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International trade

International trade. Today: Winners and losers of various international trade policies. Previously, we talked about…. How trade can benefit people Comparative advantage being the core of beneficial trade An introduction of international trade. Today: More on international trade.

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International trade

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

  2. Previously, we talked about… • How trade can benefit people • Comparative advantage being the core of beneficial trade • An introduction of international trade

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

  4. 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

  5. Comparative advantage: Same numbers, different names

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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

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

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

  18. 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

  19. 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

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

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

  22. Net gain Imports

  23. 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 • Consumer surplus decreases when trade occurs • Producer surplus increases when trade occurs • Overall, total surplus increases

  24. Tariffs, quotas, and bailouts • Even when trade is not prohibited, countries use other devices to 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 • Bailouts: An example with U.S. automakers • Subsidized loans • See additional reading on class website

  25. 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

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

  27. 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

  28. 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

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

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

  31. 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 • Consumer surplus is lower with the tariff (relative to open global trade)

  32. Voluntary export restraints (VERs) • 1970s • Many American consumers bought fuel-efficient Japanese cars • 1980s • VERs agreed to between US and Japan • U.S. auto makers benefited by decreased competition • Japanese auto makers benefited by being able to raise their prices • U.S. consumers lost by having to pay more for all cars purchased

  33. VERs • VERs are a type of quota • What does economic theory tell us about quotas?

  34. 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

  35. What else is different with quotas? • With quotas, no revenues are directly generated • Those with right to import and export gain economic rents

  36. The U.S. automaker bailout • Bad decision making • CAFE standards • What did fuel economy standards lead to? • Minivans • SUVs • Bankruptcy for some U.S. automakers in the near future?

  37. “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

  38. “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

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

  40. 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

  41. 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

  42. Upcoming attractions • For the next month, we will examine market failures and some economic fields • Market failures: Monopoly, oligopoly, monopolistic competition, externalities, cost of information, private provision of public goods • Fields • Some potential topics: Labor, Income distribution, Environment, Health/Safety, Public Good analysis

  43. End of Unit 3 • Starting next week, Unit 4 • Monopoly, including profit maximization and inefficiencies • Game theoretical tools needed to analyze small groups of people or firms • Applications, including Prisoner’s Dilemma • Study of externalities

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