Chapter 7: Global Markets in Action

1. Chapter 7: Global Markets in Action • Explain how international trade affects markets • Identify gains from trade, winners, and losers • Explain effects of trade barriers • Tariffs • Quotas • Consider arguments for/against protectionism.

2. How Global Markets Work • International Trade in 2008 • global exports and imports were $35 trillion, more than half the value of global production. • total U.S exports were $1.8 trillion, 13% of U.S. GDP. • total U.S. imports were $2.5 trillion, 18% of U.S. GDP.

3. How Global Markets Work • What Drives International Trade? • The fundamental force that generates trade between nations is comparative advantage. • The basis for comparative trade is divergent opportunity costs between countries.

4. How Global Markets Work • Suppose that the opportunity cost of producing a T-shirt is lower in China than in the U.S. • China has a comparative advantage in producing T-shirts. • Suppose the opportunity cost of producing an airplane is lower in the U.S. than in China • the U.S. has a comparative advantage in producing airplanes. • Both countries can reap gains from trade by specializing in the production of the good at which they have a comparative advantage and then trading. • Both countries can gain from trade.

5. How Global Markets Work: Imports • U.S. demand and U.S. supply with no international trade. • The price of a T-shirt in U.S. is $8. • U.S. firms produce 40 million T-shirts a year and U.S. consumers buy 40 million T-shirts a year.

6. How Global Markets Work: Imports • Because U.S. does not have comparative advantage in t-shirts, world price < U.S. price without trade. • With trade allowed, • price of t-shirts drops to $5. • U.S. production of t-shirts drops • U.S. consumption of t-shirts rises • Imports make up difference between consumption and production in U.S.

7. How Global Markets Work: Exports Without trade allowed, the price of an airplane in U.S. is at $100 million. Boeing produces 400 airplanes a year and U.S. airlines buy 400 a year.

8. How Global Markets Work: Exports • Because U.S. has comparative advantage in planes, world price> U.S. price without trade allowed. • Allowing trades causes: • the price of an airplane to rise to world price of $150 million. • U.S. production increases • U.S. consumption decreases • exports of airplanes

9. Winners, Losers, and the Net Gain from Trade • International trade lowers the price of an imported good • Consumers of imported good are better off • Sellers of imported good are worse off • International trade raises the price of an exported good • Consumers of exported good are worse off • Sellers of exported good are better off • On net, is society better off with free trade?

10. International Trade Restrictions • Governments restrict international trade to protect domestic producers from competition. • Governments use four sets of tools: • Tariffs • Import quotas • Other import barriers • Export subsidies

11. International Trade Restrictions • Tariffs • a tax on a good that is imposed by the importing country when an imported good crosses its international boundary. • For example, , the government of India imposes a 100 percent tariff on wine imported from the United States. • So when an Indian wine merchant imports a $10 bottle of Ontario wine, he pays the Indian government $10 import duty.

12. Effect of a $2 tariff on T-shirts The tariff of $2 raises the price in the United States to $7. U.S. imports decrease to 10 million a year. U.S. government collects the tax revenue of $20 million a year.

13. International Trade Restrictions Efffect of tariff: • Consumer surplus decreases (B+C+D+E) • Producer surplus increases (B) • Tariff revenue generated (D) • Loss to consumers exceeds gains to producer and government (tariff revenue) • On net, society is “worse off” by deadweight loss (C + E)

14. International Trade Restrictions • Import Quotas • a restriction that limits the maximum quantity of a good that may be imported in a given period. • For example, the United States imposes import quotas on food products such as sugar and bananas and manufactured goods such as textiles and paper.

15. International Trade Restrictions The import quota raises the price of a T-shirt to $7 and decreases imports. Area B is transferred from consumer surplus to producer surplus. Importers’ profit is the sum of the two areas D. The area C +E is the loss of total surplus—a deadweight loss created by the quota.

16. International Trade Restrictions • Other Import Barriers • Thousands of detailed health, safety, and other regulations restrict international trade. • Export Subsidies

17. Arguments for Protectionism • The Infant-Industry Argument • it is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets. • This argument is based on the concept of dynamic competitive advantage, which can arise from learning-by-doing. • Learning-by-doing is a powerful engine of productivity growth, but this fact does not justify protection.

18. Arguments for Protectionism The Dumping Argument • Dumping occurs when foreign a firm sells its exports at a lower price than its cost of production. • This argument does not justify protection because • It is virtually impossible to determine a firm’s costs. • Hard to think of a global monopoly, so even if all domestic firms are driven out, alternatives would still exist. • If the market is truly a global monopoly, better to regulate it rather than restrict trade.

19. Arguments for Protectionism • Other common arguments for protection are that it • Saves jobs • But costs jobs too. • Allows us to compete with cheap foreign labor. • But cheaper labor is less productive • Penalizes lax environmental standards. • But improved incomes tend to improve environmental standards • Prevents rich countries from exploiting developing countries. • What is “exploitation”? • Free trade will increase wages of workers in developing countries.

20. The Case Against Protection Why is trade restricted? • Rent seeking: lobbying activities to collect “rents” from trade protection. • Widely dispersed costs(consumers) • Concentrated benefits (producers) • Lobbying is done by beneficiaries, not losers.