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MB MC
International Trade
Frank danteDante
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Introduction
• Understanding the Economic Issues of International Trade– The benefits of trade– The costs of trade– The economic impact of trade restrictions
Chapter 9: International Trade Slide 2
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Comparative Advantageas 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.
Chapter 9: International Trade Slide 3
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
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 other countries
Chapter 9: International Trade Slide 4
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production Possibilities Curve for a Many-Worker Economy
Chapter 9: International Trade Slide 5
Computers (number/year)
Cof
fee
(pou
nds/
year
)
B
CA
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
100,000
40,000
1,000 2,000
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
• A country’s PPC shows the quantities of different goods that its economy can produce.
• Consumption Possibilities– The combinations of goods and services that a
country’s citizens might feasibly consume
Chapter 9: International Trade Slide 6
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
• In a closed economy:– Society’s production possibilities = consumption
possibilities.– If a country is self-sufficient, it is called autarky.
Chapter 9: International Trade Slide 7
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
• In an open economy:– The society’s consumption possibilities are
typically greater than its production possibilities.
Chapter 9: International Trade Slide 8
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buying and Selling in World Markets
Chapter 9: International Trade Slide 9
Computers/year
Cof
fee
(pou
nds/
year
)
B
CA
D
Assume:• Producing at D• Closed economy• World price of coffee = $10/lb and
computer = $500120,000
100,000
1,000
50,000
2,000 2,400
150,000
3,000
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buying and Selling in World Markets
Chapter 9: International Trade Slide 10
Computers/year
Cof
fee
(pou
nds/
year
)
B
CA
D
F
Observation:• Sell 2,000 computers @ $500• Take the $1million and buy 100,000
pounds of coffee• Consumption possibilities of 150,000 is
greater than PPC without trade
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buying and Selling in World Markets
Chapter 9: International Trade Slide 11
Computers/year
Cof
fee
(pou
nds/
year
)
B
CA
D
F
Observation:• Start at D• Sell 50,000 lbs of coffee• Buy 1,000 computers with the $500,000• Pt F is possible with trade but not on the PPC
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy
Chapter 9: International Trade Slide 12
Computers/year
Cof
fee
(pou
nds/
year
)
B
C
A
D
F
• 50 lbs of coffee trades for 1 computer• LM = consumption possibilities• G is the optimal combination for Costa Rica• Costa Rica can use trade to locate anywhere
along LM
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
160,000
3,200
G
M
L
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy
Chapter 9: International Trade Slide 13
Computers/year
Cof
fee
(pou
nds/
year
)
B
C
A
D
F
Why produce at G?• Slope of the PPC = LM• Domestic and international opportunity costs
of acquiring an extra computer (in terms of forgone coffee) are equal
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
160,000
3,200
G
M
L
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Straight-Line Production Possibilities Curve
Chapter 9: International Trade Slide 14
Tea (pounds/year
Cof
fee
(pou
nds/
year
)
B
C
A
D
Observation• The tradeoff between
coffee and tea is constant at any point on the PPC
200
200
600
800
600 800
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Two Consumption Possibilities Curves
Chapter 9: International Trade Slide 15
Tea (pounds/year
Cof
fee
(pou
nds/
year
)
B
C
A
D’600
200
600
800
800 1,600D
200
• Islandia produces at A• Islandia can use the money
earned from selling 800 lbs of coffee to choose any combination on AD’
Consumption possibilities curve when the world price of coffee is twice the world price of tea
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Two Consumption Possibilities Curves
Chapter 9: International Trade Slide 16
Tea (pounds/year
Cof
fee
(pou
nds/
year
)
B
C
A
600
200
600
800
800
1,600
D200
• Islandia produces at D• Islandia can choose any
combination on A’D
Consumption possibilities curve when the world price of tea is twice the world price of coffee
A’
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Consumption Possibilities Withand Without International Trade
• What Do You Think?– Where should Islandia produce if the price of
coffee and tea were the same?
Chapter 9: International Trade Slide 17
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Consumption Possibilities Withand Without International Trade
• Observations– With a bow-shaped PPC consumption possibilities
is typically maximized by producing where the PPC is tangent to the consumption possibilities line.
– With a straight-line PPC production is completely specialized.
Chapter 9: International Trade Slide 18
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
• Economic Naturalist– Does “cheap” foreign labor pose a danger to high-
wage economies?
Chapter 9: International Trade Slide 19
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
• Economic Naturalist– Scenario
• U.S. and Fredonia produce software and beef.• Real wages in Fredonia are lower than in the U.S.• Fredonia is half as productive as the U.S. in beef
production.• Fredonia is one-tenth as productive in software
production.
Chapter 9: International Trade Slide 20
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
• Economic Naturalist– Outcome
• Fredonia has a comparative advantage in beef.• U.S. has a comparative advantage in software.• The U.S. will trade software for beef and increase its
consumption of both.• Employment in the software industry in the U.S.
increases and employment in the beef industry will decrease.
Chapter 9: International Trade Slide 21
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market forComputers in Costa Rica
Chapter 9: International Trade Slide 22
Computer per yearWithout Trade
Computer per yearWith Trade
Domesticdemand
Domesticsupply
Consumer surpluswith trade = $1.96mil/yr
Producer surpluswith trade = $360K/yr
Worldprice
2,000 4,800
E
F
1,200 2,800
Computer Imports
2,000 4,800
2,400
1,400
400Domesticdemand
Domesticsupply
Consumer surpluswithout trade = $1mil/yr
Producer surpluswithout trade = $1mil/yr
2,400
1,400
400
1,000
E
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
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.
Chapter 9: International Trade Slide 23
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market forCoffee in Costa Rica
Chapter 9: International Trade Slide 24
Coffee (pounds/year)Without Trade
100,000 240,000
12
7
4
Domesticdemand
Domesticsupply
Consumer surpluswithout trade = $250K/yr
Producer surpluswithout trade = $150K/yr
E
Coffee (pounds/year)With Trade
100,000
12
7
4
Domesticdemand
Consumer surpluswith trade = $40K/yr
Producer surpluswith trade = $600K/yr
E
Domesticsupply
Worldprice
F
40,000 200,000 240,000
Coffee exports
10
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service.
Chapter 9: International Trade Slide 25
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Observations of the Mutually Beneficial Gains from Trade– Countries will profit by exporting the goods and
services for which they have a comparative advantage.
– The revenue from the exports are used to import goods and services for which they do not have a comparative advantage.
Chapter 9: International Trade Slide 26
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Observations of the Mutually Beneficial Gains from Trade– The markets will ensure that goods will be
produced where opportunity cost is lowest.– The consumption possibilities will be maximized.
Chapter 9: International Trade Slide 27
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Exercise 9.4
Chapter 9: International Trade Slide 28
Computers per year
Pric
e of
com
pute
rs ($
/com
pute
r)
200
Domesticsupply
Worldprice
Domesticdemand
500 800 1,200
600
1,200
2,100
2,400
Question•Given the graph shown, what impact would trade have on producer and consumer surplus?
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Winners and Losers from Trade– Winners
• Consumers of imported goods• Producers of exported goods
– Losers• Consumers of exported goods• Producers of imported goods
Chapter 9: International Trade Slide 29
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Protectionism– The view that free trade is injurious and should
be restricted• Tariff
– A tax imposed on an imported good• Quota
– A legal limit on the quantity of a good that may be imported
Chapter 9: International Trade Slide 30
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Tariff
Chapter 9: International Trade Slide 31
Computers per year
Pric
e of
com
pute
rs ($
/com
pute
r)
1,200World price + tariff
1,600 2,400
1,000
1,200
Domesticsupply
World price
Domesticdemand
4,800
400
2,400
E
2,800
Importswithouttariff
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Tariff
Chapter 9: International Trade Slide 32
Computers per year
Pric
e of
com
pute
rs ($
/com
pute
r)
1,200
Domesticsupply
World price
Domesticdemand
4,800
400
1,200
2,400
1,000
World price + tariff
E
1,600 2,400 2,800
Importswithtariff
Consumer surpluswith tariff = 1.44K/yr
Producer surpluswith tariff = 640K/yr
Tariff revenue =$160K/yr
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Exercise 9.5
Chapter 9: International Trade Slide 33
Computers per year
Pric
e of
com
pute
rs ($
/com
pute
r)
200
Domesticsupply
Worldprice
Domesticdemand
500 800 1,200
600
1,200
2,100
3,600
Question•Given the graph shown, how will a tariff of $300 per computer affect total economic surplus?
1,500
300 700
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Protectionist Policies: Tariffs and Quotas
• What do you think?– Why did President George W. Bush support the
imposition of tariffs on steel imported into the United States?
Chapter 9: International Trade Slide 34
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Protectionist Policies: Tariffs and Quotas
• Quotas– Legal limit on the number or value of foreign
goods that can be imported– Can be enforced by issuing permits
Chapter 9: International Trade Slide 35
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Quota
Chapter 9: International Trade Slide 36
1,200
1,600 2,400
Domestic supply + quota
F
Computers per year
Pric
e of
com
pute
rs ($
/com
pute
r)
1,200 2,800
Imports with free trade = 1,600 computers/yr
1,000
Domestic supply
World price
Domesticdemand
4,800
2,400
E1,400
2,000
400
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Quota
Chapter 9: International Trade Slide 37
1,200
1,600 2,400
Domestic supply + quota
F
Computers per year
Pric
e of
com
pute
rs ($
/com
pute
r)
1,200 2,800
Imports = 800 computers/year
1,000
Domestic supply
World price
Domesticdemand
4,800
2,400
E1,400
2,000
400
Economic rent to holders of import licenses = $80K/year
Producer surplus with quota = $640K/yr
Consumer surpluswith quota = $1,440K/yr
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Quotas & Tariffs– Market effects of tariffs are the same.– Tariffs generate tax revenue.– Quotas generate revenue for the firms that hold
an import license.
Chapter 9: International Trade Slide 38
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Question– Why would the government ever impose a
quota rather than a tariff?
Chapter 9: International Trade Slide 39
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Economic Naturalist– Who benefited from and who was hurt by
voluntary export restraints on Japanese automobiles in the 1980s?
Chapter 9: International Trade Slide 40
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• Other Barriers to Trade– Red-tape barriers– Regulations
Chapter 9: International Trade Slide 41
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
• 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 organized, 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.
Chapter 9: International Trade Slide 42
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
• Outsourcing– A term increasingly used to connote having
services performed by low-wage workers overseas
Chapter 9: International Trade Slide 43
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
• Outsourcing– Outsourcing of services to low-wage foreign
workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers.
Chapter 9: International Trade Slide 44
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
• Economic Naturalist– Paul Solman and his associate Lee Koromvokis
produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program, The NewsHour with Jim Lehrer.
– Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderbad?
Chapter 9: International Trade Slide 45
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
• Characteristics of Jobs that are Less Susceptible to Outsourcing– Less rules-based jobs– “Face-to-Face” complex communication jobs– Jobs that require the worker to be physically
present
Chapter 9: International Trade Slide 46
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
• Responding to changing economic conditions requires the ability to adapt quickly to new circumstances.
• Education provides the means to develop a comparative advantage that is not rules-based and does require complex face-to-face communication.
Chapter 9: International Trade Slide 47
MB MC
End ofChapter