International trade

1. International trade Today: Winners and losers of various international trade policies

2. Today: More on international trade • Addressing concerns about trade • Review of comparative advantage • Examining consumption possibilities • Without trade • With trade • Supply and demand analysis of trade • Tariffs and Quotas • “Outsourcing”

3. Addressing concerns about trade • “A majority of Americans, including 60 percent of Republicans, now believe free trade is bad for the U.S. economy, according to recent NBC News-Wall Street Journal polls.” (Source: “Trade jitters, anti-China sentiment rouse US voters,” Reuters, Nov. 14, 2007) • Why do so many Americans have this opinion about trade?

4. Trade has costs and benefits • When another country can produce goods lower than in the United States, two things happen • Jobs are lost in the United States • Consumers pay lower prices for the good that is now imported • The news media usually focuses on the jobs issue more than about prices

5. Why is media coverage skewed? • Any job lost seriously deteriorates the quality of life of an individual • Most people don’t care to read headlines advertising “The price of rice goes down by two cents per pound” • However, small gains on many products lead to substantial increases in the purchasing power of the dollar

6. Suppose there is protectionism elsewhere • The United States is a leading exporter of fresh fruit (see on-line reading list for source) • Suppose that other countries outlawed the import of fresh fruit • US jobs lost • Decrease in price of fruit in the US • Increase in the price of fruit in other countries

7. Another issue: Lead in toys • Recently, many toys manufactured in China have been recalled due to unsafe levels of lead • This has raised concerns about the viability of toy exports • China will stop exporting toys if the world does not view the toys as safe enough, given the price

8. Monitoring is costly • Monitoring toys for lead is costly, adding to the cost of toys purchased • However, testing costs may be small relative to the additional revenues that can be generated if “safe toys” can be guaranteed

9. Another example: American cars • Over the last 30 years, American cars have often been looked at as “inferior” compared to some foreign models • With competition from trade, domestic car producers must keep costs down and quality up in order to successfully sell cars in the domestic market • The same thing goes for foreign toys • If quality control standards are not maintained abroad, people will buy their toys domestically

10. Trade issues • There are many other issues that are related to trade • If you would like an in-depth analysis of trade, you can enroll in a class that deals with trade • Today, we will talk about the basic issues of trade, and who the winners and losers are

11. Review of comparative advantage • Recall the principle of comparative advantage • “Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.” (F/B p. 39) • Today, we will apply this concept on a countrywide scale

12. Comparative advantage: Same numbers, different names

13. Comparative advantage • To find comparative advantage for each person, find the lowest number in each column

14. Recall increasing opportunity cost • Opportunity cost increases as production increases within each country • Each country uses its best pizza maker to make its first pizzas • Then, the next best pizza maker is used, etc. • The same applies to salads

15. Production possibilities curve • Recall from last lecture that all of the points along PGQ are the efficient points of the production possibilities curve • Recall that this shape occurs due to increasing opportunity costs as more is produced

16. Production possibilities curve • Without trade, only points along arc PGQ (or points between this arc and the origin) can be consumed • We will see that gains can be made by trade

17. The world market • In the world market, there is an equilibrium price (based on world supply and world demand) • Any one country that enters or exits the market usually does not change the market price much • For ease of discussion, assume that entry or exit by any one country does not change the world price

18. Consumption possibilities curve • If we produce at point G, we can trade goods at the given market price • Production at G (with trade)  Consumption anywhere along FGH

19. Which consumption possibility curve is best? • We could produce at one of the red dots before we start trading • However, note that there are fewer consumption sets possible than producing at G

20. Optimal production in an open economy • Since the red line is suboptimal, we will not utilize it • Similarly, any point except G will produce a similar result to the red line • Suboptimal consumption possibilities for any production except G

21. Optimal production in an open economy • Solution • Produce such that the “line of trade possibilities” is tangent to the production possibilities curve • In this case, point G is tangent to line FGH

22. Supply and demand analysis of trade • As we just analyzed, we saw that total surplus goes up when world trade is possible • However, we will see that there are winners and losers to trade • Note that the winners’ gain is larger than the losers’ loss

23. Market for cars, w/o trade • Suppose that without trade, 40,000 cars are sold at a price of $14,000

24. Market for cars, w/o trade • Consumer surplus is blue shaded area • Producer surplus is red shaded area

25. Market for cars, with trade • Notice that the world price for cars is $10,000 • At this price, notice that 20,000 cars will be supplied and 60,000 cars will be demanded in this market

26. Market for cars, with trade • What will happen? • This is unlike the case of rent control, since the shortage is picked up by the world market • 20,000 domestic cars will be purchased • 40,000 foreign cars will be purchased Imports

27. Surplus with trade • Consumer surplus increases substantially • Producer surplus decreases, but does not change as much as consumer surplus does Imports

28. Without imports (left)With imports (right) Imports

29. Net gain Imports

30. A similar exercise can be done for a country that is a net exporter • When a country is a net exporter, the world price is above what it would be if trade was not possible (See Figure 9.7 for an example) • Consumer surplus decreases when trade occurs • Producer surplus increases when trade occurs • Overall, total surplus increases

31. Tariffs and quotas • Even when trade is not prohibited, countries sometimes control the amount of a particular good imported • Tariff • Tax that must be paid for each unit of the good imported • Quota • A binding limit set on the amount of a good that can be imported

32. What happens when we impose a tariff? • In this case, the tariff imposed is $1000 per ton of sugar imported • We will see that some potential economic surplus is lost when the tariff is imposed

33. What happens when we impose a tariff? • Total surplus without tariffs • Shaded area

34. What happens when we impose a tariff? • With a tariff, the price paid by consumers is the world price plus the amount of the tariff • Think of a tariff just like a tax • This increases the quantity supplied domestically and decreases the amount imported

35. What happens when we impose a tariff? • Quantity supplied domestically increases • Imports decrease • Before, 100 tons minus 20 tons, or 80 tons • After, 80 tons minus 40 tons, or 40 tons

36. Total surplus and tariff money collected • Consumer surplus (CS) • Producer surplus (PS) • Tariff revenue generated • What is missing?

37. Total surplus and tariff money collected • CS • PS • Tariffs • What is missing? • Two triangles are lost with the imposition of tariffs

38. Total surplus and tariff money collected • The two triangles lost are potential surplus that could be gained • Notice that relative to open global trade, producer surplus is higher • See Economic Naturalist 9.2 to see an example of why there is pressure to impose tariffs • Consumer surplus is lower with the tariff (relative to open global trade)

39. Quotas • Quotas are similar to tariffs, except: • Domestic supply plus quota determines supply available in a country’s market • Equilibrium in this example is price of 125, 80,000 TV’s

40. What else is different with quotas? • With quotas, no revenues are directly generated • Those with right to import and export gain economic rents • Example: See Economic Naturalist 9.3 for groups that benefited with “voluntary export restraints,” which is a form of quota

41. “Outsourcing” • “Outsourcing” has been a controversial term in the media in recent years • There are definitely short-run costs of outsourcing • Displaced workers • Buildings and machinery that gets unused

42. “Outsourcing” • Long-run benefits of outsourcing • Each country can specialize what it has comparative advantage in • Technological improvements lower the costs of trade • Lower costs to consumers

43. How to make sure your job does not get outsourced • Make sure it requires a lot of face-to-face contact • Construction work • Repair labor • Health care • Make sure that you have skills that nobody else has

44. Final thoughts about “outsourcing” • Trade policy can be formed such that those that are displaced are not any worse off • Some of the gains from “making the pie bigger” can be transferred to those that get displaced • Justification for re-training programs for displaced workers • Overall, the standard of living of a country improves with trade • Example: Think how much bananas would cost if we could not import them

45. Summary • Trade improves overall surplus • Some people win, while others lose • Trade barriers, such as protectionism, quotas, and tariffs limit the gains from trade • Outsourcing has short-run costs but long-run benefits in a country’s economy