CHAPTER 22 Trading with the World

1. CHAPTER22Trading with the World Chapter 35 in Economics

2. 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

3. 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

4. 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

5. 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.

6. 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

7. 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.

8. 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

9. 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

10. 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

11. 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

12. 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.

13. 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

14. 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)

15. 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)

16. 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)

17. Opportunity Cost in Mobilia 20 18 Grain(billions of bushels per year) 14 12 6 0 2 4 8 12 Cars (millions per year)

18. 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)

19. 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)

20. Opportunity Cost and Comparative Advantage • Mobilia has a comparative advantage in car production • Farmland has a comparative advantage in grain production.

21. Gains from Trade • Let’s see how two groups do business with each other.

22. 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)

23. 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)

24. 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)

25. 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)

26. 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

27. 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.

28. 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)

29. 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)

30. 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)

31. 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)

32. 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)

33. 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)

34. 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)

35. 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)

36. 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

37. 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?

38. 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.

39. 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

40. 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

41. U.S. Tariffs: 1930–1996

42. 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

43. 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.

44. 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.

45. 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)

46. 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)

47. 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)

48. 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.

49. 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)

50. 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)