Trade Policy

1. Trade Policy • This chapter covers Trade Policy -- measures to alter International Trade, or purchases of goods and services between people of different nations. • To some extent, trade policy is used to stabilize the economy (changes in net exports shift the AD curve).

2. Why Do Countries Trade? • More conceptual issue -- using trade to make world resources be allocated more efficiently. • People of different countries trade because they both stand to benefit from the deal.

3. Absolute Advantage • Absolute Advantage -- each country has an advantage in producing one good. Therefore, they produce a surplus of the advantaged good, and trade for the “other good”. • Intuitive but overly restrictive.

4. The Theorem of Comparative Advantage • Theorem of Comparative Advantage -- Consider the different economies of two nations. Then there exists an efficient trade agreement that will benefit both nations. This holds even if one nation has an absolute advantage in all goods.

5. The Production Possibility Curve • The Production Possibility Curve -- a graph of possible outputs of two different goods for a country given fixed inputs which are used efficiently. • Common example -- military goods (“guns”) versus non-military goods (“butter”).

6. The Production Possibility Curve, Economic Situations • Points on the curve -- efficient use of resources. Different points reflect emphases toward military or non-military goods. • Points inside the curve -- inefficient use of resources. • Points outside the curve -- unattainable production points given current resources.

7. Ways to Attain “Unattainable Points” • Shift production possibility curve outward -- more resources, higher labor productivity. • Trade with other countries -- increases consumption possibilities without changing production possibilities. • Comparative Advantage at work.

8. Comparative Advantage -- Promote Free Trade • Implication of Theorem of Comparative Advantage -- promote free trade, international trade with as few barriers to trade as possible. • “Free market” will find efficient trade agreement which will benefit both countries.

9. Barriers to Trade -- Quotas • Quota -- limiting the total quantity of a good that can be imported over a period of time. • Portrayed as vertical line within supply curve for the imported good. • Increases equilibrium price level (P*), decreases equilibrium quantity (Q*).

10. Properties of Quotas • Limits imports to predetermined quantity. • Policymakers can control exactly how much is imported. • Still, it limits free trade -- potential benefits to both countries (Comparative Advantage).

11. Barriers to Trade -- Tariffs • Tariff (or Duty) -- tax imposed by the government on an imported good. • Shifts the supply curve for the imported good leftward, increasing equilibrium price (P*) and decreasing equilibrium quantity (Q*).

12. Properties of Tariffs • Reduces quantity imported. • Degree of reduction depends upon steepness of demand curve. • Source of tax revenue. • Still, it limits free trade -- potential benefits to both countries (Comparative Advantage). • Also can lead to retaliation.

13. Dumping and Counterveiling Duties • Dumping -- when a country sells a good abroad at an artificially low price, subsidized by the government. • Counterveiling Duty -- a tariff imposed to offset the artificially low price.

14. The Worldwide Trend Toward Free Trade • General Agreement on Tariffs and Trade (GATT) -- negotiations on trade agreements between nations, toward dropping barriers to trade. • World Trade Organization (WTO) -- evolution of GATT, on a much broader worldwide scale.

15. Free Trade Agreements • North American Free Trade Agreement (NAFTA) -- US, Canada, Mexico • European Union -- economic bonding of major European nations, including a common currency (the Euro). • Free Trade Agreement of the Americas -- extending NAFTA to include Latin American countries.

16. Issues -- Should the World Work Toward Free Trade? • Having a level playing field. • Benefiting the majority versus significantly hurting a minority • Painful transitions versus long-run benefits • Will improving economies fix social problems in developing nations?