ECO 1003Handouts for

Chapters 28-29-30

Chapter 28Globalization and the Wealth of America• Globalization

• The integration of national economies into an international economy as a result of lower trade barriers and reduced transportation and communication costs

• North American Free Trade Agreement (NAFTA)• An agreement signed by Canada, Mexico, and the United States, creating a trilateral trade bloc in North America

• The agreement came into force on January 1, 1994

Chapter 28Globalization and the Wealth of America• General Agreement on Tariffs and Trade (GATT)

• A multilateral agreement regulating international trade

• According to its preamble, its purpose was the “substantial reduction of tariffs and other trade barriers and the elimination of preferences, on a reciprocal and mutually advantageous basis”

• It was negotiated during the United Nations Conference on Trade and Employment and was the outcome of the failure of negotiating governments to create the International Trade Organization (ITO)

• GATT was signed in 1947 and lasted until 1994, when it was replaced by the World Trade Organization in 1995

Chapter 28Globalization and the Wealth of America• World Trade Organization (WTO)

• An association of more than 145 nations that helps reduce trade barriers among its members and settles international trade disputes among them

• Trade barriers• Any rules having the effect of reducing the amount of international exchange; tariffs and quotas are trade barriers

• Tariff• A tax levied on imports

Chapter 28Globalization and the Wealth of America• Quotas

• An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

• It is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time

• Quotas, like other trade restrictions, are used to benefit the producers of a good in a domestic economy at the expense of all consumers of the good in that economy

Chapter 28Globalization and the Wealth of America• Subsidies

• Government payments for the production of specific goods, generally designed to raise the profits of the firms receiving the subsidies and often intended to increase the output of the subsidized goods

• Luxury good• A good for which the income elasticity of demand is greater than 1, meaning that people spend an increasing proportion of their income on the good as they get richer

Chapter 28Globalization and the Wealth of America• The Effects of An Import Tariff

Chapter 28Globalization and the Wealth of America• There are two sources of potential supply, domestic firms with supply curve Sd, and foreign firms with supply curve Sf

• Absent government intervention, the market supply curve would be St, which is the horizontal summation of Sc and Sf

• Market price and quantity would thus be P and Qt in the domestic market

Chapter 28Globalization and the Wealth of America• Suppose the domestic firms convince the government to

impose a per-unit tariff on imports, causing the foreign supply curve to shift up vertically by the amount of the per-unit tariff to Sf’ and result in a new market supply of St’• This causes the domestic price to rise to P′ (making

domestic consumers worse off), and reduces the total amount of the good consumed domestically to Qt’

• The rise in price is far less than the higher costs suffered by the foreign firms, so they too are made worse off

• The big winners are the domestic firms, for they enjoy higher prices and greater market share, both contributing to higher profits for them

Chapter 28Globalization and the Wealth of America• The greater the tariff that the government imposes, the greater are

the benefits to the domestic firms and the greater are the losses to both the foreign firms and to domestic consumers

• The greater the initial importance of imports in supplying domestic consumers, the greater are the benefits to the domestic industry and the greater the losses to domestic consumers

• Although a tariff definitely reduces world welfare, because it reduces the extent of mutually beneficial exchange, it may actually yield net benefits to the citizens of the nation that imposes it• This can occur if the domestic economy is large enough relative

to the world market that the domestic tariff affects world prices• In this case, the domestic government can use an import tariff to

redistribute wealth from foreigners to domestic citizens

Chapter 29The $750,000 Steelworker• Gains from trade• Productivity

• Output produced per unit of input • Comparative advantage

• The ability to produce a good at a lower opportunity cost than others; the principle of comparative advantage implies that individuals, firms and nations will specialize in producing goods for which they have the lowest opportunity cost compared to other entities

• Protectionism• The imposition of rules designed to protect certain individuals

or firms from competition, usually competition from imported goods

• Imports and exports

Chapter 29The $750,000 Steelworker• The Effects of a Quota System

Chapter 29The $750,000 Steelworker• Quotas are restrictions imposed by one nation on the

quantity of a specific foreign good that can be imported and sold in its domestic market.

• Absent any quotas, the price of autos is denoted as P0, and U.S. consumers buy QUS at that price

• The panel on the left shows the foreign-produced supply of autos to the U.S. market

• At price P0, Qf autos will be supplied by foreign firms• The middle panel shows the domestic supply of autos in the

U.S. market, with Qd being supplied at price P0

• In the right panel, SUS is the horizontal summation of the supply curves Sf and Sd

• Thus at price P0, the quantity QUS = Qf + Qd

Chapter 29The $750,000 Steelworker• If the U.S. government imposes a quota limiting imports to Q f’

the new supply curve of imported autos is ABSf’• With the decrease in the supply of foreign autos (shown in the

U.S. market as a shift from SUS to SUS’ the price in the U.S. market rises to P1 and the quantity demanded falls to QUS’

• The resulting loss in consumer surplus to U.S. auto consumers is shown by the shaded area in the right panel

• As shown in the middle panel, however, the increase in the price of autos causes an increase in the quantity of domestically supplied autos from Qd to QUS’ which increases the producer surplus of domestic manufacturers by an amount shown by the shaded area in the middle panel

• At least in the short run, a quota system can be shown to increase the profits of import-competing domestic firms, but there is also a loss in consumer surplus due to the increase in price—a loss that must exceed the gains to producers

Chapter 30The Lion, the Dragon, and the Future• Direct foreign investment (FDI)

• Resources provided to individuals and firms in a nation by individuals or firms located in other countries, often taking the form of foreign subsidiary or branch operations of a parent company

• Economic growth• Sustained increases over time in real per capita income

• Per capita income• Average income per person

Chapter 30The Lion, the Dragon, and the Future• Purchasing power

• The amount of goods or services that can be purchased with a unit of currency

• Outsourcing• The practice of having workers located in foreign lands perform tasks typically services that have traditionally been performed by domestic workers

• Intellectual property• Creative ideas and expressions of the human mind that have commercial value and receive the legal protection of a property right, as through the issuance of a patent, copyright or trademark