1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-1 Chapter 8 International trade and trade policy

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-2 Introduction Understanding the economic issues of international trade –The benefits of trade –The costs of trade –The economic impact of trade restrictions

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-3 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.

4. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-4 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 the rest of the world.

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-5 The production possibilities curve for a many-worker economy Example –A two-goods economy (Brazil) -- computers and coffee. –Two workers who work 50 weeks/year.  Carlos Can produce 100 kg of coffee/week or 1 computer.  Maria Can produce 100 kg of coffee/week or 2 computers.

6. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-6 The production possibilities curve for a many-worker economy (cont.) Example –Slope of PPC (Maria) –Slope of PPC (Carlos)

7. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-7 Production possibilities curve for a many- worker economy Computers (number/year) Coffee (kg/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

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-8 Production and consumption possibilities and the benefits of trade A country’s PPC shows the quantities of different goods that its economy can produce.

9. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-9 Consumption possibilities with and without international trade Consumption possibilities –The combinations of goods and services that a country’s citizens might feasibly consume. In a closed economy –Society’s production possibilities = consumption possibilities. –If a country is self-sufficient, it is called autarky.

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-10 Consumption possibilities with and without international trade (cont.) In an open economy –The society’s consumption possibilities are typically greater than its production possibilities.

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-11 Brazil’s consumption possibilities with trade Computers (number/year) Coffee (kg/year) 13 000 100 B 150 10 000 C A G F 5 000 162.5 Consumption possibilities with trade Slope = - 80 kg coffee/computer Production possibilities Slope = - 50 kg coffee/computer Production possibilities Slope = - 100 kg coffee/computer

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-12 Consumption possibilities curve for a many-worker economy Computers (number/year) Coffee (kg/year) B C A G F Consumption possibilities Production possibilities Slope of FG = relative prices of coffee & computers on the world market Maximum consumption by producing at C (slope of PPC = FG) and trading for the desired combination on FG

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-13 Production and consumption possibilities and the benefits of trade Thinking as an economist –Does ‘cheap’ foreign labour pose a danger to high-wage economies? –Scenario  Australia and Fredonia produce clothing and wool.  Real wages in Fredonia are lower than in Australia.  Fredonia is half as productive as Australia in wool production.  Fredonia is one-tenth as productive in clothing production.

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-14 Production and consumption possibilities and the benefits of trade (cont.) Thinking as an economist –Outcome  Fredonia has a comparative advantage in wool.  Australia has a comparative advantage in clothing.  Australia will trade clothing for wool and increase its consumption of both.  Employment in the clothing industry in Australia increases and employment in the wool industry will decrease.

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-15 The market for computers in Brazil Quantity of computers Price of computers p E q Domestic supply Domestic demand Closed economy equilibrium qSqS qDqD World price Imports

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-16 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.

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-17 The market for coffee in Brazil Quantity of coffee Price of coffee p E q Domestic supply Domestic demand Closed economy equilibrium qSqS qDqD World price Exports

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-18 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.

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-19 A supply and demand perspective on trade (cont.) 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. –The markets will ensure that goods will be produced where opportunity cost is lowest. –The consumption possibilities will be maximised.

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-20 A supply and demand perspective on trade (cont.) Winners and losers from trade –Winners  Domestic consumers of imported goods  Domestic producers of exported goods –Losers  Domestic consumers of exported goods  Domestic producers of imported goods

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-21 Protectionist politics: tariffs and quotas Protectionism –The use of policies that are intended to protect domestic industries from foreign competition. Tariff –A tax imposed on an imported good. Quota –A legal limit on the quantity of a good that may be imported.

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-22 The market for computers after the imposition of an import tariff Quantity of computers Price of computers E Domestic supply Domestic demand qSqS qDqD World price Imports before tariff Production w/o tariff

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-23 The market for computers after the imposition of an import tariff (cont.) Quantity of computers Price of computers qSqS pTpT E q’ S q’ D qDqD Domestic supply Domestic demand World price World price plus tariff Imports after tariff Production w/o tariff Tariff tax collection

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-24 A supply and demand perspective on trade Tariffs –The market for computers in Brazil:  Demand = Q D = 3000 - 0.5 P C  Supply = Q S = 1000 + 0.5 P C

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-25 A supply and demand perspective on trade (cont.) Tariffs –Closed economy  Equilibrium price: 1000 + 0.5 P C = 3000 - 0.5 P C P C = $2, 00  Equilibrium quantity: 1000 + 0.5(2000) = 2000 computers

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-26 A supply and demand perspective on trade (cont.) Tariffs –Open economy  P = world price = $1500  q S = 1000 + 0.5(1500) = 1750  q D = 3000 - 0.5(1500) = 2250  Imports = 2250 - 1750 = 500 computers/yr

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-27 A supply and demand perspective on trade (cont.) Tariffs –Tariff imposed  Tariff = $300/computer  P = world price + tariff = $1500 + $300 = $1800  q s = 1000 + (0.5)(1800) = 1900 computers/year  q D = 3000 = (0.5)(1800) = 2100  Imports = 2100 - 1900 = 200  Tariff revenue = $300/computer x 200 computers/year = $60 000/year

28. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-28 The market for computers after the imposition of an import quota Quantity of computers Price of computers qSqS qDqD Domestic supply World price Domestic demand Imports with open economy

29. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-29 The market for computers after the imposition of an import quota (cont.) Quantity of computers Price of computers qSqS pTpT F q’ S q’ D qDqD Domestic supply Domestic supply plus quota World price Domestic demand Import quota Impact of quota = impact of tariff Revenue from quota goes to the producer

30. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-30 A supply and demand perspective on trade Quotas and tariffs –Market effects of tariffs are the same. –Tariffs generate tax revenue. –Quotas generate revenue for the firms that hold an import licence.

31. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-31 A supply and demand perspective on trade (cont.) Effects of an import quota –Without quota:  q S = 1000 + 0.5P C –With a quota of 200 computers  q S = 1000 + 0.5P C + 200 = 1200 + 0.5P C  q D = 3000 - 0.5P C  Equilibrium = 1200 + 0.5P C = 3000 - 0.5 P C  Equilibrium price = $1800

32. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-32 A supply and demand perspective on trade (cont.) Effects of an import quota –With a quota of 200 computers  Domestic quantity supplied 1000 + 0.5($1800) = 1900 computers/year  Domestic quantity demanded 3000 - 0.5($1800) = 2100 computers/year  Imports = 2100 - 1900 = 200  Revenue to the importers ($1800 - $1500) x 200 = $60 000 Thinking as an economist –What would happen if, instead of being given away, import licences were sold to the highest bidder in an auction?

33. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 8-33 A supply and demand perspective on trade (cont.) Other barriers to trade –Red-tape barriers –Regulations 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 organised, 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.