Chapter 8

1. Chapter 8 International Agricultural Trade

2. Purpose of the Chapter • A discussion of the importance of trade to agriculture • Illustrate the concept of comparative advantage and gains from trade • Define and discuss a country’s trade balance and its meaning • Cover the controversial topic of creative destruction • Review the role of exchange rates in trade • Study various barriers to trade • Develop a mathematical model of international markets

3. A Story of Two Clans (Two Countries) • Imagine there are two primitive clans: Wu Tang Clan and No Tang Clan. • Each clan produces and consumes only grain and salmon • Both work 10 hours per day • Wu Tang: 1 salmon/hour, 1 bushel of grain/hr • No Tang: 1 salmon/hr, ½ bushel of grain/hr • Opportunity costs: • Wu Tang: 1 bushel is 1 salmon • No Tang: 1 bushel is 2 salmon

4. Two Clan Example continued… • Production Possibility Frontier (PPF): A graph showing the different possibilities. Figure 8.1 Production Possibility Frontiers

5. Two Clan Example continued… • Infeasible Region: The region above the PPF where neither clan can consume or produce in that region. • Infeasible Point: Where the clans would like to consume but cannot do so with trading with another clan. • Comparative Advantage: One group is said to have the comparative advantage in the production of a good if it can produce that good at a lower opportunity cost than another group.

6. Figure 8.2 Opportunity Cost of Production • No Tang can produce salmon at a lower opportunity cost. • It gives up only ½ bushel to obtain a salmon • Wu Tang gives up a whole bushel. • NO TANG HAS THE COMPARATIVE ADVANTAGE IN SALMON • WU TANG HAS THE COMPARTIVE ADVANTAGE IN GRAIN PRODUCTION • It produces grain at a lower opportunity cost.

7. If groups have a comparative advantage in certain goods, they can engage in a mutually beneficial trade. Gains From Trade: If two groups have a comparative advantage in particular goods, they can strike a mutually beneficial trade. Each group should produce the good for which they possess a comparative advantage, trade them for the goods for which they do not have a comparative advantage, and both groups can become wealthier without working more. Figure 8.3. Important Economic Result

8. If Wu Tang produces only grain, they will produce 10 bushels. • If No Tang produces only salmon, they will produce 10 salmon. • The clans strike a deal: • Wu Tang exports 4 bushels and imports 5 salmon. • No Tang exports 5 salmon and imports 4 bushels. • Consumes: • Wu Tang consumes 5 salmon and 6 bushels of grain • No Tang consumes 5 salmon and 4 bushels of grain • Both of these are points we said were infeasible in the absence of trade. Figure 8.4. Mutually Beneficial Trade Between Clans

9. Absolute Advantage • A country has an absolute advantage over another country in the production of a good if it can produce more of that good. • Wu Tang had the absolute advantage over No Tang. • Both countries still benefited from a trade. • Absolute advantage does not matter so long as the opportunity costs of production are different, each group will have a comparative advantage in something and can be made better off through trade.

10. Trade Between Countries • Tariff: A tax on imported goods. Used to encourage in-country purchasing and protect the importing country’s producers. • How are the citizens from two trading countries—like the US and Japan—affected by the elimination of the import tariff?

11. Figure 8.5. Impact of Japan Import Tariff Removal on U.S.

12. Tariff Removed? Figure 8.6. Impact of Japan Import Tariff Removal on Japan

13. Point of Trading Between Countries • When governments eliminate barriers to trade between countries, and those countries increase trade through markets, both countries are made better off.

14. Balanced Trade • Trade Balance = Total Exports – Total imports (Measured in US dollars) • If trade balance >0, we have a trade surplus. • If trade balance <0, we have a trade deficit • There is a trade balance with the world, and a trade balance with each country. • The Trade Balance must always be equal to zero.

15. One Exception: Foreign Aid • When we offer foreign aid to developing countries, we are essentially delivering them goods and services and asking nothing in return. • We are exporting more than we are importing • The US and other developed countries regularly give foreign aid, which means we regularly export more than me import, which means we regularly run a trade surplus.

16. Net Foreign Investment • Net Foreign Investment (NFI) = Exports of Goods and Services – Imports of Goods and Services. • If NFI >0, the country is a net lender to the world. • If NFI <0, the country is a net borrower from the world.

17. Why Free Trade is Often Unpopular • Creative Destruction: A concept where one thing had to be destroyed for another to be created, and that which is created has a greater value than that which was destroyed. • Example: Domestic Sugar and Imported Sugar • Imported sugar is cheaper than domesticated sugar, if importing taxes (importing tariffs) were not there. The tariffs are protecting the domestic sugar producers. • If the tariffs were removed the sugar producers would lose about $1,046 million, but consumers would gain $1,900 million.

18. Producing a Good • There are two ways to produce a good. • Directly produce it. • Produce an alternative good and trade it with other countries for the good.

19. Exchange Rates in Trade • Trade between countries is complicated and costly: • Distance, language, and different laws make striking a deal no easy matter. • Different currency is an obstacle.

20. Exchange Rates in Trade • Currency conversions take place in exchange rate markets. • If the dollar appreciates in value relative to the yen, one dollar purchases more yen, and one yen purchases less dollar. • If the dollar appreciates relative to the yen, the yen depreciates relative to the dollar. Figure 8.7. Market for Exports of U.S. Rice to Japan

21. Figure 8.8. Impact of Exchange Rate Changes

22. Figure 8.9. Impact of Exchange Rate Changes

23. Barriers To Trade • Barriers to Trade: • Import Tariffs • Import Quotas • Voluntary Import Restraints • Quality Restrictions • Export Subsidies • Export Taxes • Trade Embargoes • State Traders • Exchange-Rate Distortions

24. Import Tariffs and Import Quotas • Import tariffs and Quotas are designed to limit imports into a country. • Import Tariffs charge a tax for each unit imported. • Quotas designate a maximum amount that can be imported

25. Voluntary Import Restraints • Voluntary Import Restraints usually stem from political pressure. • In the 1980’s, Ronald Reagan convinced Japan to voluntarily limit the number of cars they exported to the United States. • President Reagan threatened to impose tariffs if they did not voluntarily limit their exports.

26. Quality Restrictions • Quality Restrictions: They prohibit imports that do not meet certain quality standards. • Nontariff trade barriers related to food quality and safety issues have increased in recent years. • Example: European Union banning US Beef • Since 1989, the European Union has banned US beef due to the use of growth hormones in the US beef production. • Countries not allowing GMO’s (Genetically Modified Organisms) into their food markets is another example. • Politicians impose Quality Restrictions in the appearance that they are protecting the consumers, when their real motive is to enhance domestic welfare.

27. Export Subsidies • Export Subsidies are one of the most widely used trade barriers. • Example: Kansas wheat farmer: • Wheat is selling across the world for $3.30 a bushel. • Government want the wheat farmers to receive $4.30. • Government will either buy the wheat for $4.30 a bushel directly from the farmer and then sell it on the market for $3.30—loosing $1.00 in the process, or it will pay the farmer a subsidy of $1.00 per bushel in addition to the $3.30 per bushel the farmer receives from her sales. • The US and the European Union (EU) were the largest users of export subsidies before 1995.

28. Other Trade Barriers • Export Tax: Where a country taxes its exports. • Example: China taxes textile exports to US in order to avoid a confrontation. • Trade Embargo: Where neither exports or imports are allowed from that country. • Example: US and Cuba

29. Other Trade Barriers continued… • State Trader: Trade only within that state. • Example: Canadian Wheat Board—only place to buy and sell wheat in Canada. • Exchange-rate distortion: Where a country can export items in a competitive, and perhaps unfair, advantage. • Example: China buying US dollars and storing them so they can temporarily run a trade surplus.

30. The Future of Trade • World Trade Organization (WTO) was creating in 1995. • Countries trying to move together towards free trade, needed a place to hold forums, set rules for trade, and a place to settle disputes. • It is not “headed” by a specific country. • It was created by many countries with 5 goals in mind.

31. Five Goals of the WTO • Trade Between countries should be: • Without discrimination • Freer • Predictable • More Competitive • More Beneficial for less developed countries

32. Goals of WTO • Without discrimination: • If you erect trade barriers for one country you do so for all countries. • Countries are allowed to discriminate through the creation of free trade agreements like NAFTA, CAFTA, and the EU. • A country is allowed to discriminate towards a country if that country is competing unfairly.

33. Goals of WTO • Freer trade: WTO members have to agree to freer trade. • Predictability: If countries arbitrarily erect trade barriers with no warning, this disrupts all economies, causing wealth losses to all. • A strong economy requires substantial capital investment, and firms will not invest in a business venture that relies on exports or imports unless the market is stable.

34. Goals of WTO • Trade should be more competitive: producers in each country should compete on a level playing field. • WTO members have agreed that trade should be more beneficial for less-developed countries.

35. Mathematics of International Market Equilibrium • There are 3 general steps to calculating the new international price of rice and trade volume. • Calculate the equilibrium price of rice in both countries if trade does not occur. • Using these prices, find the export supply curve and the import demand curve. • Set the equilibrium price and quantity. The price will be the international price.

36. Figure 8.10.

37. Figure 8.11. No Trade Equilibrium and Export Supply Curve for U.S.

38. Figure 8.12. No Trade Equilibrium and Export Supply Curve for Japan

39. Figure 8.13. International Market Equilibrium

40. Figure 8.14. Three Panel Diagram of Trade Equilibrium

41. Mathematics of Exchange Rates • Supply and Demand in each country is stated in each country’s currency. • To calculate the international market equilibrium, the supply and demand curves need to be converted to a common currency.

42. Figure 8.15.

43. Figure 8.16.

44. Figure 8.17. Notes: The y-axis is in U.S. dollars and the x-axis refers to quantities.

45. Figure 8.18.

46. Figure 8.17. answer Notes: The y-axis is in U.S. dollars and the x-axis refers to quantities.