International trade

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International trade

• Today Winners and losers of various
  international trade policies

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Previously, we talked about

• How trade can benefit people
• Comparative advantage being the core of
  beneficial trade
• An introduction of international trade

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TodayMore on international trade

• Review of comparative advantage
• Examining consumption possibilities
• Without trade
• With trade
• Supply and demand analysis of trade
• Tariffs and Quotas
• Outsourcing

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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

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Comparative advantage Same numbers, different
names
Productivity in pizza production Productivity in salad production
United States 20 pizzas cooked per hour 10 salads made per hour
Chile 16 pizzas cooked per hour 4 salads made per hour
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Comparative advantage
Opportunity cost of cooking a pizza Opportunity cost of making a salad
U.S. ½ salad 2 pizzas
Chile ¼ salad 4 pizzas

• Recall To find comparative advantage for each
  person, find the lowest number in each column

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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

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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

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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

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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

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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

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Market for cars, w/o trade

• Suppose that without trade, 40,000 cars are sold
  at a price of 14,000

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Market for cars, w/o trade

• Consumer surplus is blue shaded area
• Producer surplus is red shaded area

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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

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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
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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
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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

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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

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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

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What happens when we impose a tariff?

• Total surplus without tariffs
• Shaded area

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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

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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

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Total surplus and tariff money collected

• Consumer surplus (CS)
• Producer surplus (PS)
• Tariff revenue generated
• What is missing?

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Total surplus and tariff money collected

• CS
• PS
• Tariffs
• What is missing?
• Two triangles are lost with the imposition of
  tariffs

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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

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VERs

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

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Quotas

• Quotas are similar to tariffs, except
• Domestic supply plus quota determines supply
  available in a countrys market
• Equilibrium in this example is price of 125,
  80,000 TVs

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What else is different with quotas?

• With quotas, no revenues are directly generated
• Those with right to import and export gain
  economic rents

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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

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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

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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

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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

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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 countrys economy

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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

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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 Prisoners Dilemma
• Study of externalities