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Macroeconomics ECO 110/1, AAU Lecture 11. International trade. Eva Hrom á dkov á , 3.5 2010. Trade Patterns of C R. Czech Republic is a small open economy: Imports are goods and services purchased from foreign sources : CR (2009): 1,981 bil. CZK; 82% of 2008 values
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Macroeconomics ECO 110/1, AAU Lecture 11 International trade Eva Hromádková, 3.5 2010
Trade Patterns of CR • Czech Republic is a small open economy: • Importsare goods and services purchased from foreign sources: • CR (2009): 1,981 bil. CZK; 82% of 2008 values • Exportsare goods and services sold to foreign buyers. • CR (2009): 2,132 bil. CZK; 86% of 2008 values • GDP = 3,627 bil CZK; export ratio = 59%
Trade Balances • The trade balance is the difference between the value of exports and imports. • Any imbalance in one country’s trade must be offset by reverse imbalances elsewhere. Trade balance = exports – imports
Trade Balances II • Trade deficit is the amount by which the value of imports exceeds the value of exports in a given time period. • Trade surplus is the amount by which the value of exports exceeds the value of imports in a given time period. • CR is running a trade surplus • 151 bil. CZK (2009); 67 bil. CZK (2008)
Motivation to Trade • Why trade when . . . . . . we import many of the things we also export. . . . we could produce many of the other things we import. . . . we seem to seem to worry so much about trade imbalances. LO2
Specialization • Trade allows nations to specialize and specialization increases total output. • Example: Would you grow your food and produce all your possessions? Or would you rather work in your field and buy everything else on the market? • Trade increases world output and the standards of living in all trading countries. LO2
Production and Consumption Without Trade • The gains from trade can be illustrated using production possibilities curves. • Production possibilities– The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology. • Consumption possibilities - The alternative combinations of goods and services that a country could consume in a given time period. • In the absence of trade, a country’s consumption possibilities are identical to its production possibilities. LO2
U.S. production possibilities A 100 B 80 C 60 OUTPUT OF BREAD (zillions of loaves per year) D 40 E 20 F 0 10 20 30 40 50 60 OUTPUT OF WINE (zillions of barrels per year) Consumption Possibilities Without Trade - US LO2
French production possibilities 25 20 G 15 H OUTPUT OF BREAD (zillions of loaves per year) 10 I J 5 K L 0 10 20 30 40 50 60 OUTPUT OF WINE (zillions of barrels per year) Consumption Possibilities Without Trade - France LO2
Production and Consumption With Trade • To assess the potential gain from trade, we need to consider the combined output of trading nations. • By changing the mix of output in each trading country, we can increase total world output. • Each country produces those goods it makes best, then trades with other countries to acquire the goods it desires to consume. • E.g.: US is better in bread and France in wine making • When a country engages in international trade, its consumption possibilities always exceed its production possibilities. LO2
Consumption Possibilities Comparison without and with trade LO2
Comparative Advantage • Although international trade can make everyone better off, it’s not obvious which goods should be traded, or on what terms. • The decision to export is based on comparative advantage: The ability of a country to produce a specific good at a lower relative opportunity cost than its trading partners. • 1 wine = 2 breads – USA advantage in bread making • 1 wine = 0.25 breads – France advantage in wine making • World output, and thus potential gains from trade, will be maximized when each country pursues its comparative advantage. LO1
Absolute Advantage • The absolute advantages in production do not matter • Absolute advantage– The ability of a country to produce a specific good with fewer resources (per unit of output) than other countries. LO1
Terms of Trade • The terms of trade establish the trading rate. • Terms of tradeis the rate at which goods are exchanged – the amount of good A given up for good B in trade. • A country will not trade unless the terms of trade are superior to domestic opportunities. • The terms of trade between two countries will lie somewhere between their respective opportunity costs in production. • Ex: 1 loaf of bread between ½ barrel of wine (US) and 4 barrels of wine (France); in our example 1 loaf of bread = 3.33 barrel of wine (large gain for US)
A United States 100 Y X 80 Consumption possibilities 60 C N Bread D 40 Production possibilities 20 0 10 20 30 40 50 60 70 80 90 100 110 France 120 90 Consumption possibilities 60 Bread 30 Production possibilities L M K 0 10 20 30 40 50 60 70 80 90 100 110 Wine Searching for the Terms of Trade
The Role of Markets and Prices • The decision to import or export a particular good is often left up to the market decisions of individual consumers and producers. • The terms of trade, like the price of any good, will depend on the willingness of market participants to buy or sell at various prices. • But will stay within the limit terms of trade
Protectionist Pressures • Although the potential gains from trade are impressive, not everyone favors free trade. • Imports typically compete with a domestic industry. LO3
Protectionist PressuresMicroeconomic Pressures The affected industries will try to restrict imports in order to preserve their own jobs and incomes: • Import competing industries • E.g. wine producers in California But also a positive pressure: • Export industries: import redistributes income from import-competing industries to export industries • E.g. wheat producers in Kansas In total, everybody should be better off… LO3
Protectionist Pressures Additional Pressures • Selfish micro interests are not the only source of trade restrictions. • Other arguments are used to restrict trade • National Security Concerns • Dumping • Infant Industries • Improving the Terms of Trade LO3
Protectionist pressures1. National Security Concerns • Essential defense-related goods are vital during times of war. • A war could disrupt this flow leaving us vulnerable. • Exporting vital technology to a potential enemy is not wise. • E.g: food, steel industry LO3
Protectionist pressures2. Dumping • Dumpingis the sale of goods in export markets at prices below domestic prices (even below production costs) • Q: What is he main goal of importers then? • Import competing industries are placed at risk LO3
Protectionist pressures3. Infant Industries • Even normal export prices might make it difficult or impossible for a new domestic industry to develop. • These industries may need temporary protection from imports. • Trade restrictions are justified only if there is tangible evidence that the industry can develop a comparative advantage reasonably quickly. (e.g. computer industry in Brazil) LO3
Protectionist pressures4. Improving the Terms of Trade • The distribution of the gains from trade depends on the terms of trade. • Putting restrictions on imports can move the terms of trade in our favor • We would end up with a larger share of the gains from trade. • This strategy can backfire - retaliations LO3
Barriers to Trade • The microeconomic losses associated with trade give rise to a constant clamor for trade restrictions. • Embargoes • Tariffs • Quotas • Voluntary restraint agreements • Non-tariff barriers LO3
Barriers to trade1. Embargoes • The sure-fire way to restrict trade is simply to eliminate it. • Anembargois a prohibition against trading particular goods. • Ex.1: on Soviet mink and fur (US) • Ex.2: on Cuban goods (cigars, sugar) • Ex.3: on Georgian wine and mineral water (Russia) LO3
Barriers to trade2. Tariffs • A more frequent trade restriction is a tariff. • Atariffis a tax (duty) imposed on imported goods. • A tariff makes imported goods more expensive to domestic consumers, and less competitive with domestically priced goods. LO3
Barriers to trade3. Quotas • The same outcome of a tariff can be attained more directly by imposing an import quota. • Aquotais a limit on the quantity of a good that may be imported in a given time period. • Ex.1: max 950 gal. of Jamaican ice-cream (US) • Ex.2: lower quotas on the import of US chicken meat (Russia) • Russia is the biggest export market for US chicken meat LO3
Comparative Effects • The effect of quotas on trade is different than the effect of tariffs. LO3
No-Trade Equilibrium • The equilibrium price is completely determined by domestic demand and supply curves. • Equilibrium price – The price at which the quantity of a good demanded in a given time period equals the quantity supplied. LO3
Free-Trade Equilibrium • Free trade allows the import of unlimited quantity of foreign supplies at the world price. • Free trade results in reduced prices and increased consumption. LO3
Tariff-restricted Trade • Tariffs raise the price of imports and shifts the import supply curve upward. • Domestic prices rise, domestic production rises, and domestic consumption falls. LO3
Quota-restricted Trade • Quotas are a greater threat to competition than tariffs because quotas preclude additional imports at any price. LO3
Quota-restricted trade ( d ) Quota-restricted trade D S 1 1 S 4 Q p PRICE (dollars per unit) 1 p 4 p 2 0 q q q 1 4 2 QUANTITY (units per year) LO3
Barriers to trade4. Voluntary Restraint Agreements • A slight variant of quotas has been used in recent years. • A voluntary restraint agreement (VRA) is an agreement to reduce the volume of trade in a specific good – a “voluntary” quota. • Based on negotiation • E.g. Japan’s agreement not to export more than 1.68 mil cars to US in 1981 LO3
Barriers to trade5. Nontariff Barriers • Embargoes, export controls, tariffs, and quotas are the most visible barriers to trade, but they are only the tip of the iceberg. • e.g: product standards, licensing restrictions, restrictive procurement practices, and other nontariff barriers restrict roughly 15 percent of imports (US). LO3
Multilateral Trade Pacts • Trade policy is a continuing conflict between the proponents of free trade and the special interests that profit from trade protection. • The long-term trend is towards lowering trade barriers, thereby increasing global competition. • Protectionist forces are being countered by the worldwide recognition of the gains from trade. • Exporters and firms that use imported inputs push for free trade.
Global Pacts: GATT and WTO • The granddaddy of the multilateral, multiyear free-trade pacts was the General Agreement on Tariffs and Trade (GATT) in 1947. • The 1994 GATT pact created the World Trade Organization (WTO) to enforce free-trade rules. • The WTO has become the world’s trade police force. • Latest round – Doha (2001) - 141 countries
WTO Protests • Some people see free trade as a mixed blessing. • Environmentalists worry about depletion of resources, congestion and pollution. • Labor organizations worry about depressed wages and working conditions. • Third World countries worry about an unfair trade playing field.
Regional Pacts • Groups of nations have moved even faster toward open markets by developing regional trade pacts.
European Union • The European Union (EU) is a regional pact that virtually eliminates national boundaries between 25 countries. • The EU eliminated trade barriers and permits full inter-country mobility of workers and capital. • In effect, Europe has become one large unified market. • EFTA (Iceland, Norway, Swiss, Liechtenstein) + CEFTA
NAFTA • In December 1992, the United States, Canada, and Mexico signed the North American Free Trade Agreement (NAFTA). • The ultimate goal of NAFTA is to eliminate all trade barriers between these three countries.
CAFTA • The success of NAFTA prompted a similar 2005 agreement between the U.S. and central American nations. • The Central American Free Trade Agreement (CAFTA) aims to eliminate tariffs and standardize trade and investment policies in CAFTA nations.
