The Power Of Macroeconomics

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The Power Of Macroeconomics
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International Trade And Protectionism
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Lesson 9 Colander McConnell Samuelson
Schiller Brue Nordhaus 3rd Edition 14th
Edition 16th Edition 8th Edition
Complete Textbook (includes both Micro-and
Macroeconomics) Macroeconomics Text Only
6, 16 6, 37 35 2, 35 (pp.408-416)
6, 16 6, 20 19 2, 20 (pp. 408-416)
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Introduction

• Here is some alphabet soup for you NAFTA, GATT
  and the Euro.
• And then, of course, there are words like tariffs
  and quotas and trade deficits.

• And dumping and non-tariff barriers and
  protectionism.

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The Language ofInternational Economics

• While it may seem like a foreign language to you
  now, it is a language that we must come to
  master.
• It is this language of international trade that
  has become the foundation of economic growth and
  prosperity in the 21st century.

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The Flow of Trade

• America ships enormous volumes of food,
  airplanes, computers, and construction machinery
  to other countries.
• In return, Americans receive vast quantities of
  oil, VCRs, cars, kiwi fruits, and other goods and
  services.

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Foreign Import Dependence

• And while we may produce most of our national
  output, much of our consumption -- including
  clocks, railroads, penicillin, radar, and rock
  groups like the Rolling Stones has originated
  in faraway places.

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In This Lecture

• We're going to examine the economic principles
  governing international trade.
• Let's start with some basic statistics.

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Shares of World Exportsselected nations
percentage share of world exports
0 2 4 6 8 10 12
United States Germany Japan France United
Kingdom Italy Canada
The seven largest export nations--all industrial
nations--account for nearly 50 of world exports.
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Principle commodity exports and imports of the
United States (dollars in billions)
Exports Amount Imports Amount
Chemicals 30.1 Automobiles 52.2 Computers
29.3 Petroleum 51.5 Consumer Durables
26.6 Computers 38.0 Aircraft 20.1 Clothing
31.7 Semiconductors 19.1 Household appliances
22.5 Generating equipment 17.0 Semiconductors
19.5 Nonferrous metals 14.6 Chemicals
18.1 Automobiles 14.5 Toys and sporting goods
12.4 Grains 14.4 Iron and steel
11.8 Telecommunications 13.5 Telecommunications
11.3
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The Asian Dragons

• The four "Asian Dragons" -- Hong Kong, Singapore,
  South Korea, and Taiwan -- have all expanded
  their share of world trade from three percent in
  1972 to over 10 percent today while China has
  emerged as the most powerful new trader on the
  international block.

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Our Questions

• Why do nations trade?
• How do nations decide what to import and export?
• To answer these questions, we must explore the
  mysteries of absolute advantage versus
  comparative advantage.

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Absolute Advantage

• The idea of absolute advantage as a basis for
  trade was set forth by Adam Smith.
• A country that can produce a good at a lower cost
  than another country is said to have an absolute
  advantage in the production of that good.

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For Example

• Saudi Arabia has millions of barrels of cheap oil
  but growing food in its desert climate is very
  expensive.

• The United States can grow food cheaply in its
  temperate climate and fertile soil, but American
  oil isn't as cheap to extract as Saudi crude.

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An Absolute Advantage

• Because it can produce a certain amount of oil
  with fewer resources, Saudi Arabia has an
  absolute advantage over the United States in
  producing oil just as the United States has an
  absolute advantage over Saudi Arabia in producing
  food.
• The theory of absolute advantage would predict --
  in this case quite correctly -- that America
  should sell food to Saudi Arabia and buy oil from
  it.

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At First Glance

• The principal of absolute advantage appears to
  make imminent sense.
• Nonetheless, it has a significant implication,
  and one that is badly flawed.

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of of Resources
Resources Devoted to Autos
Food Devoted to Autos Food
Autos Produced Produced Row
Autos Produced Produced Row
100 100 0 A 100 20 0 A 80 80
40 B 80 16 1 B 60 60 80 C 60 12 2 C 40
40 120 D 40 8 3 D 20 20 160 E 20
4 4 E 0 0 200 F 0 0 5 F (a)
Germany (b)Algeria

• The theory of absolute advantage would predict
  that Germany has nothing to gain from trading
  with Algeria.

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The Theory of Comparative Advantage

• This is where a more subtle understanding of
  trade patterns enters the picture.
• This more subtle understanding is embodied in the
  theory of comparative advantage.

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The Theory Of Comparative Advantage

• Was first set forth in 1817 by David Ricardo.
• The historical context for the development of
  Ricardos theory of comparative advantage is
  interesting in and of itself.

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At The Time

• Europe was considering protecting its markets
  from American imports through the use of tariffs
  or quotas.
• Europe's concern was that America, with its
  abundant land and inexpensive labor, would have
  an absolute advantage in producing many goods and
  might therefore not import anything from Europe
  but merely export its cheaper goods -- thereby
  destroying jobs in Europe.

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The Principle of Comparative Advantage

• Each country will benefit if it specializes in
  the production and export of those goods that it
  can produce at relatively low cost.
• Conversely, each country will benefit if it
  imports those goods that it produces at
  relatively high cost.

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Back in Time

• Imagine a debate between Ricardo and another
  economist in front of a group of European trade
  ministers trying to decide whether to impose
  protective tariffs on America.

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A strong supporter of the theory of absolute
advantage
American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4

• Which country has the absolute advantage in food
  and which has the absolute advantage in clothing?

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American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4
Which country has the comparative advantage in
food versus clothing?
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American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4

• America has the comparative advantage in food
  while Europe has the comparative advantage in
  clothing.

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American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4

• David Ricardo uses a simple production
  possibilities frontier analysis to demonstrate it.

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Ricardo's PPF Demonstration

• Assume that
• Both America and Europe have 600 hours of labor
  available.
• Costs are constant so that we can draw our
  production possibilities curves as straight
  lines.
• Transportation costs are zero.

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American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4

• Try to draw the production possibilities
  frontiers for both America and Europe.
• Put clothing on the vertical axis and food on the
  horizontal axis.

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(a) America
(b) Europe
450 300 150 0
450 300 150 0
Clothing
Clothing
200 400 600
100 200 300
Food
Food
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After Trade
"Suppose that I sent you to America with a 150
units of clothing. How many units of food could
you trade that for?"
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American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4

• John Strawman might be able to trade Europe's
  clothing for as much as 300 units of food.
• This is 100 units more than Europe could have
  produced with its own labor resources alone.

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450 300 150 0
(b) Europe
100 200 300
Food
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America's Perspective
Would America be better off trading with Europe
even though it can produce both food and clothing
more efficiently than Europe?
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America's Perspective
Suppose the American President sent a Trade
Representative to Europe with 100 units of food
and instructions to trade for as much clothing as
possible. Would America be pleased with the
resultant deal?
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American and European Labor Requirements for
Production Necessary labor for production
(labor-hours) Product In America In
Europe
1 unit of food 1
3 1 unit of clothing 2
4

• America could trade some of the 100 units of food
  for as much as 133 and 1/3rd units of clothing.

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450 300 150 0
(a) America
Clothing
America might gain from trade despite having an
absolute advantage in food production.
200 400 600
Food
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The Broader Point

• The theory of comparative advantage is one of the
  deepest truths in all of economics
• Nations that disregard the lessons of comparative
  advantage will pay a heavy price in terms of
  their living standards and economic growth.

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8 6 4 2 0 -2 -4 -6
Average yearly per capita growth
Singapore
?
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Hong Kong
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South Korea
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Sri Lanka
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Tanzania
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Ghana
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Sierra Leone
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Nigeria
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Zambia
0 50 100 150 200
250 300
Level of trade protection (index number)
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End Of Part I
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