1. International trade Today: Winners and losers of various international trade policies

2. Previously, we talked about… • How trade can benefit people • Comparative advantage being the core of beneficial trade • An introduction of international trade

3. Today:More on international trade • Review of comparative advantage • Examining consumption possibilities • Without trade • With trade • Supply and demand analysis of trade • Tariffs and Quotas • “Outsourcing”

4. Review of comparative advantage • Recall the principle of comparative advantage • “Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.” (F/B p. 39) • Today, we will apply this concept on a countrywide scale

5. Comparative advantage: Same numbers, different names

6. Comparative advantage • Recall: To find comparative advantage for each person, find the lowest number in each column

7. Recall increasing opportunity cost • Opportunity cost increases as production increases within each country • Each country uses its best pizza maker to make its first pizzas • Then, the next best pizza maker is used, etc. • The same applies to salads

8. Production possibilities curve • Recall from last lecture that all of the points along PGQ are the efficient points of the production possibilities curve • Recall that this shape occurs due to increasing opportunity costs as more is produced

9. Production possibilities curve • Without trade, only points along arc PGQ (or points between this arc and the origin) can be consumed • We will see that gains can be made by trade

10. The world market • In the world market, there is an equilibrium price (based on world supply and world demand) • Any one country that enters or exits the market usually does not change the market price much • For ease of discussion, assume that entry or exit by any one country does not change the world price

11. Consumption possibilities curve • If we produce at point G, we can trade goods at the given market price • Production at G (with trade)  Consumption anywhere along FGH

12. Which consumption possibility curve is best? • We could produce at one of the red dots before we start trading • However, note that there are fewer consumption sets possible than producing at G

13. Optimal production in an open economy • Since the red line is suboptimal, we will not utilize it • Similarly, any point except G will produce a similar result to the red line • Suboptimal consumption possibilities for any production except G

14. Optimal production in an open economy • Solution • Produce such that the “line of trade possibilities” is tangent to the production possibilities curve • In this case, point G is tangent to line FGH

15. Supply and demand analysis of trade • As we just analyzed, we saw that total surplus goes up when world trade is possible • However, we will see that there are winners and losers to trade • Note that the winners’ gain is larger than the losers’ loss

16. Market for cars, w/o trade • Suppose that without trade, 40,000 cars are sold at a price of $14,000

17. Market for cars, w/o trade • Consumer surplus is blue shaded area • Producer surplus is red shaded area

18. Market for cars, with trade • Notice that the world price for cars is $10,000 • At this price, notice that 20,000 cars will be supplied and 60,000 cars will be demanded in this market

19. Market for cars, with trade • What will happen? • This is unlike the case of rent control, since the shortage is picked up by the world market • 20,000 domestic cars will be purchased • 40,000 foreign cars will be purchased Imports

20. Surplus with trade • Consumer surplus increases substantially • Producer surplus decreases, but does not change as much as consumer surplus does Imports

21. Without imports (left)With imports (right) Imports

22. Net gain Imports

23. A similar exercise can be done for a country that is a net exporter • When a country is a net exporter, the world price is above what it would be if trade was not possible • Consumer surplus decreases when trade occurs • Producer surplus increases when trade occurs • Overall, total surplus increases

24. Tariffs, quotas, and bailouts • Even when trade is not prohibited, countries use other devices to control the amount of a particular good imported • Tariff • Tax that must be paid for each unit of the good imported • Quota • A binding limit set on the amount of a good that can be imported • Bailouts: An example with U.S. automakers • Subsidized loans • See additional reading on class website

25. What happens when we impose a tariff? • In this case, the tariff imposed is $1000 per ton of sugar imported • We will see that some potential economic surplus is lost when the tariff is imposed

26. What happens when we impose a tariff? • Total surplus without tariffs • Shaded area

27. What happens when we impose a tariff? • With a tariff, the price paid by consumers is the world price plus the amount of the tariff • Think of a tariff just like a tax • This increases the quantity supplied domestically and decreases the amount imported

28. What happens when we impose a tariff? • Quantity supplied domestically increases • Imports decrease • Before, 100 tons minus 20 tons, or 80 tons • After, 80 tons minus 40 tons, or 40 tons

29. Total surplus and tariff money collected • Consumer surplus (CS) • Producer surplus (PS) • Tariff revenue generated • What is missing?

30. Total surplus and tariff money collected • CS • PS • Tariffs • What is missing? • Two triangles are lost with the imposition of tariffs

31. Total surplus and tariff money collected • The two triangles lost are potential surplus that could be gained • Notice that relative to open global trade, producer surplus is higher • Consumer surplus is lower with the tariff (relative to open global trade)

32. Voluntary export restraints (VERs) • 1970s • Many American consumers bought fuel-efficient Japanese cars • 1980s • VERs agreed to between US and Japan • U.S. auto makers benefited by decreased competition • Japanese auto makers benefited by being able to raise their prices • U.S. consumers lost by having to pay more for all cars purchased

33. VERs • VERs are a type of quota • What does economic theory tell us about quotas?

34. Quotas • Quotas are similar to tariffs, except: • Domestic supply plus quota determines supply available in a country’s market • Equilibrium in this example is price of 125, 80,000 TV’s

35. What else is different with quotas? • With quotas, no revenues are directly generated • Those with right to import and export gain economic rents

36. The U.S. automaker bailout • Bad decision making • CAFE standards • What did fuel economy standards lead to? • Minivans • SUVs • Bankruptcy for some U.S. automakers in the near future?

37. “Outsourcing” • “Outsourcing” has been a controversial term in the media in recent years • There are definitely short-run costs of outsourcing • Displaced workers • Buildings and machinery that gets unused

38. “Outsourcing” • Long-run benefits of outsourcing • Each country can specialize what it has comparative advantage in • Technological improvements lower the costs of trade • Lower costs to consumers

39. How to make sure your job does not get outsourced • Make sure it requires a lot of face-to-face contact • Construction work • Automobile repair • Health care • Make sure that you have skills that nobody else has

40. Final thoughts about “outsourcing” • Trade policy can be formed such that those that are displaced are not any worse off • Some of the gains from “making the pie bigger” can be transferred to those that get displaced • Justification for re-training programs for displaced workers • Overall, the standard of living of a country improves with trade • Example: Think how much bananas would cost if we could not import them

41. Summary • Trade improves overall surplus • Some people win, while others lose • Trade barriers, such as protectionism, quotas, and tariffs limit the gains from trade • Outsourcing has short-run costs but long-run benefits in a country’s economy

42. Upcoming attractions • For the next month, we will examine market failures and some economic fields • Market failures: Monopoly, oligopoly, monopolistic competition, externalities, cost of information, private provision of public goods • Fields • Some potential topics: Labor, Income distribution, Environment, Health/Safety, Public Good analysis

43. End of Unit 3 • Starting next week, Unit 4 • Monopoly, including profit maximization and inefficiencies • Game theoretical tools needed to analyze small groups of people or firms • Applications, including Prisoner’s Dilemma • Study of externalities