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Today: More on international trade Addressing concerns about trade Review of comparative advantage Examining consumption possibilities
Without trade With trade
Supply and demand analysis of trade Tariffs and Quotas “Outsourcing”
Addressing concerns about trade “A majority of Americans, including
60 percent of Republicans, now believe free trade is bad for the U.S. economy, according to recent NBC News-Wall Street Journal polls.”(Source: “Trade jitters, anti-China sentiment rouse US voters,” Reuters, Nov. 14, 2007)
Why do so many Americans have this opinion about trade?
Trade has costs and benefits
When another country can produce goods lower than in the United States, two things happen Jobs are lost in the United States Consumers pay lower prices for the good
that is now imported The news media usually focuses on
the jobs issue more than about prices
Why is media coverage skewed?
Any job lost seriously deteriorates the quality of life of an individual
Most people don’t care to read headlines advertising “The price of rice goes down by two cents per pound” However, small gains on many products
lead to substantial increases in the purchasing power of the dollar
Suppose there is protectionism elsewhere The United States is a leading exporter
of fresh fruit (see on-line reading list for source)
Suppose that other countries outlawed the import of fresh fruit US jobs lost Decrease in price of fruit in the US Increase in the price of fruit in other
countries
Another issue: Lead in toys Recently, many toys manufactured
in China have been recalled due to unsafe levels of lead
This has raised concerns about the viability of toy exports
China will stop exporting toys if the world does not view the toys as safe enough, given the price
Monitoring is costly
Monitoring toys for lead is costly, adding to the cost of toys purchased
However, testing costs may be small relative to the additional revenues that can be generated if “safe toys” can be guaranteed
Another example: American cars Over the last 30 years, American cars
have often been looked at as “inferior” compared to some foreign models
With competition from trade, domestic car producers must keep costs down and quality up in order to successfully sell cars in the domestic market
The same thing goes for foreign toys If quality control standards are not
maintained abroad, people will buy their toys domestically
Trade issues There are many other issues that
are related to trade If you would like an in-depth
analysis of trade, you can enroll in a class that deals with trade
Today, we will talk about the basic issues of trade, and who the winners and losers are
Review of comparative advantage
Recall the principle of comparative advantage “Everyone does best when each
person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.” (F/B p. 39)
Today, we will apply this concept on a countrywide scale
Comparative advantage: Same numbers, different names
Productivity in pizza
production
Productivity in salad production
United States
20 pizzas cooked per
hour
10 salads made per hour
Chile 16 pizzas cooked per
hour
4 salads made per hour
Comparative advantage
To find comparative advantage for each person, find the lowest number in each column
Opportunity cost of cooking
a pizza
Opportunity cost of making a salad
U.S. ½ salad 2 pizzas
Chile ¼ salad 4 pizzas
Recall increasing opportunity cost
Opportunity cost increases as production increases within each country Each country uses its best pizza
maker to make its first pizzas Then, the next best pizza maker is
used, etc. The same applies to salads
Production possibilities curve
Recall from last lecture that all of the points along PGQ are the efficient points of the production possibilities curve
Recall that this shape occurs due to increasing opportunity costs as more is produced
Production possibilities curve
Without trade, only points along arc PGQ (or points between this arc and the origin) can be consumed
We will see that gains can be made by trade
The world market In the world market, there is an
equilibrium price (based on world supply and world demand)
Any one country that enters or exits the market usually does not change the market price much For ease of discussion, assume that
entry or exit by any one country does not change the world price
Consumption possibilities curve If we produce at
point G, we can trade goods at the given market price
Production at G (with trade) Consumption anywhere along FGH
Which consumption possibility curve is best? We could
produce at one of the red dots before we start trading
However, note that there are fewer consumption sets possible than producing at G
Optimal production in an open economy Since the red line is
suboptimal, we will not utilize it
Similarly, any point except G will produce a similar result to the red line
Suboptimal consumption possibilities for any production except G
Optimal production in an open economy Solution
Produce such that the “line of trade possibilities” is tangent to the production possibilities curve
In this case, point G is tangent to line FGH
Supply and demand analysis of trade
As we just analyzed, we saw that total surplus goes up when world trade is possible
However, we will see that there are winners and losers to trade Note that the winners’ gain is larger
than the losers’ loss
Market for cars, with trade Notice that the
world price for cars is $10,000
At this price, notice that 20,000 cars will be supplied and 60,000 cars will be demanded in this market
Market for cars, with trade What will happen?
This is unlike the case of rent control, since the shortage is picked up by the world market
20,000 domestic cars will be purchased
40,000 foreign cars will be purchased
Imports
Surplus with trade Consumer
surplus increases substantially
Producer surplus decreases, but does not change as much as consumer surplus does
Imports
A similar exercise can be done for a country that is a net exporter
When a country is a net exporter, the world price is above what it would be if trade was not possible (See Figure 9.7 for an example) Consumer surplus decreases when
trade occurs Producer surplus increases when
trade occurs Overall, total surplus increases
Tariffs and quotas Even when trade is not prohibited,
countries sometimes control the amount of a particular good imported
Tariff Tax that must be paid for each unit of the
good imported Quota
A binding limit set on the amount of a good that can be imported
What happens when we impose a tariff? In this case, the
tariff imposed is $1000 per ton of sugar imported
We will see that some potential economic surplus is lost when the tariff is imposed
What happens when we impose a tariff?
With a tariff, the price paid by consumers is the world price plus the amount of the tariff Think of a tariff just like a tax
This increases the quantity supplied domestically and decreases the amount imported
What happens when we impose a tariff? Quantity
supplied domestically increases
Imports decrease
Before, 100 tons minus 20 tons, or 80 tons
After, 80 tons minus 40 tons, or 40 tons
Total surplus and tariff money collected Consumer
surplus (CS) Producer
surplus (PS) Tariff revenue
generated What is
missing?
Total surplus and tariff money collected CS PS Tariffs What is
missing? Two triangles
are lost with the imposition of tariffs
Total surplus and tariff money collected The two triangles lost are potential
surplus that could be gained Notice that relative to open global
trade, producer surplus is higher See Economic Naturalist 9.2 to see an
example of why there is pressure to impose tariffs
Consumer surplus is lower with the tariff (relative to open global trade)
Quotas Quotas are similar
to tariffs, except: Domestic supply
plus quota determines supply available in a country’s market
Equilibrium in this example is price of 125, 80,000 TV’s
What else is different with quotas?
With quotas, no revenues are directly generated Those with right to import and export
gain economic rents Example: See Economic Naturalist
9.3 for groups that benefited with “voluntary export restraints,” which is a form of quota
“Outsourcing”
“Outsourcing” has been a controversial term in the media in recent years
There are definitely short-run costs of outsourcing Displaced workers Buildings and machinery that gets
unused
“Outsourcing”
Long-run benefits of outsourcing Each country can specialize what it
has comparative advantage in Technological improvements lower
the costs of trade Lower costs to consumers
How to make sure your job does not get outsourced
Make sure it requires a lot of face-to-face contact Construction work Repair labor Health care
Make sure that you have skills that nobody else has
Final thoughts about “outsourcing” Trade policy can be formed such that those
that are displaced are not any worse off Some of the gains from “making the pie
bigger” can be transferred to those that get displaced
Justification for re-training programs for displaced workers
Overall, the standard of living of a country improves with trade Example: Think how much bananas would cost
if we could not import them