Micro Ch09 Lecnotes 6e

7/28/2019 Micro Ch09 Lecnotes 6e

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PowerPoint Lecture Notes for Chapter 9: Application: International Trade

Pri nciples of Microeconomics4th

edition, by N. Gregory Mankiw

PowerPoint Slides by Ron Cronovich

2006 Thomson South-Western, all rights reserved

N . G R E G O R Y M A N K I W

PowerPointSlidesby Ron Cronovich

9

P R I N C I P L E S O F

F O U R T H E D I T I O N

MICROECONOMICS

Application: International TradeApplication: International Trade

This relatively short chapter has a few main objectives.

Welfare analysis of free trade in a good that a country exports,relative to no trade.

Welfare analysis of free trade in a good that the country imports,relative to no trade.

Welfare analysis of a tariff, relative to free trade in a good thecountry imports.

The most common arguments for restricting imports, and theeconomists response to each.

I encourage you to bring to your students attention several interestingitems in the book itself. Theres a new In the News box on the 2005expiration of U.S. quotas on textile products from China. In anothernew In the News box, George Will addresses the outcry overMankiws famously-misquoted statement about outsourcing. Thechapters conclusion makes an effective point about international tradeby comparing it to technological progress.

In addition, one of the macro chapters of this textbook has a new Inthe News box that you should try to obtain for possible use with thischapter. In it, the Presidents of two African nations use soundeconomics to explain why the farm subsidies of rich countries arecontributing to the impoverishment of millions of African farmers. Thearticle is very well-written, effective, and impassioned. It appears inthe chapter entitled Production and Growth, chapter 25 in thecompletePrinciples of Economics textbook, and chapter 12 in the

Principles of Macroeconomics split.

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 1

In this chapter, look for the answers to

these questions:

What determines how much of a good a country

will import or export?

Who benefits from trade? Who does trade harm?

Do the gains outweigh the losses?

If policymakers restrict imports, who benefits?

Who is harmed? Do the gains of the policy

outweigh the losses?

What are some common arguments for restricting

trade? Do they have merit?


Introduction

Recall from Chapter 3:

A country has a comparative advantage in a

good if it produces the good at lower opportunity

cost than other countries.

Countries can gain from trade if each exports the

goods in which it has a comparative advantage.

Now we apply the tools of welfare economics

to see where these gains come from and

who gets them.


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The world price andcomparative advantage

PW = the world price of a good,

the price that prevails in world markets

PD = domestic price without trade

If PD < PW,

country has comparative advantage in the good

under free trade, country exports the good

If PD > PW,

country does not have comparative advantage

under free trade, country imports the good


The small economy assumption

A small economy is a price takerin world markets:

Its actions have no affect on PW.

Not always true especially for the U.S. but

simplifies the analysis without changing its lessons.

When a small economy engages in fr ee trade,

PW is the only relevant price:

No seller would accept less than PW, becauseshe could sell the good forP

W

in world markets.

No buyer would pay more than PW, becausehe could buy the good forPW in world markets.


A country that exports soybeans

Without trade,

PD = $4

Q= 500

PW = $6

Under free trade,

domesticconsumers

demand 300 domestic producers

supply 750

exports = 450

P

Q

D

S

$6

$4

500300

Soybeans

exports

750

Fun soybean facts (all data from 2004):

U.S. farmers grew 3.1 billion bushels of soybeans. The average price was $5.65/bushel, for a total of nearly $18 billion. The U.S. exported 1.1 billion bushels, comprising nearly half of

international trade in soybeans.

China purchased $2.3 billion worth of U.S. soybean exports,

making China the U.S. soybean farmers biggest foreign customer. Japan was second with $1.0 billion in purchases.Source: American Soybean Association, http://www.soystats.com/

You might alert your students that, in just a moment, they will be askedto do some analysis very similar to this analysis. This will make thempay close attention.

In this case, PD < PW, so this country will export soybeans.

The quantity of exports is simply the difference between the domesticquantity supplied and the domestic quantity demanded at the world

price.
http://www.soystats.com/http://www.soystats.com/


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A country that exports soybeans

Without trade,

CS = A + B

PS = C

Total surplus

= A + B + C

With trade,

CS = A

PS = B + C + D

Total surplus= A + B + C + D

P

Q

D

S

$6

$4

Soybeans

exportsA

B D

Cgains

from trade

Trade benefits soybean producers, because they can sell at a higherprice. Producer surplus rises by the area B + D.

Trade makes domestic buyers worse off, because they have to pay ahigher price. Consumer surplus falls by the area B.

The gains to producers are greater than the losses to consumers, so

trade increases total welfare: total surplus rises by the amount D.

AA CC TT IIVVE LE L EEAA RRNN II NN GG 11::Analysis of tradeAnalysis of trade

Without trade,

PD = $3000, Q= 400

In world markets,

PW = $1500

Under free trade,

how many TVswill country

import or export?

Identify CS, PS, and

total surplus without

trade, and with trade.7

P

Q

D

S

$1500

200

$3000

400 600

Plasma TVs

The two preceding slides show students the analysis of trade when thecountry exports. The next step is to cover the analysis of trade whenthe country imports the good.

Instead of lecturing on this material, I suggest you have students workon this exercise, which students to do this analysis themselves. Its anactivity that breaks up the lecture and gives students a chance to applythe techniques youve just presented.

I suggest you have students work on it in pairs. Give them about 5minutes, then go over the answers on the following two slides.

While students are working, circulate around the room and offer toassist any students that ask for help. This will also give you a sense ofhow well students are understanding the material.

If you prefer to lecture on the material instead, replace these slides withthe two hidden slides that immediately follow the CHAPTERSUMMARY. You will then have to unhide those slides byunselecting Hide Slide from the Slide Show drop-down menu.

AA CC TT IIVVE LE L EEAA RRNN II NN GG 11::AnswersAnswers

8

Under free trade,

domesticconsumers

demand 600

domesticproducerssupply 200

imports = 400

P

Q

D

S

$1500

200

$3000

600

Plasma TVs

imports

PD > PW, so this country will import plasma TV sets from abroad.

The quantity of imports is simply the difference between the quantitydemanded by domestic consumers and the quantity supplied bydomestic firms at the world price.


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AA CC TT IIVVE LE L EEAA RRNN II NN GG 11::AnswersAnswers

9

Without trade,

CS = A

PS = B + C

Total surplus

= A + B + C

With trade,

CS = A + B + D

PS = C

Total surplus= A + B + C + D

P

Q

D

S

$1500

$3000

Plasma TVs

A

B D

C

gainsfrom trade

imports

Trade benefits consumers in this case, because it allows them to buyplasma TVs at lower prices, so more consumers can afford plasma TVsif imports are allowed. The gains to consumers appear on the graph asthe area (B+D), which represents the increase in consumer surpluswhen the country allows trade.

In this example, trade harms domestic producers, because they now

must sell their plasma TVs at a lower price. As a result, they produce asmaller quantity, earn less revenue, and likely let go of some of theirworkers. These losses are represented on the graph by the area B ,which represents the fall in producer surplus resulting from trade.

As the graph shows, the gains to consumers outweigh the losses toproducers: total surplus increases by the amount D, which representsthe gains from trade in plasma TV sets.


total surplus

producer surplus

consumer surplus

direction of trade

rises

falls

rises

imports

PD > PW

rises

rises

falls

exports

PD < PW

Summary: the welfare effects of trade

Whether a good is imported or exported,

trade creates winners and losers.

But the gains exceed the losses.


Other benefits of international trade

consumers enjoy increased variety of goods

producers sell to a larger market, may achieve

lower costs through economies of scale

competition from abroad may reduce market

power of some firms, which would increase

total welfare

trade enhances the flow of ideas, facilitates the

spread of technology around the world


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Then why all the opposition to trade?

Recall one of the Ten Principles:Trade can make everyone better off.

The winners from trade could compensate thelosers and still be better off.

Yet, such compensation rarely occurs.

The losses are often highly concentrated amonga small group of people, who feel them acutely.

The gains are often spread thinly over manypeople, who may not see how t rade benefits them.

Hence, the losers have more incentive to organizeand lobby for restrictions on trade.

In December 2005, thousands of protestors gathered outside themeeting place of the World Trade Organization talks in Hong Kong.Some protests turned violent, and police made 900 arrests.

Mankiw addresses the issue of opposition to trade very nicely in theAsk the Author video for Chapter 3.

The Ask the Author videos are available at the Mankiw Xtra website.You may need a username and password; you can get them from yourThomson/South-Western sales rep.

There is one Ask the Author video clip per chapter. Each video isabout 2 minutes. In each, Mankiw addresses a question submitted by astudent. I encourage you to check out these videos, and considershowing some of them in your class.

The videos for Chapter 3 and Chapter 9 both go very nicely with thematerial in this PowerPoint.


Tariff: an example of a trade restriction

Tariff: a tax on imports.

Example: Cotton shirts

PW = $20

Tariff: T = $10/shirt

Consumers must pay $30 for an imported shirt.

So, domestic producers can charge $30 per shirt.

In general, the price facing domestic buyers &

sellers equals (PW + T).


$30

Analysis of a tariff on cotton shirts

PW = $20

free trade:

buyers demand 80

sellers supply 25

imports = 55

T= $10/shirt

price rises to $30

buyers demand 70

sellers supply 40

imports = 30

P

Q

D

S

$20

25

Cotton shirts

40 70 80

importsimports


$30

Analysis of a tariff on cotton shirts

free trade

CS = A + B + C+ D + E + F

PS = G

Total surplus = A + B

+ C + D + E + F + G

tariff

CS = A + B

PS = C + G

Revenue = E

Total surplus = A + B+ C + E + G

P

Q

D

S

$20

25

Cotton shirts

40

A

B

D E

GFC

70 80

deadweightloss = D + F

The tariff benefits domestic producers, by allowing them to sell for ahigher price. Producer surplus increases by C.

The tariff makes consumers worse off, because they have to pay ahigher price. Consumer surplus falls by C + D + E + F.

The tariff generates revenue for the government equal to E.

The losses from the tariff exceed the gains, so total welfare falls. Thetariff reduces total surplus by (D + F).


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ARGUMENTS FOR RESTRICTING TRADE

1. The jobs argument

Trade destroys jobs in industries that compete

with imports.

E c o n o m i s t s r e s p o n s e :

Look at the data to see whether rising importscause rising unemployment

U.S. imports & unemployment,decade averages, 1956-2005

0%

2%

4%

6%

8%

10%

12%

14%

16%

1

956

-65

1

966

-75

1

976

-85

1

986

-95

1

996

-2

005

imports

(% of GDP)

unemployment

(% of laborforce)

By using decade averages, the short-term noise and fluctuations averageout, which makes the long-term trends easier to see.

In most periods, rising imports are accompanied by falling, not risingunemployment.

Note: This data does not appear in the textbook. I include it herebecause I think it is effective. But it is not supported in the Test Bank or

Study Guide, so please feel free to omit this and the preceding slide ifyou wish.

Data source: FRED database, St Louis Federal Reserve,http://research.stlouisfed.org/fred2/ and my calculations. (I constructedimports as a percentage of GDP from quarterly, nominal, seasonallyadjusted data. Then I computed simple averages of the two series overeach of the decades shown in the graph.)



1. The jobs argument

Trade destroys jobs in the industries that compete

against imports.


Total unemployment does not rise as imports rise,because job losses from imports are offset byjob gains in export industries.

Even ifallgoods could be produced more cheaplyabroad, the country need only have a

comparative advantage to have a viable exportindustry and to gain from trade.



2. The national security argument

An industry vital to national security should be

protected from foreign competition, to preventdependence on imports that could be disruptedduring wartime.


Fine, as long as we base policy on true securityneeds.

But producers may exaggerate their ownimportance to national security to obtainprotection from foreign competition.
http://research.stlouisfed.org/fred2/http://research.stlouisfed.org/fred2/


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3. The infant-industry argument

A new industry argues for temporary protection

until it is mature and can compete with foreign

firms.


Difficult for govt to determine which industries

will eventually be able to compete, and whether

benefits of establishing these industries exceed

cost to consumers of restricting imports.

Besides, if a firm will be pr ofitable in the long run,it should be willing to incur temporary losses.



4. The unfair-competition argument

Producers argue their competitors in another

country have an unfair advantage,

e.g. due to govt subsidies.


Great! Then we can import extra-cheap product

subsidized by the other countrys taxpayers.

The gains to our consumers will exceed t he

losses to our producers.



5. The protection-as-bargaining-chip argument

Example: the U.S. can threaten to limit imports

of French wine unless France lifts t heir quotason American beef.


Suppose France refuses. Then the U.S. must

choose between two bad options:

A) Restrict imports from France, which reduceswelfare in the U.S.

B) Dont restrict imports, and suffer a loss of

credibility.

Of course, this argument and response are meant to apply moregenerally than in the specific example described. But most non-economics majors more easily learn a general concept if they start witha specific, graspable example than with the general concept itself.


Trade agreements

A country can liberalize trade with

unilateral reductions in trade restrictions

multilateral agreements with other nations

Examples of trade agreements:

North American Free T rade Agreement(NAFTA), 1993

General Agreement on Tariffs and Trade(GATT), ongoing

World Trade Organization (WTO) est. 1995,

enforces trade agreements, resolves disputes

The WTO website (http://www.wto.org) has useful information.

Especially worthwhile for students is the section Commonmisunderstandings about the WTO.
http://www.wto.org%29/http://www.wto.org%29/


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CHAPTER SUMMARY

A country will export a good if the world price ofthe good is higher than the domestic price withouttrade. Trade raises producer surplus, reducesconsumer surplus, and raises total surplus.

A country will import a good if the world priceis lower than the domestic price without trade.Trade lowers producer surplus, but raisesconsumer and total surplus.

A tariff benefits producers and generates revenue

for the govt, but the losses to consumers exceedthese gains.


CHAPTER SUMMARY

Common arguments for restricting trade include:

protecting jobs, defending national security,

helping infant industries, preventing unfair

competition, and responding to foreign trade

restrictions.

Some of these arguments have merit in some

cases, but economists believe free trade is usually

the better policy.


A country that imports plasma TVs

Without trade,

PD = $3000

Q= 400

PW = $1500

Under free trade,

domesticconsumersdemand 600

domestic producerssupply 200

imports = 400

P

Q

D

S

$1500

200

$3000

400 600

Plasma TVs

imports

This and the following slide cover the same material in Active LearningExercise 1. I provide these slides in case you wish to lecture on thismaterial instead of having students work the exercise. To do this,simply delete the three orange and yellow slides titled Active Learning1 and replace them with this and the following slide. Then, unhidethese slides by unselecting Hide Slide from the Slide Show drop-down menu.

In this case, PD > PW, so this country will import plasma TV sets fromabroad.

The quantity of imports is simply the difference between the quantitydemanded by domestic consumers and the quantity supplied bydomestic firms at the world price.


A country that imports plasma TVs

Without trade,

CS = A

PS = B + C

Total surplus

= A + B + C

With trade,

CS = A + B + D

PS = C

Total surplus

= A + B + C + D

P

Q

D

S

$1500

$3000

Plasma TVs

A

B D

C

gainsfrom trade

imports

Trade benefits consumers in this case, because it allows them to buyplasma TVs at lower prices, so more consumers can afford plasma TVsif imports are allowed. The gains to consumers appear on the graph asthe area (B+D), which represents the increase in consumer surpluswhen the country allows trade.

In this example, trade harms domestic producers, because they nowmust sell their plasma TVs at a lower price. As a result, they produce asmaller quantity, earn less revenue, and likely let go of some of theirworkers. These losses are represented on the graph by the area B ,which represents the fall in producer surplus resulting from trade.

As the graph shows, the gains to consumers outweigh the losses toproducers, as total surplus increases by the amount D, which representsthe gains from trade in plasma TV sets.

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Micro Ch09 Lecnotes 6e