Ch 17 international trade macro econ4

© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Chapter 17 ECON4 William A. McEachern

1

International

Trade



The Gains from Trade

• Law of comparative advantage

– The individual with the lowest opportunity

cost of producing a particular good

– Should specialize in that good

• Each country specializes

– In making goods with the lowest

opportunity cost

2




• U.S. exports

– $2.2 trillion (14% of GDP) in 2012

– Services (29% of U.S. exports)

• U.S. imports

– $2.7 trillion (17% of GDP) in 2012

– Industrial supply (27% of U.S. imports)

3



Exhibit 1

4

Composition of U.S. Exports and Imports in 2012




• U.S. trading partners, 2010

– Top 10 destinations for merchandise

exports

• Canada, Mexico, China, Japan, United

Kingdom, Germany, Brazil, South Korea, the

Netherlands, and France

– Top 10 sources of merchandise imports

• China, Canada, Mexico, Japan, Germany,

United Kingdom, South Korea, France, India,

and Taiwan

5



Production Possibilities without Trade

• Production possibilities

– With existing resources

• No trade

– Production possibilities = consumption

possibilities

• Production possibilities frontiers

– Straight lines

– Different slopes – different opportunity

costs

6



Exhibit 2

7

Production Possibilities Schedules for the U.S. and Izodia



Exhibit 3

8

Production Possibilities Frontiers for the United States and

Izodia Without Trade (millions of units per day)

100

200

300

400

500

600

Fo

od

(a) United States

U1

U2

U3

U5

100 200 300 400 Clothing0

100

200

300

400

500

600

Food

(b) Izodia

I1 I2I4

I5

100 200 300 400 Clothing0

Panel (a) shows the U.S. production possibilities frontier; its slope indicates that the

opportunity cost of an additional unit of clothing is 2 units of food. Panel (b) shows

production possibilities for Izodia; an additional unit of clothing costs 1/2 unit of food.

Clothing has a lower opportunity cost in Izodia.

U4

U6

I3

I6



Consumption Possibilities

• Gains from specialization and trade

– Each country should specialize

• Producing the good with the lower

opportunity cost

• Terms of trade

– How much of one good exchanges for a

unit of another good

9



Consumption Possibilities

• Consumption possibilities frontier

– Possible combinations of goods

• As result of specialization and exchange

– Depend on relative preferences

• For each good

– World production must equal world

consumption

10



Exhibit 4

11

Production (and Consumption) Possibilities Frontiers With

Trade (millions of units per day)

100

200

300

400

500

600

Food

(a) United States

100 200 300 400 Clothing0

100

200

300

400

500

600

Food

(b) Izodia

100 200 300 400 Clothing0

U

I

If Izodia and the United States can specialize and trade at the rate of 1 unit of clothing for 1 unit of

food, both can benefit as shown by the blue lines. By trading with Izodia, the U.S. can produce

only food and still consume combination U, which has more food and more clothing than U4.

Likewise, Izodia can attain preferred combination I by trading some clothing for U.S. food.

I3

U4



Reasons for Specialization

• Differences in resource endowments

– Create differences in opportunity cost

– Countries export goods

• Produce more cheaply

– Countries import

• Products unavailable domestically

• Cheaper elsewhere

12



Exhibit 5

13

U.S. Production as a Percentage of U.S.

Consumption for Various Resources

If U.S. production is less than 100 percent of U.S. consumption, then imports make up the

difference. If U.S. production exceeds U.S. consumption, then the amount by which

production exceeds 100 percent of consumption is exported.



Reasons for Specialization

• Economies of scale

– Firms produce more

– Reducing average costs

• Differences in tastes

– Differences in consumption patterns

14



Consumer and Producer Surplus

• Demand: marginal benefit

• Consumer surplus

– Difference between what consumer

would pay and what they pay

• Supply: marginal cost

• Producer surplus

– Difference between actual amount

received and what they would accept

15



Exhibit 6

16

Consumer Surplus and Producer Surplus

0 60Apples

(pounds per day)

S

D

Consumer

surplus

Producer

surplus1.00

0.50Price p

er

pound 2.00

$3.00

Consumer surplus, shown by the blue

triangle, indicates the net benefits

consumers reap from buying 60 pounds

of apples at $1.00 per pound. Some

consumers would have been willing to

pay $3.00 or more per pound for the

first few pounds. Consumer surplus

measures the difference between the

maximum sum of money consumers

would pay for 60 pounds of apples and

the actual sum they pay. Producer

surplus, shown by the gold triangle,

indicates the net benefits producers

reap from selling 60 pounds at $1.00

per pound. Some producers would have

supplied apples for $0.50 per pound or

less. Producer surplus measures the

difference between the actual sum of

money producers receive for 60 pounds

of apples and the minimum amount they

would accept for this amount.



Trade Restrictions

• Tariff: Tax on imports

– Specific: $ amount per unit

– Ad valorem: Percentage per unit

– Effects

• Loss of consumer surplus

• Increase in producer surplus

• Increase in government revenue

• Net loss in domestic social welfare

17



Exhibit 7

18

Effect of a Tariff

$0.15

0.10

Price

per

pound S

D

0 30

Sugar (millions of pounds per month)

20 60 70

a b c d

f

At a world price of $0.10 per pound,

U.S. consumers demand 70 million

pounds of sugar per month, and U.S.

producers supply 20 million pounds

per month; the difference is imported.

After the imposition of a $0.05 per

pound tariff, the U.S. price rises to

$0.15 per pound. U.S. producers

supply 30 million pounds, and U.S.

consumers cut back to 60 million

pounds. At the higher U.S. price,

consumers are worse off; their loss of

consumer surplus is the sum of areas

a, b, c, and d. The net welfare loss to

the U.S. economy consists of areas b

and d.



Trade Restrictions

• Import quotas: Legal limit on the amount

of a commodity that can be imported

– Target imports from certain countries

– Effects

• Raise the US price above the world price

• Reduce quantity below the free-trade level

• Lower consumer surplus

• Increase in producer surplus

• Net loss in domestic social welfare

19



Exhibit 8

20

Effect of a Quota

S’

$0.15

0.10

Pri

ce

per

pound

S

D

0 Sugar

(millions of pounds per month)20 50 70

$0.15

0.10

Pri

ce

per

pound

S

D

0 30 Sugar

(millions of pounds per month)20 60 70

a b c d

S’

e

In panel (a), D is the U.S. demand curve and S is the supply curve of U.S. producers. If the government

establishes a sugar quota of 30 million pounds per month, the supply curve combining U.S. production and

imports becomes horizontal at the world price of $0.10 per pound and remains horizontal until the quantity

supplied reaches 50 million pounds. For higher prices, the new supply curve equals the horizontal sum of

the U.S. supply curve, S, plus the quota of 30 million pounds. The new U.S. price, $0.15 per pound, is

determined by the intersection of the new supply curve, S, with the U.S. demand curve, D. Panel (b) shows

the welfare effect of the quota. As a result of the higher U.S. price, consumer surplus is cut by the shaded

area. The blue-shaded areas illustrate the loss in consumer surplus that is captured by domestic producers

and those who are permitted to fulfill the quota, and the pink-shaded triangles illustrate the net welfare cost

of the quota on the U.S. economy.

(a) (b)



Trade Restrictions

• Quotas in practice

– Rewards domestic and foreign producers

with higher prices

– Lobbyists for foreign producers

• Seek the right to export to U.S.

– Auction off the quotas

• Increase federal revenue

• Reduce pressure to perpetuate quotas

21



Trade Restrictions

• Comparison: Tariffs and Quotas

– Similarities

• Higher price, Lower quantity demanded

• Loss of consumer surplus (U.S. consumers)

• Gain of producer surplus (U.S. producers)

• Lower economic welfare

– Differences

• Revenue from tariff – to U.S. government

• Revenue from quota - to quota rights’ owner

22



Other Trade Restrictions

• Export subsidies - to encourage exports

• Domestic content requirements

– A certain portion of a final good must be

produced domestically

• Other requirements

– Health, Safety, Technical standards

– Discriminate against foreign goods

• Trade restrictions

– Slow economic progress23



Multilateral Agreement

• General Agreement on Tariffs and

Trade, GATT:

– 1947, 23 countries

• Reduce tariffs

• Reduce import quotas

• Equal trade

– 1986, “Uruguay Round”

• Now exceeds 150 countries

• Successor: WTO

24



The World Trade Organization

• Legal and institutional foundation for

world trade

• 500 economists and lawyers

• Trade

– Merchandise

– Services

– Intellectual property

• Phase out quotas, keep only tariffs

25



Common Markets

• U.S. economy

– Free trade zone across 50 states

• European Union

– 27 countries in 2010

– Barrier-free European market

– 16 members: common currency – Euro

• North American Free Trade Agreement

– United States, Canada, Mexico

26



Common Markets

• DR-CAFTA

– U.S, Dominican Republic, five Central

American countries

• Mercosur

– Latin American countries

• ASEAN

– Southeast Asian nations

• Southern African Customs Union

– South Africa and four neighbors 27



Arguments for Trade Restrictions

• National defense argument

– Domestic industry’s output is vital to

national defense

– More efficient

• Government subsidies

• Stockpile basic military hardware

28




• Infant industry argument

– Protect emerging domestic industries

– Foster inefficiencies

– Cost: net welfare loss from higher

domestic prices

– More efficient

• Temporary production subsidies

29




• Antidumping argument

– Dumping: sell a product abroad for less

than in the home market

• Persistent

– Consumers - pay less

– Increase consumer surplus

• Predatory

– Temporary; eliminate competitors

• Sporadic

– “sales”

30




• Jobs and income argument

– Protect domestic jobs

– Retaliation

– Great Depression: high tariffs choked

trade and jobs

• Declining industries argument

– Help lessen shocks to the economy

– Specific duration

31



Problems with Trade Protection

• Protect one stage of production

– Protect downstream stages

• Cost of protection

– Welfare loss, Cost of rent seeking

• Transaction cost of enforcing restrictions

– Black markets

• Less efficient, less innovative

• Retaliation

32

Economy & Finance

Ch 17 international trade macro econ4