International Trade

Trade Insights

Trade=exchanging one thing for another. Usually goods or services for $$.

The economics profession nearly unanimously backs free trade.

So………….If economists agree that Free Trade is a good thing….. Why all the fuss politically and internally about 1) jobs fleeing the country\2) unfair advantages for subsidies/3) what is insourcing?

Why Trade?

Check the label of anything… where was it made?

How does international trade vary from domestic trade?

1. Two governments involved2. Two currencies involved – leads to

foreign exchange market.

3 Basic Purposes for International Trade

Some things we cannot produce at all or in sufficient quantityLike: bananas, rubber, coffee, tea, cocoa, Scotch whiskey, and tequila.

Reason #2 for IT

When we trade with people we get benefit of specialization.

I no longer make my own candles or clothes…Someone who is proficient at that makes them and I purchase.Certainly it would be more costly for me to make my own shorts than to have Nike, specialize in shorts, produce and distribute.

Reason # 3 for IT

Trade gives us more choices.

Without trade our choice of autos would be limited. Everyone would drive a GM car, Ford or Chrysler.

How many of you drive a foreign-make car?

What is balance of trade?

Exports = ImportsTrade deficit = imports exceed exportsTrade surplus = exports exceed imports.

Did You Know That...• Each year, U.S. residents spend more than $5 million on U.S.

flags manufactured outside the United States.• This figure may fall somewhat in future years, however, if

some state governments have their way.

• Some state governments have made it illegal to sell U.S. flags manufactured outside of the United States.

• What effects do restrictions on imports have on quantities and prices of domestic goods?

The Worldwide Importance of International Trade

• World GDP today is nearly nine times greater than it was at the end of World War II.

• World trade has increased to more than 28 times what it was in 1950.

The Worldwide Importance of International Trade (cont'd)

• The United States has figured prominently in this expansion of world trade.

– Imports added up to barely 4% of annual U.S. GDP in 1950.

– Today they account for more than17%.

Source: Steven Husted and Michael Melvin, International Economics, 3rd ed. (New York: HarperCollins, 1995), p. 11, used with permission; World Trade Organization; Federal Reserve System; U.S. Department of Commerce.

Figure 33-1 The Growth of World Trade, Panel (a)

What is the difference?Open Economy? ____________

Closed Economy? __________

Open Economy = one with an international sector (more goods for export and fewer for import) U.S. shifts productive resources to aircraft, and wheat and fewer to television sets and clothing.)Closed Economy (or autarky) = all production resources kept internally. National self-sufficiency or non-reliance on other countries.

Absolute Advantage(a country’s ability to produce a good more

efficiently than another country.)

Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd)

• Comparative Advantage

– The ability to produce a good or service at a lower opportunity cost compared with producers

– We produce aircraft….. South Korea produces televisions.

International Example: The Comparative Advantage of Desert Dairies

• Research has found that camel’s milk contains 10 times more iron per unit than cow’s milk, not to mention antibodies that help fight cancer.

• Most of these camels are located in Africa and the Middle East, which enables residents of nations in those regions to produce camel’s milk at a lower opportunity cost compared with other nations.

Specialization among nations

– To demonstrate the concept of comparative advantage, consider a simple two-country, two-good world.

– To benefit from specialization and trade, a country only needs a comparative advantage. (which one has the lower opportunity cost.)

– Let’s break it down. Two people….

A Timeline for Trade

• Ex Ante• Phrase that means

before,” as in before a trade.

• Ex Post• Phrase that means

“after,” as in after a trade.

Ex Ante

Elizabeth and Brian Before the Trade

Elizabeth decides to produce 20 loaves bread Brian decides to produce 30 applesTerms of trade = Elizabeth trades 8 loaves for Brian’s 12 apples

Ex Post

Remember terms of trade 8 loaves for 12 apples….Elizabeth now consumes 12 loaves bread and 12 apples

Brian consumes 8 loves of bread and 18 applesClearly both are better off… See first column above!Trade works…. But free trade works great.

Video

http://education-portal.com/academy/lesson/comparative-advantaged-definition-and-examples.html

Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd)

• Specialization is the key

– Specializing in producing goods for which a nation has a comparative advantage allows for greater efficiency.

– Production capabilities increase, making possible greater worldwide consumption through international trade.

How do countries know when they have a comparative advantage in the production of a good?

• a.Government accountants collect cost data from countries and analyze it to find out which country has a comparative advantage in the production of which good.

• b.They know as the result of individuals trying to earn profits and buying low and selling high in the process.

• c.The United Nations Economic Conference Group analyzes cost data from countries and determines which country has a comparative advantage in the production of which good.

• d.There is not one major way that countries acquire this information.

Distributional Effects and Trade Restrictions

The benefits of international trade are not equally distributed to all individuals in the population.

Benefit occurs on net (gains minus losses). Every individual person may not gain, in fact some

may lose. Unfavorable distributional effects may lead to trade

restrictions such as:Tariff - A tax on imports.Quota - A legal limit on the amount of a good that may be

imported.

Consumers’ Surplus

As the shaded area indicates, the difference between the maximum or highest amount consumers would be willing to pay and the price they actually pay is consumers’ surplus.

Producers’ Surplus

As the shaded area indicates, the difference between the price sellers receive for the good and the minimum or lowest price they would be willing to sell the good for is producers’ surplus.

Why Restrict Trade? National–Defense Argument – certain industries are

necessary to the national defense. Infant-Industry Argument – new industries often need

protection from older, established foreign firms. Antidumping Argument – foreign competitors will sell goods

at below cost of production so as to penetrate markets Low-Foreign-Wage Argument- Domestic producers pay high

wages to their workers and foreign producers pay low wages to their workers

Saving-Domestic-Jobs Argument – Foreign producers displace domestic workers.

GEOPOLITICAL ECONOMIC WORLD

Why does the U.S. have to worry about the global economy?

Why can’t we just produce for ourselves and forget the rest of the

world?

Why Trade???

Think about your life without trade:1. You wake up early in small,drafty house that you

built yourself.2. Put on your clothes that you wove yourself from

shearing the sheep in your yard.3. Pluck a few coffee beans off a tree that does not

grow well in Wisconsin all the while hoping that your hen laid at least one egg overnight.

OUR STANDARD OF LIVING IS HIGH BECAUSE WE ARE ABLE TO FOCUS ON WHAT WE DO BEST AND TRADE FOR THE REST!

The U.S., when established, set up one very large trade zone… freely trading with other states.

When countries trade among themselves, the result can be the same… word “freely” is the culprit.

Bottom Line for Trade

1. Productivity is what makes us rich.

2. Specialization is what makes us productive.

3. Trade allows us to specialize

Trade Creates Losers

Any discussion of globalization immediately brings up “loss of jobs.” Dallas has experienced some heavy blows in this arena.

It’s hard to explain to the Levi workers in south Texas or elsewhere why they have no employment, but that Indonesia has all the work it can handle from Levi.

Trade, like technology, CAN DESTROY jobs, particularly low-skilled jobs.

What is the objective for every firm?

PROFIT MAXIMIZING.The key question again rolls back to

productivity. If the worker in Bangladesh is “relatively” productive for a less costly labor rate, then the firm will do a CBA (cost benefit analysis).

If the firm is receiving negative Customer Service replies (Dell, outsourcing of tech support), they may decided to pull labor for that service back into the U.S.

4 Ways government commonly interferes with trade

1. Protective tariffs. (are excise taxes or duties placed on imported goods)… Purpose. To “protect” shield domestic producers from foreign competition

Figure 33-4 The Effect of a Tariff on Japanese-Made Laptop Computers, Panel (a)

Japanese-madenotebook computers

What about “protecting” our U.S. jobs?

PROTECTIONISM SAVES JOBS IN THE SHORT RUN…. AND SLOWS ECONOMIC GROWTH IN THE LONG RUN….

(RETALIATION CAN BE EXPECTED)See Smoot-Hawley TariffLowering trade barriers has the same impact on

consumers as cutting taxes(Wright Amendment is protectionism-which I am happy to report was repealed by Congress 9/30/06) (goes into effect 2014)

2. Import Quotas….A limit on the amount of any specified good

that can enter the country over a fixed period.

(example: Only X # of bottles of Cognac can be imported)

Figure 33-3 The Effect of Quotas on Textile Imports

Equilibrium with restrictions

Equilibrium without restrictions

3. Nontariff barriers(Just a way around allowing imports into the

country by establishing standards that could not be complied with and yards of red tape to hassle with)… Countries will just forget trading with that country and go someplace else to trade.

4. Export SubsidiesGovernment pays (subsidies- gives dollars to)

domestic producers of export goods. This reduces their production costs, lowers their

taxes and allows producers to charge lower prices and sell more exports.

Legislation (Oct 2004) ceased most of this arrangement with Am companies… WTO sanctioned American trade for unfair subsidies, and Congress finally had to comply.

Figure 33-5 Tariff Rates in the United States Since 1820

Source: U.S. Department of Commerce.

A word about rate of currency exchange

The U.S. Dollar most widely accepted for of currency in the world

Fluctuation of dollar replicates the fluctuation of the supply and demand for the currency.

Dollar in relation to Yen, Euro, etc is calculated for international trade

As importer – if dollar is down – have to pay more for goods coming into U.S. to sell

As exporter – if dollar down – country receiving goods pays less for American goods.

More words for exchange

If you are selling jeans to Germany, there are two ways to consummate the sale.

1) Spot transaction – have to quote a price in either dollars and euros. A price is agreed to – but exchange rate might change before deal is completed. Either party may profit or lose since it is a floating rate.

Words continued

2.) Second way to complete the exchange of jeans to Germany. Just wait until ready to ship and purchase the euros needed to pay the company receiving the goods.

Buyer and seller have to agree which currency they want to pay and receive.

Exchange banks open 24 hours – 5 days a week. Many people speculate and invest in currency to

gain financial profit for the trade.

Currency Converter

“No nation was ever ruined by trade.”

Benjamin Franklin

* Sometime in your life, read the “Petition of the Candlemakers 1845 …” by Bastiat