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McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved International Trade Chapter 35

Chapter 35

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Page 1: Chapter 35

McGraw-Hill/Irwin

©2008 The McGraw-Hill Companies, All Rights Reserved

International TradeInternational Trade

Chapter 35 Chapter 35

Page 2: Chapter 35

2

U.S. Trade Patterns

The U.S. is the largest player in global product and resource markets.

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3

Imports

The U.S. imported more than $2.2 trillion of goods and services in 2006.

Imports are goods and services purchased from foreign sources.

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4

Exports

We exported $1 trillion of goods and $431billion in services in 2006.

Exports are goods and services sold to foreign buyers.

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5

Export Ratios

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6

Trade Balances

The trade balance is the difference between the value of exports and imports.

Any imbalance in America’s trade must be offset by reverse imbalances elsewhere.

Trade balance = exports – imports

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7

Trade Balances

Trade deficit is the amount by which the value of imports exceeds the value of exports in a given time period.

Trade surplus is the amount by which the value of exports exceeds the value of imports in a given time period.

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8

Trade Balances: 2006

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9

Bilateral Trade Balances:Top Deficit Countries

Country Trade Balance

(in billions of dollars) China –233 Japan –88 Canada –73 Mexico –64 Germany –48

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10

Bilateral Trade Balances:Top Surplus Countries

Country Trade Balance

(in billions of dollars) Netherlands +14 U.A.E. +11 Australia +10 Hong Kong +10 Belgium +7

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11

Motivation to Trade

Why trade when . . .

. . . we import many of the things we also export.

. . . we could produce many of the other things we import.

. . . we seem to seem to worry so much about trade imbalances.

LO2

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12

Specialization

Trade allows nations to specialize and specialization increases total output.

Trade increases world output and the standards of living in all trading countries.

LO2

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13

Production and Consumption Without Trade

The gains from trade can be illustrated using production possibilities curves.

Production possibilities – The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology.

LO2

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14

Production and Consumption Without Trade

In the absence of trade, a country’s consumption possibilities are identical to its production possibilities.

Consumption possibilities - The alternative combinations of goods and services that a country could consume in a given time period.

LO2

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15

Consumption Possibilities Without Trade

U.S. ProductionPossibilities

French ProductionPossibilities

Bread Wine Bread Wine100 0 15 080 10 12 1260 20 9 24

40 30 6 3620 40 3 480 50 0 60

LO2

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16

Consumption Possibilities Without Trade

OU

TP

UT

OF

BR

EA

D

(zill

ions

of l

oave

s pe

r ye

ar)

60

10OUTPUT OF WINE (zillions of barrels per year)

U.S. production possibilities

0 20 30 40 50 60

20

40

80

100 A

B

C

D

E

F

LO2

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17

Consumption Possibilities Without Trade

OU

TP

UT

OF

BR

EA

D(z

illio

ns o

f loa

ves

per

year

)

15

10OUTPUT OF WINE (zillions of barrels per year)

French production possibilities

0 20 30 40 50 60

5

10

20

25

G

H

I

J

K

L

LO2

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18

Production and Consumption With Trade

To assess the potential gain from trade, we need to consider the combined output of trading nations.

By increasing the mix of output in each trading country, we can increase total world output.

LO2

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19

Mutual Gains

Each country produces those goods it makes best, then trades with other countries to acquire the goods it desires to consume.

When a country engages in international trade, its consumption possibilities always exceed its production possibilities.

LO2

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20

Consumption Possibilities Without Trade

Bread WineU.S. (at point D) 40 30France (at point I) 9 24

World total 49 54

LO2

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21

Consumption Possibilities With Trade

Bread WineU.S. (at point C) 60 20France (at point K) 3 48

World total 63 68

LO2

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22

Consumption Possibilities With Trade

QU

AN

TIT

Y O

F B

RE

AD

(zill

ions

of l

oave

s pe

r ye

ar)

60

10QUANTITY OF WINE (zillions of barrels peryear)

(a) U.S. production andconsumption

0 20 30 40 50 60

20

40

80

100 A

C

D

120

N

Production and consumption without trade

Consumption withtrade

Production withtrade

LO2

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23

Consumption Possibilities With Trade

QU

AN

TIT

Y O

F B

RE

AD

(zill

ions

of

loav

es p

er y

ear)

15

10QUANTITY OF WINE (zillions of barrels peryear)

(b) French production and consumption

0 20 30 40 50 60

5

10

20

K

Productionwith trade

Consumption with tradeMI

Production andconsumption without trade

LO2

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24

Gains from Specialization

Old Mix ofOutput

New Mix ofOutput

Bread Wine Bread WineUnited States 40 30 60 20

(point D) (point C)France 9 24 3 48

(point I) (point K)World total 49 54 63 68

LO2

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25

Pursuit of Comparative Advantage

Although international trade can make everyone better off, it’s not obvious which goods should be traded, or on what terms.

LO1

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Opportunity Costs

The decision to export is based on comparative advantage.

Comparative advantage - The ability of a country to produce a specific good at a lower opportunity cost than its trading partners.

Opportunity cost - The most desired goods or services that are forgone in order to obtain something else.

LO1

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27

Comparative Advantage

Comparative advantage refers to the relative (opportunity costs) of producing particular goods.

World output, and thus potential gains from trade, will be maximized when each country pursues its comparative advantage.

LO1

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28

Absolute Costs Don’t Count

The absolute advantages in production do not matter.

Absolute advantage – The ability of a country to produce a specific good with fewer resources (per unit of output) than other countries.

LO1

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29

Terms of Trade

The terms of trade establish the trading rate.

Terms of trade is the rate at which goods are exchanged – the amount of good A given up for good B in trade.

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Limits to the Terms of Trade

A country will not trade unless the terms of trade are superior to domestic opportunities.

The terms of trade between two countries will lie somewhere between their respective opportunity costs in production.

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Searching for the Terms of Trade

Wine

France

0 10 20 30 40 50 60 70 80 90 100 110

306090

120

Bre

ad Consumption possibilities

Production possibilitiesL M K

UnitedStates

0 10 20 30 40 50 60 70 80 90 100 110

20406080

100

Bre

ad

DC

X

N

YConsumptionpossibilities

Productionpossibilities

A

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The Role of Markets and Prices

The decision to import or export a particular good is often left up to the market decisions of individual consumers and producers.

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The Role of Markets and Prices

The terms of trade, like the price of any good, will depend on the willingness of market participants to buy or sell at various prices.

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34

Protectionist Pressures

Although the potential gains from trade are impressive, not everyone favors free trade.

Imports typically compete with a domestic industry.

LO3

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35

Microeconomic Pressures

The affected industries will try to restrict imports in order to preserve their own jobs and incomes.

LO3

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Import-Competing Industries

Workers and producers who compete with imported products – who work in import-competing industries – have an economic interest in restricting trade.

LO3

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37

Export Industries

Trade not only alters the mix of output but also redistributes income from import-competing industries to export industries.

LO3

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38

Net Gain

Trade restrictions designed to protect specific microeconomic interests reduce the total gains from trade.

LO3

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39

Additional Pressures

Selfish micro interests are not the only source of trade restrictions.

Other arguments are used to restrict trade.

LO3

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40

National Security Concerns

Essential defense-related goods are vital during times of war.

A war could disrupt this flow leaving us vulnerable.

Exporting vital technology to a potential enemy is not wise.

LO3

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41

Dumping

Import competing industries are placed at risk when goods are consistently dumped in a nation.

Dumping is the sale of goods in export markets at prices below domestic prices.

LO3

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42

Infant Industries

Even normal export prices might make it difficult or impossible for a new domestic industry to develop.

These industries may need temporary protection from imports.

LO3

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Infant Industries

Trade restrictions are justified only if there is tangible evidence that the industry can develop a comparative advantage reasonably quickly.

LO3

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44

Improving the Terms of Trade

The distribution of the gains from trade depends on the terms of trade.

Putting restrictions on imports can move the terms of trade in our favor

We would end up with a larger share of the gains from trade.

LO3

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Barriers to Trade

The microeconomic losses associated with trade give rise to a constant clamor for trade restrictions.

LO3

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Embargoes

The sure-fire way to restrict trade is simply to eliminate it.

An embargo is a prohibition against trading particular goods.

LO3

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47

Tariffs

A more frequent trade restriction is a tariff.

A tariff is a tax (duty) imposed on imported goods.

A tariff makes imported goods more expensive to domestic consumers, and less competitive with domestically priced goods.

LO3

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48

“Beggar-Thy-Neighbor”

The curtailment of imports looks like an easy solution to the problem of domestic unemployment.

Tariffs inflict harm on foreign producers.

When foreign countries retaliate with tariffs of their own, world trade shrinks and unemployment increases in all countries.

LO3

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49

Quotas

The same outcome of a tariff can be attained more directly by imposing an import quota.

A quota is a limit on the quantity of a good that may be imported in a given time period.

LO3

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Comparative Effects

The effect of quotas on trade is different than the effect of tariffs.

LO3

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No-Trade Equilibrium

The equilibrium price is completely determined by domestic demand and supply curves.

Equilibrium price – The price at which the quantity of a good demanded in a given time period equals the quantity supplied.

LO3

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Free-Trade Equilibrium

Free trade allows the import of unlimited quantity of foreign supplies at the world price.

Free trade results in reduced prices and increased consumption.

LO3

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Tariff-Restricted Trade

Tariffs raise the price of imports and shifts the import supply curve upward.

Domestic prices rise, domestic production rises, and domestic consumption falls.

LO3

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Quota-Restricted Trade

Quotas are a greater threat to competition than tariffs because quotas preclude additional imports at any price.

LO3

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Impact of Trade Restrictions

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

(a) No-trade equilibrium

D1

p1

0 q1

LO3

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Impact of Trade Restrictions

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

D1

p2

p1

q2qd

S2

0

(b) Free-trade equilibrium

B

q1

LO3

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Impact of Trade Restrictions

p3

qt

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

D1

p1

q3

S3

C

0

(c) Tariff-restricted trade

S2p2

q2qd q1

LO3

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58

Impact of Trade Restrictions

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

D1

p1

q40

(d) Quota-restricted trade

p2

q2q1

p4

S4

Q

LO3

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59

Voluntary Restraint Agreements

A slight variant of quotas has been used in recent years.

A voluntary restraint agreement (VRA) is an agreement to reduce the volume of trade in a specific good – a “voluntary” quota.

LO3

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Nontariff Barriers

Embargoes, export controls, tariffs, and quotas are the most visible barriers to trade, but they are only the tip of the iceberg.

LO3

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Nontariff Barriers

The U.S. uses product standards, licensing restrictions, restrictive procurement practices, and other nontariff barriers to restrict roughly 15 percent of imports.

LO3

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An Increasingly Global Market

Trade policy is a continuing conflict between the proponents of free trade and the special interests that profit from trade protection.

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Multilateral Trade Pacts

The long-term trend is towards lowering trade barriers, thereby increasing global competition.

Protectionist forces are being countered by the worldwide recognition of the gains from trade.

Exporters and firms that use imported inputs push for free trade.

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Global Pacts: GATT and WTO

The granddaddy of the multilateral, multiyear free-trade pacts was the General Agreement on Tariffs and Trade (GATT).

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WTO

The 1994 GATT pact created the World Trade Organization (WTO) to enforce free-trade rules.

The WTO has become the world’s trade police force.

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WTO Protests

Some people see free trade as a mixed blessing.

Environmentalists worry about depletion of resources, congestion and pollution.

Labor organizations worry about depressed wages and working conditions.

Third World countries worry about an unfair trade playing field.

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Regional Pacts

Groups of nations have moved even faster toward open markets by developing regional trade pacts.

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68

NAFTA

In December 1992, the United States, Canada, and Mexico signed the North American Free Trade Agreement (NAFTA).

The ultimate goal of NAFTA is to eliminate all trade barriers between these three countries.

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CAFTA

The success of NAFTA prompted a similar 2005 agreement between the U.S. and central American nations.

The Central American Free Trade Agreement (CAFTA) aims to eliminate tariffs and standardize trade and investment policies in CAFTA nations.

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European Union

The European Union (EU) is a regional pact that virtually eliminates national boundaries between 25 countries.

The EU eliminated trade barriers and permits full inter-country mobility of workers and capital.

In effect, Europe has become one large unified market.

Page 71: Chapter 35

McGraw-Hill/Irwin

©2008 The McGraw-Hill Companies, All Rights Reserved

International TradeInternational Trade

End of Chapter 35 End of Chapter 35