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International Trade

International Trade. Introduction. Understanding the Economic Issues of International Trade The benefits of trade The costs of trade The economic impact of trade restrictions. Comparative Advantage as a Basis for Trade.

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International Trade

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  1. International Trade

  2. Introduction • Understanding the Economic Issues of International Trade • The benefits of trade • The costs of trade • The economic impact of trade restrictions Chapter 9: International Trade

  3. Comparative Advantageas a Basis for Trade • The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries. Chapter 9: International Trade

  4. Production and Consumption Possibilities and the Benefits of Trade • Closed Economy • An economy that does not trade with the rest of the world • Open Economy • An economy that trades with other countries Chapter 9: International Trade

  5. A • Observations • The OC of producing an additional unit = the slope of the line that touches the point • OC will increase as output of on good increases C 100,000 D 40,000 B 1,000 2,000 Production Possibilities Curve for a Many-Worker Economy Coffee (pounds/year) Computers (number/year) Chapter 9: International Trade

  6. Production and Consumption Possibilities and the Benefits of Trade • A country’s PPC shows the quantities of different goods that its economy can produce. • Consumption Possibilities • The combinations of goods and services that a country’s citizens might feasibly consume Chapter 9: International Trade

  7. Production and Consumption Possibilities and the Benefits of Trade • In a closed economy: • Society’s production possibilities = consumption possibilities. • If a country is self-sufficient, it is called autarky. Chapter 9: International Trade

  8. Production and Consumption Possibilities and the Benefits of Trade • In an open economy: • The society’s consumption possibilities are typically greater than its production possibilities. Chapter 9: International Trade

  9. 150,000 • Assume: • Producing at D • Closed economy • World price of coffee = $10/lb and computer = $500 A 120,000 C 100,000 Coffee (pounds/year) D 50,000 B 1,000 2,000 2,400 3,000 Computers/year Buying and Selling in World Markets Chapter 9: International Trade

  10. E 150,000 • Observation: • Sell 2,000 computers @ $500 • Take the $1million and buy 100,000 pounds of coffee • Consumption possibilities of 150,000 is greater than PPC without trade A 120,000 C 100,000 Coffee (pounds/year) D 50,000 F B 1,000 2,000 2,400 3,000 Computers/year Buying and Selling in World Markets Consumption possibilities Production possibilities Chapter 9: International Trade

  11. E 150,000 • Observation: • Start at D • Sell 50,000 lbs of coffee • Buy 1,000 computers with the $500,000 • Pt F is possible with trade but not on the PPC A 120,000 C 100,000 Coffee (pounds/year) D 50,000 F B 1,000 2,000 2,400 3,000 Computers/year Buying and Selling in World Markets Consumption possibilities Production possibilities Chapter 9: International Trade

  12. Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy L 160,000 Consumption possibilities 150,000 E • 50 lbs of coffee trades for 1 computer • LM = consumption possibilities • G is the optimal combination for Costa Rica • Costa Rica can use trade to locate anywhere along LM A 120,000 100,000 C G Coffee (pounds/year) 50,000 D Production possibilities B M F 1,000 2,000 2,400 3,000 3,200 Computers/year Chapter 9: International Trade

  13. Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy L 160,000 Consumption possibilities 150,000 E • Why produce at G? • Slope of the PPC = LM • Domestic and international opportunity costs of acquiring an extra computer (in terms of forgone coffee) are equal A 120,000 100,000 C G Coffee (pounds/year) 50,000 D Production possibilities B M F 1,000 2,000 2,400 3,000 3,200 Computers/year Chapter 9: International Trade

  14. A Straight-Line Production Possibilities Curve A • Observation • The tradeoff between coffee and tea is constant at any point on the PPC 800 B 600 Coffee (pounds/year) C 200 D 200 600 800 Tea (pounds/year Chapter 9: International Trade

  15. Consumption possibilities curve when the world price of coffee is twice the world price of tea A 800 • Islandia produces at A • Islandia can use the money earned from selling 800 lbs of coffee to choose any combination on AD’ 600 B Coffee (pounds/year) C 200 D D’ 200 600 800 1,600 Tea (pounds/year Two Consumption Possibilities Curves Chapter 9: International Trade

  16. A’ 1,600 Consumption possibilities curve when the world price of tea is twice the world price of coffee A 800 Coffee (pounds/year) • Islandia produces at D • Islandia can choose any combination on A’D B 600 200 C D 200 600 800 Tea (pounds/year Two Consumption Possibilities Curves Chapter 9: International Trade

  17. Consumption Possibilities Withand Without International Trade • What Do You Think? • Where should Islandia produce if the price of coffee and tea were the same? Chapter 9: International Trade

  18. Consumption Possibilities Withand Without International Trade • Observations • With a bow-shaped PPC consumption possibilities is typically maximized by producing where the PPC is tangent to the consumption possibilities line. • With a straight-line PPC production is completely specialized. Chapter 9: International Trade

  19. Production and Consumption Possibilities and the Benefits of Trade • Economic Naturalist • Does “cheap” foreign labor pose a danger to high-wage economies? Chapter 9: International Trade

  20. Production and Consumption Possibilities and the Benefits of Trade • Economic Naturalist • Scenario • U.S. and Fredonia produce software and beef. • Real wages in Fredonia are lower than in the U.S. • Fredonia is half as productive as the U.S. in beef production. • Fredonia is one-tenth as productive in software production. Chapter 9: International Trade

  21. Production and Consumption Possibilities and the Benefits of Trade • Economic Naturalist • Outcome • Fredonia has a comparative advantage in beef. • U.S. has a comparative advantage in software. • The U.S. will trade software for beef and increase its consumption of both. • Employment in the software industry in the U.S. increases and employment in the beef industry will decrease. Chapter 9: International Trade

  22. Consumer surplus without trade = $1mil/yr Consumer surplus with trade = $1.96mil/yr Domestic supply Domestic supply 2,400 2,400 Producer surplus with trade = $360K/yr E E 1,400 1,400 F Producer surplus without trade = $1mil/yr World price 1,000 Computer Imports 400 400 Domestic demand Domestic demand 2,000 4,800 1,200 2,000 2,800 4,800 The Market forComputers in Costa Rica Computer per year Without Trade Computer per year With Trade Chapter 9: International Trade

  23. A Supply and Demand Perspective on Trade • If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service. Chapter 9: International Trade

  24. Consumer surplus without trade = $250K/yr Consumer surplus with trade = $40K/yr Domestic supply Domestic supply 12 12 10 World price F E E 7 7 Producer surplus with trade = $600K/yr Producer surplus without trade = $150K/yr 4 4 Coffee exports Domestic demand Domestic demand 100,000 240,000 40,000 100,000 200,000 240,000 The Market forCoffee in Costa Rica Coffee (pounds/year) Without Trade Coffee (pounds/year) With Trade Chapter 9: International Trade

  25. A Supply and Demand Perspective on Trade • If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service. Chapter 9: International Trade

  26. A Supply and Demand Perspective on Trade • Observations of the Mutually Beneficial Gains from Trade • Countries will profit by exporting the goods and services for which they have a comparative advantage. • The revenue from the exports are used to import goods and services for which they do not have a comparative advantage. Chapter 9: International Trade

  27. A Supply and Demand Perspective on Trade • Observations of the Mutually Beneficial Gains from Trade • The markets will ensure that goods will be produced where opportunity cost is lowest. • The consumption possibilities will be maximized. Chapter 9: International Trade

  28. Domestic supply 2,400 • Question • Given the graph shown, what impact would trade have on producer and consumer surplus? 2,100 Price of computers ($/computer) World price 1,200 600 Domestic demand 200 500 800 1,200 Computers per year Exercise 9.4 Chapter 9: International Trade

  29. A Supply and Demand Perspective on Trade • Winners and Losers from Trade • Winners • Consumers of imported goods • Producers of exported goods • Losers • Consumers of exported goods • Producers of imported goods Chapter 9: International Trade

  30. A Supply and Demand Perspective on Trade • Protectionism • The view that free trade is injurious and should be restricted • Tariff • A tax imposed on an imported good • Quota • A legal limit on the quantity of a good that may be imported Chapter 9: International Trade

  31. Domestic supply 2,400 E World price + tariff 1,200 World price 1,000 Imports without tariff 400 Domestic demand 1,200 1,600 2,400 2,800 4,800 The Market for Computers after the Imposition of an Import Tariff Price of computers ($/computer) Computers per year Chapter 9: International Trade

  32. The Market for Computers after the Imposition of an Import Tariff Consumer surplus with tariff = 1.44K/yr Domestic supply 2,400 Tariff revenue = $160K/yr E Price of computers ($/computer) World price + tariff 1,200 World price 1,000 Imports with tariff 400 Domestic demand Producer surplus with tariff = 640K/yr 1,200 1,600 2,400 2,800 4,800 Computers per year Chapter 9: International Trade

  33. Exercise 9.5 Domestic supply 3,600 • Question • Given the graph shown, how will a tariff of $300 per computer affect total economic surplus? 2,100 Price of computers ($/computer) 1,500 World price 1,200 600 Domestic demand 200 300 500 700 800 1,200 Computers per year Chapter 9: International Trade

  34. Protectionist Policies: Tariffs and Quotas • What do you think? • Why did President George W. Bush support the imposition of tariffs on steel imported into the United States? Chapter 9: International Trade

  35. Protectionist Policies: Tariffs and Quotas • Quotas • Legal limit on the number or value of foreign goods that can be imported • Can be enforced by issuing permits Chapter 9: International Trade

  36. Domestic supply 2,400 Domestic supply + quota E 1,400 Imports with free trade = 1,600 computers/yr F 1,200 World price 1,000 400 Domestic demand 1,200 1,600 2,400 2,800 4,800 2,000 The Market for Computers after the Imposition of an Import Quota Price of computers ($/computer) Computers per year Chapter 9: International Trade

  37. Domestic supply + quota F 1,200 1,600 2,400 The Market for Computers after the Imposition of an Import Quota Domestic supply Consumer surplus with quota = $1,440K/yr 2,400 E Economic rent to holders of import licenses = $80K/year 1,400 Price of computers ($/computer) World price 1,000 Imports = 800 computers/year 400 Domestic demand Producer surplus with quota = $640K/yr 1,200 2,800 4,800 2,000 Computers per year Chapter 9: International Trade

  38. A Supply and Demand Perspective on Trade • Quotas & Tariffs • Market effects of tariffs are the same. • Tariffs generate tax revenue. • Quotas generate revenue for the firms that hold an import license. Chapter 9: International Trade

  39. A Supply and Demand Perspective on Trade • Question • Why would the government ever impose a quota rather than a tariff? Chapter 9: International Trade

  40. A Supply and Demand Perspective on Trade • Economic Naturalist • Who benefited from and who was hurt by voluntary export restraints on Japanese automobiles in the 1980s? Chapter 9: International Trade

  41. A Supply and Demand Perspective on Trade • Other Barriers to Trade • Red-tape barriers • Regulations Chapter 9: International Trade

  42. A Supply and Demand Perspective on Trade • The Inefficiency of Protectionism • Trade barriers are inefficient and reduce the size of the economic pie. • Because trade barriers benefit certain groups, and these groups may be well organized, they may be successful in lobbying for trade barriers. • The gains from trade could be used to assist groups that have been hurt by trade. Chapter 9: International Trade

  43. Outsourcing • Outsourcing • A term increasingly used to connote having services performed by low-wage workers overseas Chapter 9: International Trade

  44. Outsourcing • Outsourcing • Outsourcing of services to low-wage foreign workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers. Chapter 9: International Trade

  45. Outsourcing • Economic Naturalist • Paul Solman and his associate Lee Koromvokis produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program, The NewsHour with Jim Lehrer. • Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderbad? Chapter 9: International Trade

  46. Outsourcing • Characteristics of Jobs that are Less Susceptible to Outsourcing • Less rules-based jobs • “Face-to-Face” complex communication jobs • Jobs that require the worker to be physically present Chapter 9: International Trade

  47. Outsourcing • Responding to changing economic conditions requires the ability to adapt quickly to new circumstances. • Education provides the means to develop a comparative advantage that is not rules-based and does require complex face-to-face communication. Chapter 9: International Trade

  48. End of Chapter

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