International Economics

1. International Economics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS

2. Economics… is the study of how individuals and society choose, with or without the use of money, to employ scarce productive resources to produce various commodities over time and distribute them for consumption, now and in the future, among various people and groups in a society.

3. Why People and Nations Trade

4. What Would Your Life Be Like If You Could Not Trade with Anyone?

5. Self-Sufficiency

6. International Trade • International trade increases world economic efficiency for the same reasons that domestic trade increases national economic efficiency. • People gain when they trade voluntarily • Review Circular Flow • Review Comparative Advantage • Review Opportunity Cost • Review Specialization

7. Activity • The Iowa Car Crop Example

8. THE IOWA CAR CROP There are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. Everybody knows about the first technology; let me tell you about the second. First you plant seed, which are the raw material from which automobiles are constructed. You wait a few months until corn appears. Then you harvest the corn, load it onto ships, and sail the ships eastward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them. International trade is nothing but a form of technology. The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans' well-being. To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert corn into cars.

9. Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa. A tax or a ban on "imported" automobiles is a tax or a ban on Iowa-grown automobiles. If you protect Detroit car makers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition. That means that protection for Detroit does more than just transfer income from farmers to autoworkers. It also raises the total cost of providing Americans with a given number of automobiles. The efficiency loss comes with no off-setting gain; it impoverishes the nation as a whole.

10. There is much talk about improving the efficiency of American car manufacturing. When you have two ways to make a car, the road to efficiency is to use both in optimal proportions. The last thing you should want to do is to artificially hobble one of your production technologies. It is sheer superstition to think that an Iowa-grown Camry is any less "American" than a Detroit-built Taurus. Policies rooted in superstition do not frequently bear efficient fruit.

11. In 1817, David Ricardo--the first economist to think with the precision, though not language, of pure mathematics--laid the foundation for all future thought about international trade. In the intervening nineteen decades his theory has been much elaborated but its foundations remain as firmly established as anything in economics. Trade theory predicts first if you protect American producers in one industry from foreign competition, then you must damage American producers in other industries. It predicts second that if you protect American producers in one industry from foreign competition, there must be a net loss in economic efficiency. Ordinarily, textbooks establish these propositions through graphs, equations, and intricate reasoning. The Iowa Car Crop story makes the same propositions blindingly obvious with a single compelling metaphor portraying economics at its best.

12. Iowa Car Crop • Who is helped by restricting car imports? • U.S. auto industry • Owners • Workers • Who is hurt by restricting car imports? • U.S. consumer • Fewer choices • Higher prices for cars • U.S. agricultural industry • Japanese auto industry and workers

13. Iowa Car Crop • Why does trade result in the most efficient production of goods and services? • Free trade allows for specialization • Why do people and nations gain when they trade? • Efficiency • Can produce & consume more goods • More choice

14. Adam Smith • Is this statement true or false? • “The economic goal of international trade is to maximize our exports and to provide jobs for U.S. citizens.” • False. The purpose of trade is to improve the welfare of consumers • Improve efficiency • More & better products Consumption is the sole end and purpose of all production, and the interest of the producer ought to be attended to only as far as it may be necessary for promoting that of the consumer.

15. The Nature & Causes of the Wealth of Nations • A engineer who, while visiting China, came across a large crew of men building a dam with picks and shovels. • When the engineer pointed out to the supervisor that the job could be completed in a few days, rather than many months, if the men were given motorized earthmoving equipment, the supervisor replied: • . . . such equipment would destroy many jobs.

16. The Real Source of Wealth? • Oh, the engineer responded, • “I thought you were interested in building a dam. • If it’s more jobs you want, why don’t you have your men use spoons instead of shovels.” • Moral: • Purpose of economic activity • produce as much VALUE as possible with scarce resources. • Always jobs to do • Creating jobs is not the problem • Problem: • creating jobs in which people produce the most value.

17. A Key Concept • A country’s standard of living depends on its ability to produce goods and services.

18. Activity you might use in classThe Story of the Potatoes & the Oranges

19. Getting Started • Split into pairs: • Decide who’s Mary, who’s John • Each person can produce 2 goods: • Potatoes (P) and oranges (O)

20. Mary has 10 oranges and 5 potatoes In class you could have envelopes labeled “Mary” prepared with 10 orange circles and 5 brown squares for ½ of your class

21. John has 3 oranges and 3 potatoes In class you could have envelopes labeled “John” prepared with 3 orange circles and 3 brown squares for ½ of your class

22. Production Capabilities Mary can produce OrangesPotatoes 10 0 8 1 6 2 4 3 2 4 0 5 John can produce OrangesPotatoes 3 0 2 1 1 2 0 3 • John wants at least 3 O & 1 P • Mary wants at least 7 O & 2 P

23. “Year” One: No Contact with Partner Objective: achieve your desired consumption bundle below. (1) Decide production level (whole # only). (2) “Produce” by removing that number of P & O from the envelope & place on desk in front of you. Leave the rest of P & O in envelope. Mary can produce OP 10 0 8 1 6 2 4 3 2 4 0 5 John can produce OP 3 0 2 1 1 2 0 3 • Mary: at least 7 O & 2 P • John: at least 3 O & 1 P

24. Ask…. “Year 1 Results?” • John, have you achieved your objective? • Mary, you appear rich, certainly you’ve achieved the objective . . . haven’t you? • Rich or poor, we appear to face scarcity. • Have students return all P and O to their envelopes. • Completely new round – do not have to produce combination of first round; free to produce any acceptable combination.

25. “Year” 2: Allow Trade Objective: achieve your desired consumption bundle below. 1. Discuss with partner. 2. Decide production (whole # only). 3. Circle production on the table. 4. Remove “production” from envelope & lay on desk in front of you. 5. If desire, trade with partner & record. Mary can produce OP 10 0 8 1 6 2 4 3 2 4 0 5 John can produce OP 3 0 2 1 1 2 0 3 • Mary: at least 7 O & 2 P • John: at least 3 O & 1 P

26. Discussion • Mary, are you better off than in Round 1? • 4 • John, certainly Mary’s gain has come at your expense . . . • … you must be worse off? • Then both of you are better off? • How did you accomplish this miracle?!

27. Free Trade Allows … • Specialization • Mary: produce 10 oranges and 0 potatoes • John: produce 0 oranges and 3 potatoes • Trade: • Mary: trades 3 oranges for 2 potatoes • achieves objective with 7 oranges & 2 potatoes • John: trades 2 potatoes for 3 oranges • achieves objective with 3 oranges & 1 potato

28. In Other Words, Both Mary and John are simultaneously and unambiguously better off!

29. Miracle of Trade – Source of Gains? • Exchange only • No specialization • No production • Merely trade the already existing items • People are made better off • You can demonstrate this with a “bag trade game” which is another NCEE lesson • Free trade allows • Specialization in production • Theory of comparative advantage

30. Together, Let’s Complete “Opportunity Cost” First, John and Mary return to your original number of Oranges and Potatoes in your envelope: Mary – 10 oranges and 5 potatoes John – 3 oranges and 3 potatoes

31. Together, Let’s Complete “Opportunity Cost” • 1. John's cost to produce a potato is ___ oranges (s). • 2. Mary's cost to produce a potato is ___ oranges (s). • 3. John's cost to produce an orange is ___ potato(es). • Mary's cost to produce an orange is ___ potato(es). • …….. Go to the table…..

32. Determine Opportunity Cost – Physically Verify John can produce OP 3 0 2 1 1 2 0 3 Mary can produce OP 10 0 8 1 6 2 4 3 2 4 0 5 Opportunity cost of a P is 1 O’s Opportunity cost of a P is 2 O’s

33. Determine Opportunity Cost – Physically Verify John can produce OP 3 0 2 1 1 2 0 3 Mary can produce OP 10 0 8 1 6 2 4 3 2 4 0 5 Opportunity cost of a O is 1 P Opportunity cost of a O is 0.5 P’s

34. Concept: Comparative Advantage Specialize in lowest cost – most efficient production • Oranges: • Mary: cost of one Orange = 0.5 Potato • John: cost of one Orange = 1.0 Potato • Mary specialize in O production • Potatoes: • Mary: cost of one Potato = 2.0 Orange • John: cost of one Potato = 1.0 Orange • John specialize in P production

35. Key Points • Free trade is not a zero-sum game • Zero-sum game: Mary’s gains = John’s losses +10 = -10 → net gain = 0 (zero sum) • Instead, • both parties gain – positive-sum game

36. Pre-specialization & trade size of pie? After-specialization & trade size of pie? Trade Creates Wealth. . . not merely redistributes it!

37. Key Points • Mary has “absolute advantage” in production of both goods but, she still gains! • Are both countries now equally wealthy? • Mary is still wealthier than John has absolute advantage in both • But both have gained from voluntary trade

38. Production Possibilities • Production possibilities curves (PPC or PPF)– Remember? • This model helps describe • production, • efficiency, • choice, and • scarcity.

39. Unattainable with your own production 10 7 3 2 5 1 3 Graphical Treatment Mary’s PPC John’s PPC O O 0 0 P P PPF = “production possibilities curve”

40. Specialize in Potatoes 3 Comparative Advantage in Potatoes? Mary’s PPC John’s PPC O O 10 Opportunity cost of P: two O Opportunity cost of P: one O 0 5 0 3 P P

41. Specialize in O 3 Comparative Advantage in Oranges Mary’s PPC John’s PPC O O 10 Opportunity cost of O: 0.5P Opportunity cost of O: 1P 0 5 0 3 P P

42. 3 Gains from Specialization & Trade Mary’s PPC John’s PPC O O 10 7 0 2 5 0 1 3 P P

43. Production Possibilities Curve/Frontier • All points on curve are possible & equally efficient in production (satisfy comparative advantage) • Outside the curve impossible now, with own production • Inside the curve → inefficient • Inconsistent with comparative advantage • Some unemployment exists O P

44. Beyond Present PPC? How can a country achieve this point? O • Specialize & trade • Economic growth P

45. trade specialize 1. Specialization & Trade O Assume comparative advantage in Oranges P

46. 2. Dynamic Gains from Competition Economic Growth O P

47. In Conclusion:Free Trade Consensus • Clear that free trade is beneficial • Issue closest to unanimity among economists

48. Benefits to Trade • Review of Absolute Advantage • Production using the fewest resources – doesn’t take into account opportunity cost • Review of Comparative Advantage • Focus on producing the good which has the lowest opportunity cost • Leads to specialization • Benefits to Trade • Greater choice at lower prices to consumers • Increase consumer surplus at the “cost” of reduced producer surplus

49. Free Trade Consensus • It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy . . . • What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom . . .

50. . . . very good wine can be made [in Scotland] at thirty times the expense for which equally good can be bought from foreign countries . . • Would it be reasonable law to prohibit the importation of all foreign wines merely to encourage the making of ... burgundy in Scotland? Adam Smith The Wealth of Nations 1776