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CHAPTER 22 Trading with the World. Chapter 35 in Economics. Learning Objectives. Describe the trends and patterns in international trade Explain comparative advantage and explain why all countries can gain from international trade

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CHAPTER22Trading with the World

Chapter 35 in Economics

learning objectives
Learning Objectives
  • Describe the trends and patterns in international trade
  • Explain comparative advantage and explain why all countries can gain from international trade
  • Explain how economies of scale and diversity of taste lead to gains from trade
learning objectives cont
Learning Objectives (cont.)
  • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities
  • Explain the arguments used to justify trade restrictions and show how they are flawed
  • Explain why we have trade restrictions
learning objectives4
Learning Objectives
  • Describe the trends and patterns in international trade
  • Explain comparative advantage and explain why all countries can gain from international trade
  • Explain how economies of scale and diversity of taste lead to gains from trade
patterns and trends in international trade
Patterns and Trends in International Trade
  • Imports are the goods and services we buy from other countries.
  • Exports are the goods and services we sell to people in other countries.
patterns and trends in international trade6
Patterns and Trends in International Trade
  • Trade in Goods
    • 50% of our exports and 60% of our imports are manufactured goods
    • Capital goods and autos are the leading export and import
    • Services make up 26% of our exports and 17% or our imports
patterns and trends in international trade7
Patterns and Trends in International Trade
  • Trade in Services
    • The spending of a foreigner (students, vacationers) in a country is the importation of services.
    • Shipping and insurance charges paid to foreign firms on imported goods is the importation of services.
patterns and trends in international trade8
Patterns and Trends in International Trade
  • Geographical Patterns
    • Canada is the Unites States’ leading trading partner for both imports and exports
    • 45% of our imports are from Asian countries
patterns and trends in international trade9
Patterns and Trends in International Trade
  • Trends in the Volume of Trade
    • In 1960, the U.S. exported less than 5% of total output and imported 4.5% of the goods and services consumed domestically.
    • Since, 1960 the composition of imports have changed dramatically
      • food and raw material imports have fallen
      • machinery comprise close to 50% of total imports
patterns and trends in international trade10
Patterns and Trends in International Trade
  • Balance of Trade and International Borrowing
    • The balance of trade is the value of exports minus the value of imports
    • In 1996 the U.S. had a $95 billion deficit
    • We must either borrow from foreigners or sell some of our assets
learning objectives11
Learning Objectives
  • Describe the trends and patterns in international trade
  • Explain comparative advantage and explain why all countries can gain from international trade
  • Explain how economies of scale and diversity of taste lead to gains from trade
opportunity cost and comparative advantage
Opportunity Cost and Comparative Advantage
  • A comparative advantage exists for a country if it can perform an activity at a lower opportunity cost than any other country.
  • Recall Tom and Nancy — Chapter 3.
opportunity cost and comparative advantage13
Opportunity Cost and Comparative Advantage
  • Countries can increase consumption if they produce only those goods in which they have a comparative advantage.
  • Let’s look at Farmland and Mobilia
opportunity cost in farmland
Opportunity Cost in Farmland

36

30

24

Grain(billions of bushels per year)

15

6

0

4

7

8

9

12

Cars (millions per year)

opportunity cost in farmland15
Opportunity Cost in Farmland

36

30

24

Grain(billions of bushels per year)

a

15

6

Farmland’s PPF

0

4

7

8

9

12

Cars (millions per year)

opportunity cost in farmland16
Opportunity Cost in Farmland

36

30

Opportunity cost

of 1 car is 9,000

bushels of grain

24

Grain(billions of bushels per year)

18 billion

bushels

of grain

a

15

6

2 million

cars

Farmland’s PPF

0

4

7

8

9

12

Cars (millions per year)

opportunity cost in mobilia
Opportunity Cost in Mobilia

20

18

Grain(billions of bushels per year)

14

12

6

0

2

4

8

12

Cars (millions per year)

opportunity cost in mobilia18
Opportunity Cost in Mobilia

20

a'

18

Grain(billions of bushels per year)

14

12

Mobilia’s PPF

6

0

2

4

8

12

Cars (millions per year)

opportunity cost in mobilia19
Opportunity Cost in Mobilia

6 billion bushels

of grain

Opportunity cost

of 1 car is 1,000

bushels of grain

20

a'

18

Grain(billions of bushels per year)

14

12

6 million

cars

Mobilia’s PPF

6

0

2

4

8

12

Cars (millions per year)

opportunity cost and comparative advantage20
Opportunity Cost and Comparative Advantage
  • Mobilia has a comparative advantage in car production
  • Farmland has a comparative advantage in grain production.
gains from trade
Gains from Trade
  • Let’s see how two groups do business with each other.
international trade in cars
International Trade in Cars

9

6

Price (thousands of bushels of grain per car)

3

0

2

4

6

Quantity (millions of cars per year)

international trade in cars23
International Trade in Cars

a

9

6

Price (thousands of bushels of grain per car)

3

Farmland’s import

demand for cars

0

2

4

6

Quantity (millions of cars per year)

international trade in cars24
International Trade in Cars

a

9

6

Price (thousands of bushels of grain per car)

Mobilia’s

export supply

of cars

3

Farmland’s import

demand for cars

1

a'

0

2

4

6

Quantity (millions of cars per year)

international trade in cars25
International Trade in Cars

Farmland’s

no-trade point

a

9

6

Price (thousands of bushels of grain per car)

Mobilia’s

export supply

of cars

Mobilia’s

no-trade point

3

Farmland’s import

demand for cars

1

a'

0

2

4

6

Quantity (millions of cars per year)

gains from trade26
Gains from Trade
  • Balanced Trade
    • Farmland pays for its cars by exporting grain
    • They must export 12 billion bushels of grain for 4 million cars.
    • Mobilia is exporting 4 million cars for 12 billion bushels of grain.
  • Trade is balanced
gains from trade27
Gains from Trade
  • Changes in Production and Consumption
    • How is it possible for everyone to gain?
    • With international trade economies can consume a different quantity than it produces.
expanding consumption possibilities
Expanding Consumption Possibilities

48

Farmland

42

36

Grain(billions of bushels per year)

30

24

18

12

6

0

4

5

8

9

12

15

16

Cars (millions per year)

expanding consumption possibilities29
Expanding Consumption Possibilities

48

Farmland

42

36

No-trade

production

and

consumption

Grain(billions of bushels per year)

30

24

18

a

12

6

0

4

5

8

9

12

15

16

Cars (millions per year)

expanding consumption possibilities30
Expanding Consumption Possibilities

48

Farmland

42

Production

with trade

36

No-trade

production

and

consumption

Grain(billions of bushels per year)

30

b

24

18

a

12

6

0

4

5

8

9

12

15

16

Cars (millions per year)

expanding consumption possibilities31
Expanding Consumption Possibilities

48

Farmland

42

Production

with trade

36

No-trade

production

and

consumption

Grain(billions of bushels per year)

30

b

24

c

18

a

Consumption

with trade

12

6

0

4

5

8

9

12

15

16

Cars (millions per year)

expanding consumption possibilities32
Expanding Consumption Possibilities

Mobilia

36

Grain(billions of bushels per year)

24

21

9

0

4

5

8

9

12

16

Cars (millions per year)

expanding consumption possibilities33
Expanding Consumption Possibilities

Mobilia

36

Grain(billions of bushels per year)

24

21

a'

No-trade

production

and

consumption

9

0

4

5

8

9

12

16

Cars (millions per year)

expanding consumption possibilities34
Expanding Consumption Possibilities

Mobilia

36

Grain(billions of bushels per year)

24

21

a'

No-trade

production

and

consumption

9

b'

Production

with trade

0

4

5

8

9

12

16

Cars (millions per year)

expanding consumption possibilities35
Expanding Consumption Possibilities

Mobilia

36

Grain(billions of bushels per year)

Consumption

with trade

c'

24

21

a'

No-trade

production

and

consumption

9

b'

Production

with trade

0

4

5

8

9

12

16

Cars (millions per year)

learning objectives36
Learning Objectives
  • Describe the trends and patterns in international trade
  • Explain comparative advantage and explain why all countries can gain from international trade
  • Explain how economies of scale and diversity of taste lead to gains from trade
gains from trade in reality
Gains from Trade in Reality
  • The U.S. buys TVs and VCRs from Korea, machinery from Europe, and fashion goods from Hong Kong.
  • We sell machinery, grain, and lumber, airplanes, computers and financial services.
  • Why do we exchange manufactured goods?
gains from trade in reality38
Gains from Trade in Reality
  • Diversity of Taste and Economies of Scale
    • Due to the large diversity in human tastes, people value diversity and are willing to pay for it.
    • The production of many manufactured goods are faced with economies of scale.
learning objectives cont39
Learning Objectives (cont.)
  • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities
  • Explain the arguments used to justify trade restrictions and show how they are flawed
  • Explain why we have trade restrictions
trade restrictions
Trade Restrictions
  • Tariffs are a tax imposed by an importing country when an imported good crosses its international boundary.
  • Nontariff barriers are actions other than a tariff that restricts international trade.
    • quantity restrictions, licensing requirements
trade restrictions42
Trade Restrictions
  • The North American Free Trade Agreement (NAFTA) became effective January 1, 1994.
    • All trade barriers will virtually be eliminated between the U.S., Mexico, and Canada during a 15 year phasing-in period.
  • European Union
    • Created the largest unified tariff-free market in the world
trade restrictions43
Trade Restrictions
  • How Tariffs Work
    • What happens if Farmland places a tariff on the importation of cars.
      • The supply of cars in Farmland decreases
      • The price of a car in Farmland rises.
      • The quantity of cars imported by Farmland decreases.
trade restrictions44
Trade Restrictions
  • How Tariffs Work
    • What happens if Farmland places a tariff on the importation of cars.
      • The government of Farmland collects the tariff revenue
      • Resource use is inefficient
      • The value of exports changes by the same amount as the value of imports and trade remains balanced.
the effects of a tariff
The Effects of a Tariff

9

6

Price (thousands of bushels of grain per car)

3

2

1

0

2

4

6

Quantity (millions of cars per year)

the effects of a tariff46
The Effects of a Tariff

9

6

Price (thousands of bushels of grain per car)

Mobilia’s

export supply

of cars

3

2

Farmland’s import

demand for cars

1

0

2

4

6

Quantity (millions of cars per year)

the effects of a tariff47
The Effects of a Tariff

9

Mobilia’s

export supply of

cars plus tariff

6

Price (thousands of bushels of grain per car)

Mobilia’s

export supply

of cars

Tariff

revenue

3

2

Farmland’s import

demand for cars

1

0

2

4

6

Quantity (millions of cars per year)

trade restrictions48
Trade Restrictions
  • Nontariff Barriers
    • Quotas are a quantitative restriction on the import of a particular good.
    • Voluntary export restraints (VER) are agreements between two governments in which the government of the exporting country agrees to restrain the volume of its own exports.
the effects of a quota
The Effects of a Quota

9

6

Price (thousands of bushels of grain per car)

Mobilia’s

export supply

of cars

3

2

Farmland’s import

demand for cars

1

0

2

4

6

Quantity (millions of cars per year)

the effects of a quota50
The Effects of a Quota

Quota

9

6

Price (thousands of bushels of grain per car)

Mobilia’s

export supply

of cars

Importer’s

profit

3

2

Farmland’s import

demand for cars

1

0

2

4

6

Quantity (millions of cars per year)

learning objectives cont51
Learning Objectives (cont.)
  • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities
  • Explain the arguments used to justify trade restrictions and show how they are flawed
  • Explain why we have trade restrictions
the case against protection
The Case Against Protection
  • The National Security Argument
    • “A country must protect industries that produce defense equipment and armaments and those on which the defense industries rely for their raw materials and other intermediate inputs.”
the case against protection53
The Case Against Protection
  • The National Security Argument
    • This argument is false because:
      • In a time of war, all industries contribute to national defense.
      • It is more efficient to subsidize firms, financed from taxes, if a country wishes to increase the output of a strategic industry.
the case against protection54
The Case Against Protection
  • The Infant-Industry Argument
    • “It is necessary to protect a new industry to enable it to grow into a mature industry that can compete in world markets.”
the case against protection55
The Case Against Protection
  • The Infant-Industry Argument
    • This argument is false because:
      • It only applies if the benefits of learning-by-doing not only accrue to the owners and workers of the firms in the infant industry but also spill over to other industries and parts of the economy.
      • It is more efficient to protect an infant industry by using a subsidy financed from taxes.
the case against protection56
The Case Against Protection
  • The Dumping Argument
    • Dumping occurs when a foreign firm sells its exports at a lower price that its cost of production.
the case against protection57
The Case Against Protection
  • The Dumping Argument
    • The dumping argument should be resisted because:
      • Dumping is virtually impossible to detect.
      • A natural global monopoly is not likely.
      • Regulation would be the best way of dealing with a natural global monopoly.
other arguments for protection
Other Arguments for Protection

1) Saves jobs

2) Allows us to compete with cheap foreign labor

3) Brings diversity and stability

4) Penalizes lax environmental standards

other arguments for protection59
Other Arguments for Protection

5) Protect National Culture

6) Prevents rich countries from exploiting developing countries

learning objectives cont60
Learning Objectives (cont.)
  • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities
  • Explain the arguments used to justify trade restrictions and show how they are flawed
  • Explain why we have trade restrictions
why is international trade restricted
Why Is InternationalTrade Restricted?
  • Tariff Revenue
  • Rent Seeking
    • Free trade brings benefits to some but imposes costs on others, with total benefits exceeding total costs
why is international trade restricted62
Why Is InternationalTrade Restricted?
  • Compensating Losers
    • Losers are compensated, to some degree, in reality:
      • NAFTA and retraining workers
      • Unemployment compensation
why is international trade restricted63
Why Is InternationalTrade Restricted?
  • Difficulties
    • Cost of identifying losers and estimating losses would be enormous.
    • Losers today, may be winners tomorrow.