MBMC International Trade. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights...

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International TradeInternational Trade

Chapter 9: International Trade Slide 2

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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.

Introduction

Understanding the Economic Issues of International TradeThe benefits of tradeThe costs of tradeThe economic impact of trade restrictions


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Comparative Advantageas a Basis for Trade

The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries.


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Production and Consumption Possibilities and the Benefits of Trade

Closed EconomyAn economy that does not trade with the

rest of the world

Open Economy

An economy that trades with other countries


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Production Possibilities Curve for a Many-Worker Economy

Computers (number/year)

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

Observations• The OC of producing an

additional unit = the slope of the line that touches the point

• OC will increase as output of on good increases

100,000

40,000

1,000 2,000


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A country’s PPC shows the quantities of different goods that its economy can produce.

Consumption PossibilitiesThe combinations of goods and services

that a country’s citizens might feasibly consume



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In a closed economy:Society’s production possibilities =

consumption possibilities.If a country is self-sufficient, it is called

autarky.



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In an open economy:The society’s consumption possibilities are

typically greater than its production possibilities.



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Buying and Selling in World Markets

Computers/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

Assume:• Producing at D• Closed economy• World price of coffee = $10/lb and

computer = $500120,000

100,000

1,000

50,000

2,000 2,400

150,000

3,000


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Computers/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

F

Observation:• Sell 2,000 computers @ $500• Take the $1million and buy 100,000

pounds of coffee• Consumption possibilities of 150,000 is

greater than PPC without trade

E150,000

120,000

100,000

1,000

50,000

2,000 2,400 3,000

Consumptionpossibilities

Productionpossibilities


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Computers/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

F

Observation:• Start at D• Sell 50,000 lbs of coffee• Buy 1,000 computers with the $500,000• Pt F is possible with trade but not on the PPC

E150,000

120,000

100,000

1,000

50,000

2,000 2,400 3,000




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Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy

Computers/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

F

• 50 lbs of coffee trades for 1 computer• LM = consumption possibilities• G is the optimal combination for Costa Rica• Costa Rica can use trade to locate anywhere

along LM

E150,000

120,000

100,000

1,000

50,000

2,000 2,400 3,000



160,000

3,200

G

M

L


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Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy

Computers/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

F

Why produce at G?• Slope of the PPC = LM• Domestic and international opportunity costs

of acquiring an extra computer (in terms of forgone coffee) are equal

E150,000

120,000

100,000

1,000

50,000

2,000 2,400 3,000



160,000

3,200

G

M

L


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A Straight-Line Production Possibilities Curve

Tea (pounds/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D

Observation• The tradeoff between

coffee and tea is constant at any point on the PPC

200

200

600

800

600 800


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Two Consumption Possibilities Curves

Tea (pounds/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

D’

600

200

600

800

800 1,600

D

200

• Islandia produces at A• Islandia can use the money

earned from selling 800 lbs of coffee to choose any combination on AD’

Consumption possibilities curve when the world price of coffee is twice the world price of tea


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Two Consumption Possibilities Curves

Tea (pounds/year

Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

600

200

600

800

800

1,600

D

200

• Islandia produces at D• Islandia can choose any

combination on A’D

Consumption possibilities curve when the world price of tea is twice the world price of coffee

A’


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What Do You Think?Where should Islandia produce if the price

of coffee and tea were the same?

Consumption Possibilities Withand Without International Trade


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ObservationsWith a bow-shaped PPC consumption

possibilities is typically maximized by producing where the PPC is tangent to the consumption possibilities line.

With a straight-line PPC production is completely specialized.

Consumption Possibilities Withand Without International Trade


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Economic NaturalistDoes “cheap” foreign labor pose a danger

to high-wage economies?



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Economic NaturalistScenario

U.S. and Fredonia produce software and beef.Real wages in Fredonia are lower than in the

U.S.Fredonia is half as productive as the U.S. in

beef production.Fredonia is one-tenth as productive in software

production.



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Economic NaturalistOutcome

Fredonia has a comparative advantage in beef.U.S. has a comparative advantage in software.The U.S. will trade software for beef and

increase its consumption of both.Employment in the software industry in the U.S.

increases and employment in the beef industry will decrease.



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The Market forComputers in Costa Rica

Computer per yearWithout Trade

Computer per yearWith Trade

Domesticdemand

Domesticsupply

Consumer surpluswith trade = $1.96mil/yr

Producer surpluswith trade = $360K/yr

Worldprice

2,000 4,800

E

F

1,200 2,800

Computer Imports

2,000 4,800

2,400

1,400

400Domesticdemand

Domesticsupply

Consumer surpluswithout trade = $1mil/yr

Producer surpluswithout trade = $1mil/yr

2,400

1,400

400

1,000

E


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A Supply and Demand Perspective on Trade

If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service.


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The Market forCoffee in Costa Rica

Coffee (pounds/year)Without Trade

100,000 240,000

12

7

4

Domesticdemand

Domesticsupply

Consumer surpluswithout trade = $250K/yr

Producer surpluswithout trade = $150K/yr

E

Coffee (pounds/year)With Trade

100,000

12

7

4

Domesticdemand

Consumer surpluswith trade = $40K/yr

Producer surpluswith trade = $600K/yr

E

Domesticsupply

Worldprice

F

40,000 200,000 240,000

Coffee exports

10


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If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service.


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Observations of the Mutually Beneficial Gains from TradeCountries will profit by exporting the goods

and services for which they have a comparative advantage.

The revenue from the exports are used to import goods and services for which they do not have a comparative advantage.


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Observations of the Mutually Beneficial Gains from TradeThe markets will ensure that goods will be

produced where opportunity cost is lowest.The consumption possibilities will be

maximized.


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Exercise 9.4

Computers per year

Pri

ce o

f co

mp

ute

rs (

$/co

mp

ute

r)

200

Domesticsupply

Worldprice

Domesticdemand

500 800 1,200

600

1,200

2,100

2,400

Question•Given the graph shown, what impact would trade have on producer and consumer surplus?


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Winners and Losers from TradeWinners

Consumers of imported goodsProducers of exported goods

LosersConsumers of exported goodsProducers of imported goods


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ProtectionismThe view that free trade is injurious and

should be restricted

TariffA tax imposed on an imported good

QuotaA legal limit on the quantity of a good that

may be imported


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The Market for Computers after the Imposition of an Import Tariff

Computers per year

Pri

ce o

f co

mp

ute

rs (

$/co

mp

ute

r)

1,200World price + tariff

1,600 2,400

1,000

1,200

Domesticsupply

World price

Domesticdemand

4,800

400

2,400

E

2,800

Importswithouttariff


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The Market for Computers after the Imposition of an Import Tariff

Computers per year

Pri

ce o

f co

mp

ute

rs (

$/co

mp

ute

r)

1,200

Domesticsupply

World price

Domesticdemand

4,800

400

1,200

2,400

1,000

World price + tariff

E

1,600 2,400 2,800

Importswithtariff

Consumer surpluswith tariff = 1.44K/yr

Producer surpluswith tariff = 640K/yr

Tariff revenue =$160K/yr


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Exercise 9.5

Computers per year

Pri

ce o

f co

mp

ute

rs (

$/co

mp

ute

r)

200

Domesticsupply

Worldprice

Domesticdemand

500 800 1,200

600

1,200

2,100

3,600

Question•Given the graph shown, how will a tariff of $300 per computer affect total economic surplus?

1,500

300 700


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Protectionist Policies: Tariffs and Quotas

What do you think?Why did President George W. Bush support

the imposition of tariffs on steel imported into the United States?


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Protectionist Policies: Tariffs and Quotas

QuotasLegal limit on the number or value of foreign

goods that can be importedCan be enforced by issuing permits


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1,200

1,600 2,400

Domestic supply + quota

F

The Market for Computers after the Imposition of an Import Quota

Computers per year

Pri

ce o

f co

mp

ute

rs (

$/co

mp

ute

r)

1,200 2,800

Imports with free trade = 1,600 computers/yr

1,000

Domestic supply

World price

Domesticdemand

4,800

2,400

E1,400

2,000

400


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The Market for Computers after the Imposition of an Import Quota

1,200

1,600 2,400

Domestic supply + quota

F

Computers per year

Pri

ce o

f co

mp

ute

rs (

$/co

mp

ute

r)

1,200 2,800

Imports = 800 computers/year

1,000

Domestic supply

World price

Domesticdemand

4,800

2,400

E1,400

2,000

400

Economic rent to holders of import licenses = $80K/year

Producer surplus with quota = $640K/yr

Consumer surpluswith quota = $1,440K/yr


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Quotas & TariffsMarket effects of tariffs are the same.Tariffs generate tax revenue.Quotas generate revenue for the firms that

hold an import license.


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QuestionWhy would the government ever impose a

quota rather than a tariff?


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Economic NaturalistWho benefited from and who was hurt by

voluntary export restraints on Japanese automobiles in the 1980s?


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Other Barriers to TradeRed-tape barriersRegulations


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The Inefficiency of ProtectionismTrade barriers are inefficient and reduce the

size of the economic pie.Because trade barriers benefit certain

groups, and these groups may be well organized, they may be successful in lobbying for trade barriers.

The gains from trade could be used to assist groups that have been hurt by trade.


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Outsourcing

OutsourcingA term increasingly used to connote having

services performed by low-wage workers overseas


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Outsourcing

OutsourcingOutsourcing of services to low-wage foreign

workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers.


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Economic NaturalistPaul Solman and his associate Lee

Koromvokis produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program, The NewsHour with Jim Lehrer.

Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderbad?

Outsourcing


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Outsourcing

Characteristics of Jobs that are Less Susceptible to OutsourcingLess rules-based jobs“Face-to-Face” complex communication jobsJobs that require the worker to be physically

present


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Outsourcing

Responding to changing economic conditions requires the ability to adapt quickly to new circumstances.

Education provides the means to develop a comparative advantage that is not rules-based and does require complex face-to-face communication.

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End ofChapterEnd of

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MBMC International Trade. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights...

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