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Chapter 31

Chapter 31. International Trade. Economic Principles. Absolute advantage Comparative advantage Free trade Tariffs. Economic Principles. Quotas Customs unions Free trade areas. EXHIBIT 1 ILLINOIS PRODUCTION POSSIBILITIES CURVE. Exhibit 1: Illinois Production Possibilities Curve.

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Chapter 31

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  1. Chapter 31 International Trade Gottheil — Principles of Economics, 7e

  2. Economic Principles • Absolute advantage • Comparative advantage • Free trade • Tariffs Gottheil — Principles of Economics, 7e

  3. Economic Principles • Quotas • Customs unions • Free trade areas Gottheil — Principles of Economics, 7e

  4. EXHIBIT 1 ILLINOIS PRODUCTION POSSIBILITIES CURVE Gottheil — Principles of Economics, 7e

  5. Exhibit 1: Illinois Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Illinois? • The opportunity cost of producing an additional barrel of oil is one bushel of corn. Gottheil — Principles of Economics, 7e

  6. Exhibit 1: Illinois Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Illinois? • The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 1. Gottheil — Principles of Economics, 7e

  7. Exhibit 1: Illinois Production Possibilities Curve 2. What is the opportunity cost of producing an additional bushel of corn in Illinois? • The opportunity cost of producing an additional bushel of corn is one barrel of oil. Gottheil — Principles of Economics, 7e

  8. Intrastate Trade 1. If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Illinois? • We know that one barrel of oil must be given up to get one bushel of corn in Illinois. As a result one bushel of corn will trade for one barrel of oil in Illinois. Gottheil — Principles of Economics, 7e

  9. EXHIBIT 2 OKLAHOMA PRODUCTION POSSIBILITIES CURVE Gottheil — Principles of Economics, 7e

  10. Exhibit 2: Oklahoma Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Oklahoma? • The opportunity cost of producing an additional barrel of oil is 0.0833 bushels of corn. Gottheil — Principles of Economics, 7e

  11. Exhibit 2: Oklahoma Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Oklahoma? • The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 2. Gottheil — Principles of Economics, 7e

  12. Exhibit 2: Oklahoma Production Possibilities Curve 2. What is the opportunity cost of producing an additional bushel of corn in Oklahoma? • The opportunity cost of producing an additional bushel of corn is 12 barrels of oil. Gottheil — Principles of Economics, 7e

  13. Intrastate Trade 2. If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Oklahoma? • We know that 12 barrels of oil must be given up to get one bushel of corn in Oklahoma. As a result one bushel of corn will trade for 12 barrels of oil in Oklahoma. Gottheil — Principles of Economics, 7e

  14. Interstate Trade 3. If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil? • Since oil producers must give 12 barrels of oil for a bushel of corn in Oklahoma, but need only give one barrel of oil for a bushel of corn in Illinois, Oklahoma oil producers would seek out buyers in Illinois. Gottheil — Principles of Economics, 7e

  15. Interstate Trade 3. If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil? • Likewise, since a bushel of corn trades for one barrel of oil in Illinois, but trades for 12 barrels of oil in Oklahoma, Illinois corn farmers would seek out buyers in Oklahoma. Gottheil — Principles of Economics, 7e

  16. Interstate Trade Free trade • International trade that is not encumbered by protectionist government policies such as tariffs and quotas. Gottheil — Principles of Economics, 7e

  17. EXHIBIT 3 PRODUCTION OF CORN AND OIL IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (bushels and barrels) Gottheil — Principles of Economics, 7e

  18. Exhibit 3: Production of Corn and Oil in Illinois and Oklahoma, before and after Free Trade What are the total gains from free trade between Oklahoma and Illinois? • By having Illinois specialize in producing corn, and Oklahoma specialize in producing oil, an additional 75 bushels of corn and an extra 200 barrels of oil are produced. Gottheil — Principles of Economics, 7e

  19. EXHIBIT 4 CORN AND OIL CONSUMPTION IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (bushels and barrels) Gottheil — Principles of Economics, 7e

  20. Exhibit 4: Corn and Oil Consumption in Illinois and Oklahoma, before and after Free Trade What relative price leads to Oklahoma and Illinois consuming the same quantity of oil after trade? • A relative price of three barrels of oil for one bushel of corn will result in both states consuming 300 barrels of oil. Gottheil — Principles of Economics, 7e

  21. Interstate Trade 4. If Illinois and Oklahoma engage in free trade, and if there are aggregate gains from trade, then is it true that nobody loses? • No. Oil producers in Illinois are priced out by cheap imports of Oklahoma oil. Likewise corn growers in Oklahoma are priced out by cheap imports of Illinois corn. Gottheil — Principles of Economics, 7e

  22. International Trade International specialization • The use of a country’s resources to produce specific goods and services, allowing other countries to focus on the production of other goods and services. Gottheil — Principles of Economics, 7e

  23. EXHIBIT 5 PRODUCTION OF CORN AND OIL IN THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (bushels and barrels) Gottheil — Principles of Economics, 7e

  24. Exhibit 5: Production of Corn and Oil in the United States and Mexico, before and after Free Trade What does Mexico specialize in producing in Exhibit 5? • Mexico specializes in producing oil. Gottheil — Principles of Economics, 7e

  25. EXHIBIT 6 CORN AND OIL CONSUMPTION THE THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (bushels and barrels) Gottheil — Principles of Economics, 7e

  26. Exhibit 6: Corn and Oil Consumption in the United States and Mexico, before and after Free Trade What relative price leads to Mexico and the United States consuming the same quantity of corn after trade in Exhibit 6? • Four barrels of oil for one bushel of corn. Gottheil — Principles of Economics, 7e

  27. Absolute and Comparative Advantage Absolute advantage • A country’s ability to produce a good using fewer resources than the country it trades with. Gottheil — Principles of Economics, 7e

  28. Absolute and Comparative Advantage Comparative advantage • A country’s ability to produce a good at a lower opportunity cost than the country with which it trades. Gottheil — Principles of Economics, 7e

  29. Absolute and Comparative Advantage 1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? • The opportunity cost of producing one bushel of corn in the United States is three barrels of oil. Gottheil — Principles of Economics, 7e

  30. Absolute and Comparative Advantage 1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? • The opportunity cost of producing one bushel of corn in Mexico is 12 barrels of oil. Gottheil — Principles of Economics, 7e

  31. Absolute and Comparative Advantage 1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? • The U.S. has a comparative advantage in growing corn because it can do so at a lower opportunity cost than Mexico. Gottheil — Principles of Economics, 7e

  32. Absolute and Comparative Advantage 2. In the example of corn and oil trade between the United States and Mexico, what was Mexico’s comparative advantage? • Using the same process as that used for the U.S., we find that Mexico has a lower opportunity cost for producing oil. Gottheil — Principles of Economics, 7e

  33. Absolute and Comparative Advantage 3. What determines how much each country gains from free trade? • The relative price of the goods being traded. Gottheil — Principles of Economics, 7e

  34. EXHIBIT 7 CORN AND OIL CONSUMPTION IN THE UNITED STATES AND MEXICO, UNDER CONDITIONS OF NO TRADE AND FREE TRADE Gottheil — Principles of Economics, 7e

  35. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade 1. If a bushel of corn trades for four barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.? • Mexico must trade 800 barrels of oil with the United States in order to get 200 bushels of corn. Gottheil — Principles of Economics, 7e

  36. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade 2. If a bushel of corn now trades for five barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.? • Mexico must trade 1000 barrels of oil with the United States in order to get 200 bushels of corn. Gottheil — Principles of Economics, 7e

  37. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade 3. When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off? • Mexico is worse off because it must trade an extra 200 barrels of oil just to keep getting 200 bushels of corn from the United States. Gottheil — Principles of Economics, 7e

  38. Exhibit 7: Corn and Oil Consumption in the United States and Mexico, under Conditions of No Trade and Free Trade 3. When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off? • The United States is better off because it gets an extra 200 barrels of oil for the same 200 bushels of corn it exports to Mexico. Gottheil — Principles of Economics, 7e

  39. Absolute and Comparative Advantage During the colonial period, European colonial powers used their political power to manipulate trade prices so that most all of the gains from trade were shifted to them. Gottheil — Principles of Economics, 7e

  40. Calculating Terms of Trade Imports • Good and services bought by people in one country that are produced in other countries. Gottheil — Principles of Economics, 7e

  41. Calculating Terms of Trade Exports • Good and services produced by people in one country that are sold in other countries. Gottheil — Principles of Economics, 7e

  42. Calculating Terms of Trade Terms of trade • The amount of a good or service (export) that must be given up to buy a unit of another good or service (import). A country’s terms of trade is measured by the ratio of the country’s export prices to its import prices. Gottheil — Principles of Economics, 7e

  43. EXHIBIT 8 JAPANESE MOTORCYCLE AND BOLIVIAN TIN EXPORTS Gottheil — Principles of Economics, 7e

  44. Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8? • The price of Japanese motorcycles rises in panel a, while the price of Bolivian tin falls in panel b. Gottheil — Principles of Economics, 7e

  45. Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8? • As a result, Bolivia’s terms of trade equation goes from (6,000/6000) × 100 = 100 in 1987, to (5,000/7,500) × 100 = 66.7 in 1995 Gottheil — Principles of Economics, 7e

  46. Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8? • Bolivia’s terms of trade have deteriorated. Bolivia’s exports end up with only 67 percent of their former purchasing power. Gottheil — Principles of Economics, 7e

  47. EXHIBIT 9 LDC TERMS OF TRADE FOR 2002 (1980 = 100) Source:Human Development Report, Oxford University Press, 2005. Gottheil — Principles of Economics, 7e

  48. Exhibit 9: LDC Terms of Trade for 2002 Which of the countries shown in Exhibit 9 has experienced the smallest deterioration in its terms of trade between 1980 and 2002? • Pakistan’s terms of trade declined the least during this time period. Gottheil — Principles of Economics, 7e

  49. EXHIBIT 10 INDUSTRIAL ECONOMIES’ TERMS OF TRADE FOR 2002 (1980 = 100) Source:Human Development Report, Oxford University Press, 2005. Gottheil — Principles of Economics, 7e

  50. Exhibit 10: Industrial Economies’ Terms of Trade for 2002 Which of the countries shown in Exhibit 10 has experienced the largest increase in its terms of trade between 1980 and 2002? • Japan’s terms of trade increased the most during this time period. Gottheil — Principles of Economics, 7e

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