Naturalist Outcome Fredonia has a comparative advantage in beef. U.S. has a comparative advantage in software. The U.S. will trade software for beef and increase its consumption of both. Employment in the software industry in the U.S. increases and employment in the beef industry will decrease. Chapter 9: International Trade Slide 21

22. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Market for Computers in Costa Rica Chapter 9: International Trade Slide 22 Computer per year Without Trade Computer per year With Trade Domestic demand Domestic supply Consumer surplus with trade = $1.96mil/yr Producer surplus with trade = $360K/yr World price 2,0004,800 E F 1,2002,800 Computer Imports 2,0004,800 2,400 1,400 400 Domestic demand Domestic supply Consumer surplus without trade = $1mil/yr Producer surplus without trade = $1mil/yr 2,400 1,400 400 1,000 E

23. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service. Chapter 9: International Trade Slide 23

24. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Market for Coffee in Costa Rica Chapter 9: International Trade Slide 24 Coffee (pounds/year) Without Trade 100,000240,000 12 7 4 Domestic demand Domestic supply Consumer surplus without trade = $250K/yr Producer surplus without trade = $150K/yr E Coffee (pounds/year) With Trade 100,000 12 7 4 Domestic demand Consumer surplus with trade = $40K/yr Producer surplus with trade = $600K/yr E Domestic supply World price F 40,000200,000240,000 Coffee exports 10

25. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service. Chapter 9: International Trade Slide 25

26. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Observations of the Mutually Beneficial Gains from Trade Countries will profit by exporting the goods and services for which they have a comparative advantage. The revenue from the exports are used to import goods and services for which they do not have a comparative advantage. Chapter 9: International Trade Slide 26

27. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Observations of the Mutually Beneficial Gains from Trade The markets will ensure that goods will be produced where opportunity cost is lowest. The consumption possibilities will be maximized. Chapter 9: International Trade Slide 27

28. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Exercise 9.4 Chapter 9: International Trade Slide 28 Computers per year Price of computers ($/computer) 200 Domestic supply World price Domestic demand 5008001,200 600 1,200 2,100 2,400 Question Given the graph shown, what impact would trade have on producer and consumer surplus?

29. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Winners and Losers from Trade Winners Consumers of imported goods Producers of exported goods Losers Consumers of exported goods Producers of imported goods Chapter 9: International Trade Slide 29

30. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Protectionism The view that free trade is injurious and should be restricted Tariff A tax imposed on an imported good Quota A legal limit on the quantity of a good that may be imported Chapter 9: International Trade Slide 30

31. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Market for Computers after the Imposition of an Import Tariff Chapter 9: International Trade Slide 31 Computers per year Price of computers ($/computer) 1,200 World price + tariff 1,6002,400 1,000 1,200 Domestic supply World price Domestic demand 4,800 400 2,400 E 2,800 Imports without tariff

32. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Market for Computers after the Imposition of an Import Tariff Chapter 9: International Trade Slide 32 Computers per year Price of computers ($/computer) 1,200 Domestic supply World price Domestic demand 4,800 400 1,200 2,400 1,000 World price + tariff E 1,6002,4002,800 Imports with tariff Consumer surplus with tariff = 1.44K/yr Producer surplus with tariff = 640K/yr Tariff revenue = $160K/yr

33. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Exercise 9.5 Chapter 9: International Trade Slide 33 Computers per year Price of computers ($/computer) 200 Domestic supply World price Domestic demand 5008001,200 600 1,200 2,100 3,600 Question Given the graph shown, how will a tariff of $300 per computer affect total economic surplus? 1,500 300700

34. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Protectionist Policies: Tariffs and Quotas What do you think? Why did President George W. Bush support the imposition of tariffs on steel imported into the United States? Chapter 9: International Trade Slide 34

35. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Protectionist Policies: Tariffs and Quotas Quotas Legal limit on the number or value of foreign goods that can be imported Can be enforced by issuing permits Chapter 9: International Trade Slide 35

36. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Market for Computers after the Imposition of an Import Quota Chapter 9: International Trade Slide 36 1,200 1,6002,400 Domestic supply + quota F Computers per year Price of computers ($/computer) 1,2002,800 Imports with free trade = 1,600 computers/yr 1,000 Domestic supply World price Domestic demand 4,800 2,400 E 1,400 2,000 400

37. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Market for Computers after the Imposition of an Import Quota Chapter 9: International Trade Slide 37 1,200 1,6002,400 Domestic supply + quota F Computers per year Price of computers ($/computer) 1,2002,800 Imports = 800 computers/year 1,000 Domestic supply World price Domestic demand 4,800 2,400 E 1,400 2,000 400 Economic rent to holders of import licenses = $80K/year Producer surplus with quota = $640K/yr Consumer surplus with quota = $1,440K/yr

38. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Quotas & Tariffs Market effects of tariffs are the same. Tariffs generate tax revenue. Quotas generate revenue for the firms that hold an import license. Chapter 9: International Trade Slide 38

39. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Question Why would the government ever impose a quota rather than a tariff? Chapter 9: International Trade Slide 39

40. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Economic Naturalist Who benefited from and who was hurt by voluntary export restraints on Japanese automobiles in the 1980s? Chapter 9: International Trade Slide 40

41. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade Other Barriers to Trade Red-tape barriers Regulations Chapter 9: International Trade Slide 41

42. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. A Supply and Demand Perspective on Trade The Inefficiency of Protectionism Trade barriers are inefficient and reduce the size of the economic pie. Because trade barriers benefit certain groups, and these groups may be well organized, they may be successful in lobbying for trade barriers. The gains from trade could be used to assist groups that have been hurt by trade. Chapter 9: International Trade Slide 42

43. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Outsourcing A term increasingly used to connote having services performed by low-wage workers overseas Chapter 9: International Trade Slide 43

44. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Outsourcing Outsourcing of services to low-wage foreign workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers. Chapter 9: International Trade Slide 44

45. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Outsourcing Economic Naturalist Paul Solman and his associate Lee Koromvokis produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program, The NewsHour with Jim Lehrer. Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderbad? Chapter 9: International Trade Slide 45

46. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Outsourcing Characteristics of Jobs that are Less Susceptible to Outsourcing Less rules-based jobs “Face-to-Face” complex communication jobs Jobs that require the worker to be physically present Chapter 9: International Trade Slide 46

47. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Outsourcing Responding to changing economic conditions requires the ability to adapt quickly to new circumstances. Education provides the means to develop a comparative advantage that is not rules-based and does require complex face-to-face communication. Chapter 9: International Trade Slide 47

48. MBMC End of Chapter End of Chapter