Chapter 19 notes

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Eastern Illinois University

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19International Trade

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The Gains from Trade

• Law of comparative advantage – The individual with the lowest opportunity

cost of producing a particular good

– Should specialize in that good

• Each country specializes– In making goods with the lowest

opportunity cost

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• U.S. exports– $1.6 trillion (11% of GDP) in 2009

– Services (32% of U.S. exports)

• U.S. imports– $1.9 trillion (14% of GDP) in 2009

– Industrial supply (25% of U.S. imports)

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Exhibit 1

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Composition of U.S. Exports and Imports in 2009



• U.S. trading partners, 2009– Top 10 destinations for merchandize

exports• Canada, Mexico, China, Japan, United

Kingdom, Germany, Netherlands, South Korea, France, and Brazil

– Top 10 sources of merchandize imports• China, Canada, Mexico, Japan, Germany,

United Kingdom, South Korea, France, Taiwan, and Ireland

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Consumption Possibilities

• Gains from specialization and trade– Each country should specialize

• Producing the good with the lower opportunity cost

• Terms of trade – How much of one good exchanges for a

unit of another good

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Reasons for Specialization

• Differences in resource endowments– Create differences in opportunity cost

– Countries export goods• Produce more cheaply

– Countries import• Products unavailable domestically• Cheaper elsewhere

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Exhibit 5

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U.S. Production as a Percentage of U.S. Consumption for Various Resources

If U.S. production is less than 100 percent of U.S. consumption, then imports make up the difference. If U.S. production exceeds U.S. consumption, then the amount by which production exceeds 100 percent of consumption is exported.


Reasons for Specialization

• Economies of scale– Firms produce more

– Reducing average costs

• Differences in tastes– Differences in consumption patterns

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Consumer and Producer Surplus

• Demand: marginal benefit • Consumer surplus

– Difference between what consumer would pay and what they pay

• Supply: marginal cost• Producer surplus

– Difference between actual amount received and what they would accept

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Exhibit 6

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Consumer Surplus and Producer Surplus

0 60 Apples

(pounds per day)

S

D

Consumer

surplus

Producer surplus

1.00

0.50Pric

e pe

r po

und 2.00

$3.00

Consumer surplus, shown by the blue triangle, indicates the net benefits consumers reap from buying 60 pounds of apples at $1.00 per pound. Some consumers would have been willing to pay $3.00 or more per pound for the first few pounds. Consumer surplus measures the difference between the maximum sum of money consumers would pay for 60 pounds of apples and the actual sum they pay. Producer surplus, shown by the gold triangle, indicates the net benefits producers reap from selling 60 pounds at $1.00 per pound. Some producers would have supplied apples for $0.50 per pound or less. Producer surplus measures the difference between the actual sum of money producers receive for 60 pounds of apples and the minimum amount they would accept for this amount.


Trade Restrictions

• Tariff: Tax on imports– Specific: $ amount per unit

– Ad valorem: Percentage per unit

– Effects • Loss of consumer surplus• Increase in producer surplus• Increase in government revenue• Net loss in domestic social welfare

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Exhibit 7

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Effect of a Tariff

$0.15

0.10

Pric

e p

er p

ound S

D

0 30

Sugar (millions of pounds per month)

20 60 70

a b c d

f

At a world price of $0.10 per pound, U.S. consumers demand 70 million pounds of sugar per month, and U.S. producers supply 20 million pounds per month; the difference is imported. After the imposition of a $0.05 per pound tariff, the U.S. price rises to $0.15 per pound. U.S. producers supply 30 million pounds, and U.S. consumers cut back to 60 million pounds. At the higher U.S. price, consumers are worse off; their loss of consumer surplus is the sum of areas a, b, c, and d. The net welfare loss to the U.S. economy consists of areas b and d.


Trade Restrictions

• Import quotas: Legal limit on the amount of a commodity that can be imported– Target imports from certain countries

– Effects• Raise the US price above the world price• Reduce quantity below the free-trade level• Lower consumer surplus• Increase in producer surplus• Net loss in domestic social welfare

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Trade Restrictions

• Quotas in practice– Rewards domestic and foreign producers

with higher prices

– Lobbyists for foreign producers• Seek the right to export to U.S.

– Auction off the quotas• Increase federal revenue• Reduce pressure to perpetuate quotas

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Trade Restrictions

• Comparison: Tariffs and Quotas– Similarities

• Higher price, Lower quantity demanded• Loss of consumer surplus (U.S. consumers)• Gain of producer surplus (U.S. producers)• Lower economic welfare

– Differences• Revenue from tariff – to U.S. government• Revenue from quota - to quota rights’ owner

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Other Trade Restrictions

• Export subsidies - to encourage exports• Domestic content requirements

– A certain portion of a final good must be produced domestically

• Other requirements– Health, Safety, Technical standards

– Discriminate against foreign goods

• Trade restrictions– Slow economic progress

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Multilateral Agreement

• General Agreement on Tariffs and Trade, GATT:– 1947, 23 countries

• Reduce tariffs• Reduce import quotas• Equal trade

– 1986, “Uruguay Round”• 150 countries• Successor: WTO

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The World Trade Organization

• Legal and institutional foundation for world trade

• 500 economists and lawyers• Trade

– Merchandise

– Services

– Intellectual property

• Phase out quotas, keep only tariffs

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Common Markets

• U.S. economy– Free trade zone across 50 states

• European Union– 27 countries in 2010

– Barrier-free European market

– 17 members: common currency – Euro

• North American Free Trade Agreement– United States, Canada, Mexico

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Arguments for Trade Restrictions

• National defense argument– Domestic industry’s output is vital to

national defense

– More efficient• Government subsidies• Stockpile basic military hardware

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• Infant industry argument – Protect emerging domestic industries

– Foster inefficiencies

– Cost: net welfare loss from higher domestic prices

– More efficient• Temporary production subsidies

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• Antidumping argument– Dumping: sell a product abroad for less

than in the home market• Persistent

– Consumers - pay less– Increase consumer surplus

• Predatory– Temporary; eliminate competitors

• Sporadic– “sales”

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• Jobs and income argument– Protect domestic jobs

– Retaliation

– Great Depression: high tariffs choked trade and jobs

• Declining industries argument– Help lessen shocks to the economy

– Specific duration

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Problems with Trade Protection

• Protect one stage of production– Protect downstream stages

• Cost of protection– Welfare loss, Cost of rent seeking

• Transaction cost of enforcing restrictions– Black markets

• Less efficient, less innovative• Retaliation

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Chapter 19 notes

Economy & Finance

Transcript of Chapter 19 notes