International trade

Today: Winners and losers of various international trade

policies

Previously, we talked about…

How trade can benefit people Comparative advantage being the

core of beneficial trade An introduction of international

trade

Today:More on international trade

Review of comparative advantage Examining consumption possibilities

Without trade With trade

Supply and demand analysis of trade Tariffs and Quotas “Outsourcing”

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

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

Comparative advantage

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

Opportunity cost of cooking

a pizza

Opportunity cost of making a salad

U.S. ½ salad 2 pizzas

Chile ¼ salad 4 pizzas

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

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

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

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

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

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

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

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

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

Market for cars, w/o trade Suppose that

without trade, 40,000 cars are sold at a price of $14,000

Market for cars, w/o trade Consumer

surplus is blue shaded area

Producer surplus is red shaded area

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

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

Surplus with trade Consumer

surplus increases substantially

Producer surplus decreases, but does not change as much as consumer surplus does

Imports

Without imports (left)With imports (right)

Imports

Net gain

Imports

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

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

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

What happens when we impose a tariff? Total surplus

without tariffs Shaded area

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

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

Total surplus and tariff money collected Consumer

surplus (CS) Producer

surplus (PS) Tariff revenue

generated What is

missing?

Total surplus and tariff money collected CS PS Tariffs What is

missing? Two triangles

are lost with the imposition of tariffs

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)

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

VERs

VERs are a type of quota What does economic theory tell us

about quotas?

Quotas Quotas are similar

to tariffs, except: Domestic supply

plus quota determines supply available in a country’s market

Equilibrium in this example is price of 125, 80,000 TV’s

What else is different with quotas?

With quotas, no revenues are directly generated Those with right to import and export

gain economic rents

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?

“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

“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

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

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

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 country’s economy

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

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 Prisoner’s Dilemma

Study of externalities