International Trade &amp; Decision making

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What you will learn in this chapter

INTERNATIONAL TRADE

International trade improves the welfare of Chinese smart phone producers as well as American consumers.

Image: Imaginechina/Corbis

INTERNATIONAL TRADE…

…is more important for the U.S. than it used to be and is more important for some countries than others…

PRODUCTION POSSIBILITIES AND COMPARATIVE ADVANTAGE REVISITED

(Click here to skip this review section based on material found in Chapter 2)

Trade follows the Ricardian model.

(We assume that countries will specialize in goods they can produce more cheaply than other countries.)

Autarky: a situation in which a country does not trade with other countries.

COMPARATIVE ADVANTAGE AND GAINS FROM TRADE

100

100,000

100

25,000

50,0000

(a) U.S. production possibilities

U.S. production and consumption

without trade

U.S.

PPF

China’s

PPF

Quantity of

trucks

Quantity of

trucks

Quantity of phones

(b) China’s production possibilities

China’s production and consumption

without trade

50,000

Since each country has a different opportunity cost, it makes sense to specialize and trade.

200

More trucks will be produced than before with the same resources

(from 75,000 (50,000+25,000) to 100,000 trucks and from 150 (50 + 100) to 300 phones).

Since the United States has the comparative advantage in trucks, it will specialize in trucks.

And China has the comparative advantage in phones, so it will specialize in phones.

COMPARATIVE ADVANTAGE AND GAINS FROM TRADE

100

100,000

100

25,000

50,0000

(a) U.S. production possibilities

U.S. production and consumption

without trade

U.S.

PPF

China’s

PPF

Quantity of

trucks

Quantity of

trucks

Quantity of phones

(b) China’s production possibilities

China’s production and consumption

without trade

50,000

200

COMPARATIVE ADVANTAGE AND GAINS FROM TRADE

Both countries will be happy to export their goods for any price ABOVE their cost of production and import for any price BELOW their cost of production.

The United States will send trucks to China in return for phones…

…and China will send phones to the United States in return for trucks.

Both are happy with 1 truck trading for 2,000 phones.

100

100,000

100

25,000

50,0000

(a) U.S. production possibilities

U.S. production and consumption

without trade

U.S.

PPF

China’s

PPF

Quantity of

trucks

Quantity of

trucks

Quantity of phones

(b) China’s production possibilities

China’s production and consumption

without trade

50,000

200

62,500

U.S. consumption

with trade

China’s consumption

with trade

37,500

125

Don’t confuse absolute and comparative advantage.

Just because the United States can produce more of both goods doesn’t mean we’re better off without trade.

Pay attention to opportunity costs:

If it’s cheaper for China to produce phones than it is for the United States, the United States will want to import phones from China.

PRODUCTIVITY AND WAGES AROUND THE WORLD

The real explanation for low wages in poor countries is low overall productivity.

Image: Penn world tables

SOURCES OF COMPARATIVE ADVANTAGE

Differences in climate

(Bananas grow better here.)

SOURCES OF COMPARATIVE ADVANTAGE

Differences in factor endowments

(Canada can produce paper more cheaply because it’s heavily forested.)

Factor abundance: the supply of a factor of production relative to other factors.

How many forests does a country have compared to machines or people?

Factor intensity: a measure of the quantity of a factor used in comparison with other factors.

How much labor is used compared to natural resources or machines?

THE HECKSCHER-OHLIN MODEL

Bertil Ohlin

Eli Filip Heckscher

“A country that has an abundant supply of a factor of production will have a comparative advantage in goods whose production is intensive in that factor.”

THE HECKSCHER-OHLIN MODEL IN ACTION

Who produces (labor-intensive) clothing? Countries with lots of labor.

China and Bangladesh produce much of the world’s clothing.

SOURCES OF COMPARATIVE ADVANTAGE

Differences in technology

Sometimes a country has developed a particular technology that explains its comparative advantage.

Swiss watches, for example

Increasing returns to scale also play a role in trade:

If an industry gets more efficient as it grows, then there will be a few large producers…

and production may take place in only a few countries.

HOW HONG KONG LOST ITS SHIRTS

Hong Kong lost its comparative advantage in garments.

Why?

It got better at other things too, which meant it was now giving up MORE to produce garments.

Image: Jennifer Thermes/Getty Images

SUPPLY, DEMAND, AND INTERNATIONAL TRADE

We can use the demand and supply model to determine:

the effects of free trade on:

domestic equilibrium price and quantity.

imports.

the effects of trade barriers on:

domestic equilibrium price and quantity.

imports.

CONSUMER AND PRODUCER SURPLUS IN AUTARKY

Price of phones

Quantity of phones

Consumer surplus

Producer surplus

Domestic supply

Domestic demand

THE DOMESTIC MARKET WITH IMPORTS

Price of phones

Quantity of phones

Imports

Domestic quantity supplied with trade

Domestic quantity demanded with trade

Domestic supply

Domestic demand

Autarky price

World price

Suppose this country opens to trade and that the world price is equal to D. Then we know that they will:

import the number of bicycles between points R and S.

import the number of bicycles between points P and S.

export the number of bicycles between points P and R.

export the number of bicycles between points P and T.

LEARN BY DOING: PRACTICE QUESTION

THE EFFECTS OF IMPORTS ON SURPLUS

Price of phones

Quantity of phones

Domestic supply

Domestic demand

- X

X + Z

+ Z

Gain

Loss

Changes in surplus

Consumer surplus

Producer surplus

Change in total surplus

Imports

Allowing imports increases total surplus.

THE DOMESTIC MARKET WITH EXPORTS

Price of

phones

Quantity of

phones

Autarky price

World price

Exports

Domestic quantity demanded with trade

Domestic quantity supplied with trade

Domestic supply

Domestic demand

Suppose this country opens to trade and the world price is equal to B. Then we know that they will:

import the quantity of bicycles between points M and W.

import the quantity of bicycles between points W and T.

export the quantity of bicycles between points M and W.

export the quantity of bicycles between points W and T.

LEARN BY DOING: PRACTICE QUESTION

THE EFFECTS OF EXPORTS ON SURPLUS

Exports

Price of phones

Quantity of

phones

Domestic supply

Domestic demand

–

+ Z

Gain

Loss

Changes in surplus

Consumer surplus

Producer surplus

Change in total surplus

Allowing exports increases total surplus.

INTERNATIONAL TRADE AND WAGES

Broader effects of international trade: income distribution

Terms:

Exporting industries produce goods and services that are sold abroad.

Import-competing industries produce goods and services that are also imported.

INTERNATIONAL TRADE AND WAGES

Does the combination of:

growing imports of labor-intensive products from newly industrializing economies and

the export of high-technology goods

cause a widening wage gap between highly educated and less well educated U.S. workers?

Many economists think so.

THE EFFECTS OF TRADE PROTECTION

Policies that limit imports are known as trade protection or simply as protection.

A tariff is a tax levied on imports.

THE EFFECTS OF A TARIFF

A tariff has two effects:

↑ domestic production, ↓ domestic consumption.

The good is now produced by the higher-cost country.

Less is consumed → lower gains from trade.

Measuring the losses and wasted resources

Can we measure the value of wasted resources? Yes!

THE EFFECT OF A TARIFF

World price

Tariff

QST

Imports after tariff

Price with tariff

Imports before tariff

QDT

Price of

phones

Quantity of

phones

Domestic supply

Domestic demand

The tariff pushes up the price, which reduces quantity demanded and increases domestic quantity supplied.

A TARIFF REDUCES TOTAL SURPLUS

–(A + B + C + D)

Government revenue

–(

)

Gain

Loss

Changes in surplus

Consumer surplus

Producer surplus

Change in total surplus

QST

QDT

Price of phones

Quantity of phones

Domestic supply

Domestic demand

Tariff

Imports after tariff

Imports before tariff

The tariff reduces consumer surplus,

increases producer surplus,

and creates deadweight loss.

creates new government revenue,

If this country is an autarky, which is the area that corresponds to consumer surplus? Which area corresponds to producer surplus?

Consumer surplus = ACQ; producer surplus = CQIF.

Consumer surplus = ADS; producer surplus = DPE.

Consumer surplus = ACQ; producer surplus = CQE.

Consumer surplus = BMNC; producer surplus = CNOD.

LEARN BY DOING: PRACTICE QUESTION

THE EFFECTS OF AN IMPORT QUOTA

Import quota: legal limit on the quantity of a good that can be imported.

Effect?

Same as tariff, except instead of government revenue, “quota rents” will go to quota license holders (usually foreigners).

TRADE PROTECTION IN THE UNITED STATES

Until recently, clothing and textiles were strongly protected from import competition.

Now: the United States has very low tariffs, which increased the benefit of trade (or, as in the graph, reduced the lost “welfare”).

ARGUMENTS FOR TRADE PROTECTION

National Security

In times of national crisis or war the United States must be able to rely on key domestic industries:

Oil

Steel

Defense

Food

Protection is required even during peacetime to ensure their availability.

ARGUMENTS FOR TRADE PROTECTION

Trade and domestic employment

Globalization will force some firms to lay off workers.

Even so, increased trade usually increases jobs in other industries (exporters).

But: for workers who lose their jobs, switching industries can be difficult and time-consuming.

At TEDIndia, TED favorite Hans Rosling gives another lively and humorous talk here and graphs global economic growth since 1858. He also predicts the exact date that India and China will outstrip the United States. (15:50 minutes)

http://www.ted.com/talks/hans_rosling_asia_s_rise_how_and_when.html

ARGUMENTS FOR TRADE PROTECTION

The infant industry argument:

Infant industry: New industries need a temporary period of protection to develop.

Critique:

Hard for government to predict the best emerging technologies.

Difficult to become competitive when protected from competition.

Many times politics determine which industries are granted protection.

Which argument against trade is the strongest in your opinion?

Trade reduces the number of jobs in the United States and should therefore be limited.

It’s wrong to trade with countries that use child labor.

We need to keep some industries for reasons of national security.

We need to protect certain industries while they develop.

LEARN BY DOING: PRACTICE QUESTION

INTERNATIONAL TRADE AGREEMENTS AND THE WORLD TRADE ORGANIZATION

Countries care about each others’ trade policies…

International trade agreements: treaties in which a country promises to reduce import tariffs in return for a promise by the other country to do the same.

NAFTA (North American Free Trade Agreement): a trade agreement between the United States, Canada, and Mexico.

EU (European Union): a customs union among 27 European nations.

Global trade agreements

WTO (World Trade Organization): oversees international trade agreements and rules on disputes between countries over those agreements.

NEW CHALLENGES TO GLOBALIZATION

Globalization and inequality: Outsourcing

Offshore outsourcing: hiring people in another country to perform various tasks.

Sweatshop labor fallacy: It’s easy to get outraged about the low wages paid to the person who made your shirt, harder to appreciate how much worse off that person would be if denied the opportunity to sell goods in rich countries’ markets.

A tariff results in a higher:

I. consumer surplus.

II. producer surplus.

III. government revenue.

I and II only

II and III only

I and III only

I, II, and III

LEARN BY DOING: PRACTICE QUESTION