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CHAPTER 17

CHAPTER 17. INTERNATIONAL TRADE AND PUBLIC POLICY. THE UNITED STATES RESTRICTS IMPORTS OF MANY GOODS. These restrictions protect jobs in domestic industries These restrictions increase consumer prices These restrictions lead to retaliatory trade restrictions that harm exporters.

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CHAPTER 17

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  1. CHAPTER 17 INTERNATIONAL TRADE AND PUBLIC POLICY

  2. THE UNITED STATES RESTRICTS IMPORTS OF MANY GOODS • These restrictions protect jobs in domestic industries • These restrictions increase consumer prices • These restrictions lead to retaliatory trade restrictions that harm exporters

  3. PRINCIPLE OF OPPORTUNITY COST The opportunity cost of something is what you sacrifice to get it. Output and Opportunity Cost Shirtland Chipland Shirts produced per day 108 120 Chips produced per day 36 120 Opportunity cost of shirts 1/3 chip 1 chip Opportunity cost of chips 3 shirts 1 shirt

  4. PRODUCTION POSSIBILITY CURVE • Shows all the feasible combinations of two goods, assuming that the nation’s resources are fully employed • The curve provides a sort of menu of production options

  5. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland Shirtland The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. Shirts Per Day Chips Computer Chips per day

  6. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland Shirtland 108 r The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. Shirts Per Day Chips Computer Chips per day

  7. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland Shirtland 108 r The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. For Shirtland, the tradeoff is 3 shirts for every computer chip. Shirts Per Day t Chips 36 Computer Chips per day

  8. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland Shirtland 108 r The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. For Shirtland, the tradeoff is 3 shirts for every computer chip. Shirts Per Day h 54 t Chips 18 36 Computer Chips per day

  9. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland Shirtland 108 r The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. For Shirtland, the tradeoff is 3 shirts for every computer chip. In the absence trade, Shirtland picks point s (28 chips and 24 shirts). Shirts Per Day h 54 s 24 t Chips 18 28 36 Computer Chips per day

  10. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland b 120 Shirtland 108 r The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. For Shirtland, the tradeoff is 3 shirts for every computer chip. For Chipland, there is a one-for-one tradeoff between the two goods. In the absence trade, Shirtland picks point s (28 chips and 24 shirts). Shirts Per Day h 54 s 24 t d Chips 18 28 36 120 Computer Chips per day

  11. Shirtland’s and Chipland’s Production Possibility Curves Shirts Chipland b 120 Shirtland 108 r The production possibilities curve shows the combinations of two goods that can be produced with a nation’s resources. For Shirtland, the tradeoff is 3 shirts for every computer chip. For Chipland, there is a one-for-one tradeoff between the two goods. In the absence trade, Shirtland picks point s (28 chips and 24 shirts) and Chipland picks point c (60 chips and 60 shirts). Shirts Per Day c 60 h 54 s 24 t d Chips 60 18 28 36 120 Computer Chips per day

  12. AUTARKY Each nation could decide to be self-sufficient in shirts and chips

  13. COMPARATIVE ADVANTAGE AND TERMS OF TRADE • The nation with the lower opportunity cost in producing a good has a comparative advantage in producing that good • The rate at which two nations will exchange goods (i.e., shirts and chips) is the terms of trade

  14. CONSUMPTION POSSIBILITIES CURVE • The consumption possibilities curve shows the combinations of two goods that a nation can consume when it specializes in one good and trades with another nation • For two nations specializing in production and trading, each of their consumption possibilities curves lies above their corresponding production possibilities curve • By specializing and trading, each country increases the consumption of both goods

  15. CONSUMPTION POSSIBILITIES CURVES Shirts Per Day Shirts Per Day A B 120 r c 60 24 s d 60 120 28 Computer Chips per day Computer Chips per day The consumption possibilities curve shows the combinations of computer chips and shirts that can be consumed if each country specializes in a particular good and trades some of its output for the other good. The exchange rate is 2 shirts for every chip.

  16. CONSUMPTION POSSIBILITIES CURVES Shirts Per Day Shirts Per Day A B 120 r 108 x Consumption Possibilities for Chipland 80 c 60 24 s d 60 80 120 28 Computer Chips per day Computer Chips per day The consumption possibilities curve shows the combinations of computer chips and shirts that can be consumed if each country specializes in a particular good and trades some of its output for the other good. The exchange rate is 2 shirts for every chip. In panel A, Chipland produces 120 chips and trades 40 of these chips to Shirtland for 80 shirts.

  17. CONSUMPTION POSSIBILITIES CURVES Shirts Per Day Shirts Per Day A B 120 r 108 x Consumption Possibilities for Chipland 80 c Consumption Possibilities for Shirtland 60 28 y 24 s d 60 80 120 28 40 Computer Chips per day Computer Chips per day The consumption possibilities curve shows the combinations of computer chips and shirts that can be consumed if each country specializes in a particular good and trades some of its output for the other good. The exchange rate is 2 shirts for every chip. In panel A, Chipland produces 120 chips and trades 40 of these chips to Shirtland for 80 shirts. In panel B, Shirtland produces 108 shirts and trades 80 of these shirts to Chipland for 40 chips.

  18. PERCENTAGE CHANGE IN EMPLOYMENT IN U.S. MANUFACTURING RESULTING FROM FOREIGN TRADE, 1970 - 1980 20 20 18 16 13 15 Radio and Television Equipment Motor vehicles and equipment Leather Products 10 6 Footwear Apparel 5 Percentage Change in Employment 0 - 5 Service Industry Machines - 6 - 6 - 6 Construction and Mining Machinery Aircraft and Parts - 10 Other Computing, and Accounting Machines Engines and Turbines - 11 - 15 - 16 Source: R.Z. Lawrence, Can America Compete ? Washington, D.C.: The Brookings Institution, 1984, pages 58 - 59

  19. THE EMPLOYMENT EFFECTS OF FREE TRADE • Competition from imports decreased employment in footwear, motor vehicles, and several other industries • Growing exports created many jobs in construction and mining equipment, engines, office and computing machines, aircraft and other industries • An increase in trade changes the mix of employment, with some industries growing at the expense of others • On average, people in each country will benefit from free trade • Some people will be harmed by free trade

  20. FOUR COMMON IMPORT RESTRICTION POLICIES • Import Ban • Import Quota • Voluntary Export Restraints • Tariff

  21. THE EFFECTS OF AN IMPORT BAN ON SHIRTS Price per Shirt ( $ ) Total Supply with free trade x 12 Demand Shirts per day 80 In the free-trade equilibrium, demand intersects the total supply curve at point x, with a price of $12 and a quantity of 80 shirts.

  22. THE EFFECTS OF AN IMPORT BAN ON SHIRTS Price per Shirt ( $ ) Domestic Supply Total Supply with free trade m 17 x 12 Demand Shirts per day 80 In the free-trade equilibrium, demand intersects the total supply curve at point x, with a price of $12 and a quantity of 80 shirts. The price is below the minimum price of domestic suppliers ($17 ), so domestic firms do not participate in market.

  23. THE EFFECTS OF AN IMPORT BAN ON SHIRTS Price per Shirt ( $ ) Domestic Supply c 23 Total Supply with free trade m 17 x 12 Demand Shirts per day 60 80 In the free-trade equilibrium, demand intersects the total supply curve at point x, with a price of $12 and a quantity of 80 shirts. The price is below the minimum price of domestic suppliers ($17 ), so domestic firms do not participate in market. If shirt imports are banned, the equilibrium is at point c. The price increases to $23.

  24. IMPORT QUOTA • A limit on the amount of a good that can be imported • A sort of intermediate policy between free trade and an import ban: imports are decreased but not eliminated

  25. MARKET EFFECTS OF A QUOTA, A VER, OR A TARIFF Price per Shirt ( $ ) Domestic Supply Total Supply with an import quota or tariff Total Supply with free trade Demand Shirts per day An import quota shifts the supply curve to the left because foreigners supply a smaller quantity of shirts.

  26. MARKET EFFECTS OF A QUOTA, A VER, OR A TARIFF Price per Shirt ( $ ) Domestic Supply Total Supply with an import quota or tariff c 23 20 Total Supply with free trade q x 12 Demand Shirts per day 66 An import quota shifts the supply curve to the left because foreigners supply a smaller quantity of shirts. The market moves upward along the demand curve to point q, which is between x (free trade) and c (an import ban).

  27. MARKET EFFECTS OF A QUOTA, A VER, OR A TARIFF Price per Shirt ( $ ) Domestic Supply Total Supply with an import quota or tariff c 23 20 e Total Supply with free trade q x 12 Demand Shirts per day 22 66 An import quota shifts the supply curve to the left because foreigners supply a smaller quantity of shirts. The market moves upward along the demand curve to point q, which is between x (free trade) and c (an import ban). We can reach the same point, with a tariff (a tax on imports) that shifts the total supply curve to the same position.

  28. VOLUNTARY EXPORT RESTRICTION (VER) • An exporting country voluntarily decreases its exports in an attempt to avoid more restrictive trade policies • A VER has the same effect as an import quota, which is illegal under the rules of the World Trade Organization (WTO) • Although VERs are legal under WTO rules, they violate the spirit of international trade agreements • Like a quota, a VER increases the price of the restricted good, allowing domestic firms to participate in the market

  29. WORLD TRADE ORGANIZATION (WTO) An organization with over 100 member nations that oversees the General Agreement on Tariffs and Trade (GATT) and other international agreements.

  30. PRICE EFFECTS OF VERs FOR JAPANESE CARS 55 55 50 44 45 40 35 35 30 Percentage increase in price of Japanese cars 25 20 11 15 10 5 1 0 United Kingdom France Germany Italy Spain and Portugal Source: Alasdair Smith and Anthony J. Venables, “Cost of Voluntary Export Restraints in the European Car Market,” Chapter 10 in International Trade and Trade Policy, edited by Elhanan Helpman and Assaf Razin (Cambridge, MA : MIT Press, 1991)

  31. TARIFF • A tax on an imported good • Shifts the supply curve left • We reach the same point reached with a quota • Difference between quota and tariff: -- An import quota allows importers to buy shirts from foreign suppliers at a low price and sell them at the artificially high price -- Importers make money from the quota -- Under a tariff, the government makes money

  32. RESPONSES TO PROTECTIONIST POLICY A restriction on imports is likely to cause further restrictions on trade • Smoot-Hawley tariff of 1930 - When the U.S. increased average tariff to 59%, its trading partners retaliated with higher tariffs; decreased international trade and deepened depression • Chicken tariff of 1963 - The European Economic Community (EEC) imposed a large tariff on frozen chickens from the U.S., the U.S. retaliated by increasing tariffs on brandies, potato starch and light trucks • Pasta Tariff of 1985 -The U.S. imposed tariffs on pasta from the EEC; the EEC retaliated with increased tariffs on U.S. lemons and walnuts

  33. OTHER REACTIONS TO PROTECTIONIST POLICIES • The threat of retaliatory policies may persuade a nation to loosen its protective policies • Import restrictions also create an incentive to smuggle goods

  34. NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA) • Took effect January , 1994 • Will gradually phase out tariffs and other trade barriers between the United States, Canada, and Mexico • Economists predicted NAFTA would increase imports from Mexico and exports to Mexico • Two presidential candidates claimed NAFTA was responsible for turning a small trade surplus into a huge trade deficit

  35. TRADE DATA FOR THE UNITED STATES AND MEXICO Year U.S. Imports U.S. Exports Exchange U.S. Trade from Mexico to Mexico Rate (Pesos Surplus (+) ($ billion) ($ billion) per dollar) or Deficit (-) with Mexico ($ billion) 1993 40 42 3.12 +2 1994 49 51 3.11 +2 1995 62 46 5.33 -16 Source: U.S. Department of Commerce, Statistical Abstract of the United States, 1996, (Washington, D.C.: U.S. Government Printing Office, 1996)

  36. RATIONALES FOR PROTECTIONIST POLICIES • To shield workers from foreign competition • To nurture “infant” industries until they mature • To help domestic firms establish monopolies in world markets

  37. TO SHIELD WORKERS FROM FOREIGN COMPETITION • In some industries (i.e., textiles), domestic manufacturers could not compete if the U.S. reduced existing tariffs • Factories would close and workers would be laid off • Many workers don’t have the skills to work in other sectors, and obtaining the skills takes time • However, protectionist policies for one industry (textiles and apparel) cost $177,759, over eight times the average wage in the industry

  38. TO NURTURE INFANT INDUSTRIES • Infant industries are new industries in the early stages of learning by doing • In practice, infant industries rarely become competitive with their foreign rivals • Another problem with protecting an infant industry is that once the industry is given tariff protection, it is difficult to take it away

  39. TO HELP DOMESTIC FIRMS ESTABLISH MONOPOLIES IN WORLD MARKETS • If the production of a particular good has very large scale economies, the world market will support only a few firms • A nation might be tempted to adopt policies to capture the monopoly profits for itself

  40. DUMPING • A firm is dumping when the price it charges in a foreign market is lower than either the price it charges in its home market or its production cost • Dumping is illegal under international trade agreements Reasons for Dumping 1. Price discrimination If a firm has a monopoly in its home market but faces strong competition in a foreign market, it will charge a higher price in the home market 2. Predatory pricing (predatory dumping) The practice of cutting prices in an attempt to drive a rival out of business

  41. ENVIRONMENTAL PROTECTION AND TRADE Under current WTO rules, a country can adopt any environmental standard it chooses, as long as it does not discriminate against foreign producers.

  42. DOES TRADE CAUSE INCOME INEQUALITY ? • Trade theory suggests that there may be a link between increased trade and increased wage inequality • The U.S. is likely to have comparative advantage in products that use skilled labor, while developing countries are likely to have a comparative advantage in products that use unskilled labor • An increase in U.S. exports means that we’ll produce more goods that require skilled labor, so domestic demand for skilled labor will increase, pulling up the wage of skilled labor • An increase in U.S. imports means we’ll import more goods produced by unskilled labor

  43. RECENT TRADE AGREEMENTS 1. North American Free Trade Agreement (NAFTA) 2. World Trade Organization (WTO) 3. European Union (EU) 4. Asian Pacific Economic Cooperation (APEC)

  44. NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA) • Took effect in 1994 and will be implemented over a 15-year period • The agreement will eventually eliminate all tariffs and other trade barriers between Canada, Mexico, and the United States • NAFTA may soon be extended to other nations in the western hemisphere

  45. WORLD TRADE ORGANIZATION (WTO) • Organization has more than 120 member nations • Oversees the General Agreement of Tariffs and Trade (GATT) and other international trade agreements • There have been eight rounds of tariff negotiations, resulting in much lower tariffs among member nations • The last set of negotiations, the Uruguay round completed in 1994, decreased tariffs by about 1/3 • The WTO has eliminated many import quotas, reduced subsidies, and outlawed restrictions on international trade in banking, insurance, and accounting

  46. EUROPEAN UNION (EU) • A total of 15 nations have joined the European Union • Designed to remove all trade barriers within Europe and create a “single market” • The nations are trying to develop a single currency for all member nations

  47. ASIAN PACIFIC ECONOMIC COOPERATION (APEC) In 1994, the leaders of 18 Asian nations signed a nonbinding agreement to reduce trade barriers between their nations.

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