CHAPTER 19 Trading with the World

1. ECONOMICS 5e Michael Parkin CHAPTER 19Trading with the World Chapter 36 in Economics

2. Learning Objectives • Describe the patterns in international trade • Explain comparative advantage and explain why all countries can gain from international trade • Explain how economies of scale and diversity of taste lead to gains from trade

3. Learning Objectives (cont.) • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities • Explain the arguments used to justify trade restrictions and show how they are flawed • Explain why we have trade restrictions

4. Learning Objectives • Describe the patterns in international trade • Explain comparative advantage and explain why all countries can gain from international trade • Explain how economies of scale and diversity of taste lead to gains from trade

5. Patterns in International Trade Imports are the goods and services we buy from other countries. Exports are the goods and services we sell to people in other countries.

6. Patterns in International Trade Trade in Goods • 50 percent of our exports and 60 percent of our imports are manufactured goods • Capital goods and autos are the leading export and import • Services make up 26 percent of our exports and 17 percent of our imports

7. Patterns in International Trade Trade in Services • The spending of a foreigner (students, vacationers) in a country is the importation of services. • Shipping and insurance charges paid to foreign firms on imported goods is the importation of services.

8. Patterns in International Trade Geographical Patterns • Canada is the Unites States’ leading trading partner for both imports and exports • 45 percent of our imports are from Asian countries

9. Patterns in International Trade Trends in the Volume of Trade • In 1960, the U.S. exported less than 5 percent of total output and imported 4.5 percent of the goods and services consumed domestically. • Since 1960, the composition of imports have changed dramatically • Food and raw material imports have fallen. • Machinery comprise close to 50 percent of total imports.

10. Patterns in International Trade Balance of Trade and International Borrowing • The balance of trade is the value of exports minus the value of imports. • In 1996 the U.S. had a $95 billion deficit. • We must either borrow from foreigners or sell some of our assets.

11. Learning Objectives • Describe the patterns in international trade • Explain comparative advantage and explain why all countries can gain from international trade • Explain how economies of scale and diversity of taste lead to gains from trade

12. Opportunity Cost and Comparative Advantage A comparative advantage exists for a country if it can perform an activity at a lower opportunity cost than any other country. Recall Tom and Nancy — Chapter 3.

13. Opportunity Cost and Comparative Advantage Countries can increase consumption if they produce only those goods in which they have a comparative advantage. Let’s look at Farmland and Mobilia

14. Opportunity cost of 1 car is 9,000 bushels of grain 18 billion bushels of grain 2 million cars Opportunity Cost in Farmland 36 30 24 Grain(billions of bushels per year) a 15 6 Farmland’s PPF 0 4 7 8 9 12 Cars (millions per year)

15. 6 billion bushels of grain Opportunity cost of 1 car is 1,000 bushels of grain 6 million cars Opportunity Cost in Mobilia 20 a' 18 14 Grain(billions of bushels per year) 12 Mobilia’s PPF 6 0 2 4 8 12 Cars (millions per year)

16. Opportunity Cost and Comparative Advantage Mobilia has a comparative advantage in car production. Farmland has a comparative advantage in grain production.

17. Gains from Trade Let’s see how two groups do business with each other.

18. Farmland’s no-trade point a Mobilia’s export supply of cars Mobilia’s no-trade point Farmland’s import demand for cars a' International Trade in Cars 9 6 Price (thousands of bushels of grain per car) 3 1 0 2 6 4 Quantity (millions of cars per year)

19. Gains from Trade Balanced Trade • Farmland pays for its cars by exporting grain. • They must export 12 billion bushels of grain for 4 million cars. • Mobilia is exporting 4 million cars for 12 billion bushels of grain. Trade is balanced.

20. Gains from Trade Changes in Production and Consumption • How is it possible for everyone to gain? • With international trade economies can consume a different quantity than it produces.

21. Production with trade b c No-trade production and consumption a Consumption with trade Expanding Consumption Possibilities 48 42 Farmland 36 Grain(billions of bushels per year) 30 24 18 12 6 18 0 4 5 8 9 12 15 Cars (millions per year)

22. Consumption with trade No-trade production and consumption b' Production with trade Expanding Consumption Possibilities Mobilia 36 Grain(billions of bushels per year) c' 24 21 a' 9 0 4 5 8 9 12 16 Cars (millions per year)

23. Learning Objectives • Describe the patterns in international trade • Explain comparative advantage and explain why all countries can gain from international trade • Explain how economies of scale and diversity of taste lead to gains from trade

24. Gains from Trade in Reality • The U.S. buys TVs and VCRs from Korea, machinery from Europe, and fashion goods from Hong Kong. • We sell machinery, grain, and lumber, airplanes, computers, and financial services. • Why do we exchange manufactured goods?

25. Gains from Trade in Reality Diversity of Taste and Economies of Scale • Due to the large diversity in human tastes, people value diversity and are willing to pay for it. • The production of many manufactured goods are faced with economies of scale.

26. Learning Objectives (cont.) • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities • Explain the arguments used to justify trade restrictions and show how they are flawed • Explain why we have trade restrictions

27. Trade Restrictions • Tariffs are tax imposed by an importing country when an imported good crosses its international boundary. • Nontariff barriers are actions other than a tariff that restricts international trade. • Quantity restrictions, licensing requirements.

28. U.S. Tariffs: 1930–1996

29. Trade Restrictions The North American Free Trade Agreement (NAFTA) became effective January 1, 1994. • All trade barriers will virtually be eliminated between the U.S., Mexico, and Canada during a 15 year phasing-in period. European Union • Created the largest unified tariff-free market in the world

30. Trade Restrictions How Tariffs Work What happens if Farmland places a tariff on the importation of cars: • The supply of cars in Farmland decreases. • The price of a car in Farmland rises. • The quantity of cars imported by Farmland decreases.

31. Trade Restrictions How Tariffs Work What happens if Farmland places a tariff on the importation of cars: • The government of Farmland collects the tariff revenue. • Resource use is inefficient. • The value of exports changes by the same amount as the value of imports and trade remains balanced.

32. Mobilia’s export supply of cars plus tariff Tariff revenue The Effects of a Tariff 9 6 Price (thousands of bushels of grain per car) Mobilia’s export supply of cars 3 2 Farmland’s import demand for cars 1 0 2 4 6 Quantity (millions of cars per year)

33. Trade Restrictions Nontariff Barriers • Quotas are a quantitative restriction on the import of a particular good. • Voluntary export restraints (VER) are agreements between two governments in which the government of the exporting country agrees to restrain the volume of its own exports.

34. Quota Importer’s profit The Effects of a Quota 9 6 Price (thousands of bushels of grain per car) Mobilia’s export supply of cars 3 2 Farmland’s import demand for cars 1 0 2 4 6 Quantity (millions of cars per year)

35. Learning Objectives (cont.) • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities • Explain the arguments used to justify trade restrictions and show how they are flawed • Explain why we have trade restrictions

36. The Case Against Protection The National Security Argument “A country must protect industries that produce defense equipment and armaments and those on which the defense industries rely for their raw materials and other intermediate inputs.”

37. The Case Against Protection The National Security Argument This argument is false because: • In a time of war, all industries contribute to national defense. • It is more efficient to subsidize firms, financed from taxes, if a country wishes to increase the output of a strategic industry.

38. The Case Against Protection The Infant-Industry Argument “It is necessary to protect a new industry to enable it to grow into a mature industry that can compete in world markets.”

39. The Case Against Protection The Infant-Industry Argument This argument is false because: • It only applies if the benefits of learning-by-doing not only accrue to the owners and workers of the firms in the infant industry, but also spill over to other industries and parts of the economy. • It is more efficient to protect an infant industry by using a subsidy financed from taxes.

40. The Case Against Protection The Dumping Argument Dumping occurs when a foreign firm sells its exports at a lower price that its cost of production.

41. The Case Against Protection The Dumping Argument The dumping argument should be resisted because: • Dumping is virtually impossible to detect. • A natural global monopoly is not likely. • Regulation would be the best way of dealing with a natural global monopoly.

42. Other Arguments for Protection 1) Saves jobs. 2) Allows us to compete with cheap foreign labor. 3) Brings diversity and stability. 4) Penalizes lax environmental standards. 5) Protect national culture. 6) Prevents rich countries from exploiting developing countries.

43. Learning Objectives (cont.) • Explain why trade restrictions reduce the volume of imports and exports and reduce our consumption possibilities • Explain the arguments used to justify trade restrictions and show how they are flawed • Explain why we have trade restrictions

44. Why Is InternationalTrade Restricted? Tariff Revenue Rent Seeking Free trade brings benefits to some but imposes costs on others, with total benefits exceeding total costs

45. Why Is InternationalTrade Restricted? Compensating Losers Losers are compensated, to some degree, in reality: • NAFTA and retraining workers • Unemployment compensation

46. Why Is InternationalTrade Restricted? Difficulties: • Cost of identifying losers and estimating losses would be enormous. • Losers today may be winners tomorrow.

47. The End