Principles & Policies I: Macroeconomics

1. Principles & Policies I: Macroeconomics Chapter 17: International Trade Policy Macroeconomics, Maclachlan Fall 2004

2. Chapter 17: International Trade Policy Macroeconomics, Maclachlan Fall 2004

3. Chapter 17 Learning Objectives. You should be able to: • Explain the principle of comparative advantage. • List three determinants of the terms of trade. • Explain three policies countries use to restrict trade. • Discuss why countries impose trade restrictions. • Summarize why economists generally oppose trade restrictions. • Explain how free trade associations both help and hinder international trade. Macroeconomics, Maclachlan Fall 2004

4. U.S. Exports by Region, 2001 OPEC 3% Central and South America 8% European Union 22% Other 4% Mexico 14% Pacific Rim 24% Canada 22% Other Europe 3% Macroeconomics, Maclachlan Fall 2004

5. U.S. Imports by Region, 2001 OPEC 5% Central and South America 6% European Union 19% Other 2% Mexico 12% Pacific Rim 32% Canada 19% Other Europe 5% Macroeconomics, Maclachlan Fall 2004

6. Adam Smith (1723-1790) Critic of mercantilism. Countries should specialize and trade. Specialize where there’s an ABSOLUTE ADVANTAGE Macroeconomics, Maclachlan Fall 2004

7. ABSOLUTE ADVANTAGE A region has an absolute advantage if it takes fewer resources to produce a good there than elsewhere. Coffee in Columbia. Computer software in Silicon Valley. Macroeconomics, Maclachlan Fall 2004

8. David Ricardo (1772-1823) Theory of comparative advantage. Even without an absolute advantage a region can trade to the benefit of all parties. Macroeconomics, Maclachlan Fall 2004

9. The Benefits of Trade • The argument for the benefits of trade underlies the general policy of laissez-faire. • Laissez-faire – an economic policy of leaving coordination of individuals’ actions to the market. Macroeconomics, Maclachlan Fall 2004

10. Production Possibilities without Trade • Pakistan can produce 4,000 yards of textile per day or 1 ton of chocolate per day. • Belgium can produce 1,000 yards of textile a day or 4 tons of chocolate per day. Macroeconomics, Maclachlan Fall 2004

11. Production Possibilities without Trade • Pakistan has a comparative advantage in producing textiles. • Belgium has a comparative advantage in chocolate. Macroeconomics, Maclachlan Fall 2004

12. 5 4 Textiles (in thousands of yards) 3 2 1 1 2 3 4 5 Chocolate (in tons) Production Possibilities without Trade Pakistan Belgium McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

13. Production Possibilities without Trade • Pakistan has chosen to produce 2,000 yards of textiles and 0.5 tons of chocolate. • Belgium has chosen to produce 500 yards of textile and 2 tons of chocolate. Macroeconomics, Maclachlan Fall 2004

14. Production Possibilities without Trade • Point A: The combination of textile and chocolate chosen by Pakistan. • Point B: The combination of textile and chocolate chosen by Belgium. • Point C: The joint combination without trade. Macroeconomics, Maclachlan Fall 2004

15. Production Possibilities without Trade Macroeconomics, Maclachlan Fall 2004

16. A C B Production Possibilities without Trade 5 4 Pakistan Textiles (in thousands of yards) 3 2 Belgium 1 1 2 3 4 5 Chocolate (in tons) McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

17. Production Possibilities without Trade • The two extreme combinations are both countries producing only textile (point D) and both producing only chocolate (point E). • The combined production possibilities curve with no trade is drawn by connecting these two points. Macroeconomics, Maclachlan Fall 2004

18. Production Possibilities with Trade This is where each nation is focusing on that activity for which it has a comparative advantage. • Pakistan produces 4,000 yards of textile. • Belgium produces 4 tons of chocolate. Macroeconomics, Maclachlan Fall 2004

19. Production Possibilities with Trade Macroeconomics, Maclachlan Fall 2004

20. The Gains From Trade Macroeconomics, Maclachlan Fall 2004

21. The Gains From Trade Macroeconomics, Maclachlan Fall 2004

22. The Gains From Trade Macroeconomics, Maclachlan Fall 2004

23. The Gains From Trade Macroeconomics, Maclachlan Fall 2004

24. Terms of trade: who gets the gains from trade? Three determinants: • The greater the competition, the less of the gain goes to traders, more goes to citizens. • Smaller countries will get a larger proportional gain. • Countries with economies of scale (increasing returns to scale) get a larger gain. Macroeconomics, Maclachlan Fall 2004

25. Policies used to restrict trade: • Tariffs • Quotas • Regulatory trade restrictions (e.g. building codes, environmental laws) Macroeconomics, Maclachlan Fall 2004

26. Why impose trade restrictions? • Protect domestic jobs. • Infant industry argument. • National security. • Unfair competition (dumping, lax environmental and labor laws abroad). Macroeconomics, Maclachlan Fall 2004

27. Why do economists oppose trade restrictions? • There are gains from trade. • More competition improves efficiency. Macroeconomics, Maclachlan Fall 2004

28. Smoot-Hawley Tariff (1930)—average tariff of 60%, beggar-thy-neighbor. General Agreement on Tariffs and Trade (1947-1995), replaced by World Trade Organization. Macroeconomics, Maclachlan Fall 2004

29. The World Trade Organization (WTO) is committed to getting nations to agree not to impose new tariffs or other trade restrictions except under certain limited conditions. Macroeconomics, Maclachlan Fall 2004

30. Free Trade Associations • European Union • NAFTA Macroeconomics, Maclachlan Fall 2004