International Trade 1

1. International Trade 1 February 27, 2010

2. Quiz Take a clean sheet of paper and write your name and id number. Quizzes without both these cannot be graded.

3. Question 1 Indicate the letter of the correct answer: Ordinary citizens in the West in medieval times tended to see economics in terms of: • Marxism • Moral economy • Liberalism

4. Question 2 A mercantilist wants the state to regulate the economy and international trade in order to: • Create fair prices • Create a trade deficit • Create a trade surplus

5. Question 3 A follower of Adam Smith would argue that: • The state should not heavily regulate the market • Markets are bad • Karl Marx was right

6. Trade and Economic Transactions The basis for trade is the operation of market mechanisms. Liberals and mercantilists again have different ideas about the place of markets: • Liberals: markets should generally be left alone; if they are, they will create wealth through the spurring of productivity and the reduction if inefficiencies.

7. Mercantilists • While markets are useful, their free operation assumes that everyone will benefit from all transactions and that the free flow of goods and the elimination of inefficiencies will not hinder the security of states. • That is not the case. Free markets can damage countries by creating trade deficits, destroying industries, displacing workers, holding the population hostage to the supply of goods from outside the country

8. Basic Operation of Markets Markets generally are good for creating wealth in an overall sense and in creating efficiency. Efficiency = maximize output and minimize waste Operate through the interaction of buyers and sellers. These have complementary needs that allow them to engage in transactions that allow both to be better off than they were before (though the gain to each party is not always equal).

9. Markets • Exchanges are possible when there is an overlap between the highest price a buyer will pay for a good and the lowest price a seller will accept for a good. No overlap = no exchange. • If the overlap is large, then there is room for negotiation as each side attempts to get the best deal without losing the opportunity to make an exchange.

10. Markets • In a more general sense, prices are set not by individuals engaging in separate negotiations, but by all buyers and sellers interacting. The point at which many buyers and sellers agree are determined importantly by how many sellers there are and how many goods they are willing to part with, and how many buyers there are and how many goods they are willing to buy.

11. Markets • This is a dynamic process, as the number of goods available for sale and the willingness of buyers to buy them interact on one another in the form of supply and demand curves. • Supply curve: curve representing the dynamic situation in which the higher the price, the more product suppliers are willing to sell. • Demand curve: curve representing the dynamic in which the lower the price, the more product buyers are willing to purchase.

12. Markets • Equilibrium price: the point at which the supply and demand curves cross, thus creating a situation in which the market is cleared of goods • X axis: Amount of Goods; Y axis: Price

13. Markets • On the individual level, markets exist because individuals are not able to supply all the goods and services they need to survive, or at least could not do so efficiently. Someone who had to grow his own food, make his own clothes, build his own house, etc., would never be able to discharge all those tasks well or with a minimum amount of labor and time. • A division of labor that entails people specializing and then trading their products tends to benefit everyone.

14. Productivity • According to this logic, it is the desire to maximize utility across individuals that results in increases in standards of living and efficiency due to competition among buyers and sellers and interactions between the two groups. • Demand for goods, indicated by rising prices, stimulates the production of more goods, while competition leads to lower prices. Falling prices allow people to buy more things and signal to producers to stop producing so much, but more buying will drive up prices. • No government or other outside agent is necessary for this to occur.

15. Markets The same is true of international markets and international trade. Exchanges take place on the international market because it benefits everyone to specialize in the types of goods they create and then trade what one produces for things they do not produce. Again, liberals argue that nothing outside this mechanism is need in order for everyone to get what they need and enjoy a rising standard of living

16. International Markets • While the logic of a division of labor is similar on the international stage as on the domestic, it does operate a bit differently. • On the individual level, a division of labor is efficient because it is better for particular individuals to specialize the in production of goods due to the loss of productivity that comes from switching from one activity to another and the inability to develop high levels of expertise.

17. International Markets • Internationally, the efficiencies that come from a division of labor and the resulting possibilities for trade are conceptualized in other concepts: • Absolute advantage: a country is better off concentrating on producing and exporting product A (and importing product B) because it produces product a at a lower cost than another country.

18. International Markets • Example: Taiwan can engage in trade in flatscreentv’sand should concentrate on their manufacture because it can produce them at a lower price than other countries. As a result, it may import car batteries because it does not produce enough of them due to its concentration on flatscreentv’s.

19. International Markets • However, a country need not have an absolute advantage in order to trade. Indeed, if that were the case, trade volumes would be small and few countries would engage in trade. • Instead, a country can engage in trade if it enjoys merely a comparative advantage. Having a comparative advantage does not mean you produce a good at a lower cost than another country. The US trades with the PRC, and in almost all cases, the PRC has a lower cost of production than the US

20. International Markets • In the case of comparative advantage, a country is better of concentrating on producing a product and exporting it to a partner when it can create a good at a lower opportunity cost than the other country. • Opportunity cost: the cost incurred when the decision to select one option means foregoing the gains that could be realized by selecting another option

21. International Markets • General example of opportunity cost: The opportunity costs of studying may entail forgoing the pleasure of going out drinking with your friends. • Economic example: the opportunity costs of manufacturing good A rather than Good B is the absence of the amount of good B that could be created with the labor and capital expended in creating good A.

22. International Markets • Say the US is more efficient in producing boats than it is in producing computers. • Taiwan is more efficient in producing computers than it is boats. • The opportunity cost in the US is • Produce 1 boat costs 2 computers • The opportunity cost for Taiwan is: • Produce 1 boat costs 3 computers. • We see that in terms of boats, the US has a lower opportunity cost than Taiwan, and for computers, Taiwan has a lower opportunity cost than the US

23. International Markets • It is more efficient for US to concentrate on boats and export them to Taiwan, and for Taiwan to concentrate on computers and export them to the US, even though: • For US, 1 boat costs 20 units of labor and capital • For Taiwan, 1 boat costs 15 units of labor and capital

24. International Markets • This is because if both sides specialize and trade: • The US will have the same number of boats it would have had if trade had not occurred, and will have more computers; • Taiwan will have the same number of computers it would have had if trade had not occurred, but more boats. • Thus, the standard of living for both countries will rise.

25. International Trade • However, while both countries collectively would benefit, that does not mean everyone benefits: • Workers and industries that are favored will benefit, those who do not will pay a prices in the loss of jobs and business • Costs to country of unemployment, retraining • Dissatisfaction among those who lose jobs and opportunities • Loss of manufacturing base

26. Government Intervention These negative effects can lead to government intervention even if the government does not generally follow mercantilist principles Sometimes intervention is necessary to correct market problems: • Existence of monopolies or oligopolies • Combat corruption • Enforce contracts

27. Government Interference • To pursue political goals • Sanctions: attempt to influence the behavior of other countries by limiting or prohibiting economic interactions • Pursue autarky: protect national security by pursuing a situation in which the nation becomes self-sufficient in the production of necessary goods.

28. Government Interference • Protectionism: shielding domestic industries from international competition by prohibiting or discouraging imports • Reasons: • Protect industries vital to security • Protect infant industries • Protect classes of workers • Respond to industry lobbying • Defend against predators seeking to create monopolies

29. Government Interference • Means of pursuing protectionism: • Tariffs: a tax on imported goods • Quotas: a ceiling on the amount of a kind of good that can be imported • Subsidies: money given to an industry to allow it to lower its prices. • Regulations: restrict distribution of goods, high quality standards, labor or environmental standards

30. Effects of Protectionism • Benefit particular industries and workers • Put other industries and workers at a disadvantage due to domestic competition or foreign retaliation • Higher prices for consumers • Loss of comparative advantage • Shield inefficient industries • Stabilize economy, shield important industries, maintain manufacturing base.