PSCI 1500: Introduction to

Economics

Government Policies on International Trade

International TradeBuying and selling of goods and services among different countries.

Export (X)Good or service sold abroad.

Import (M)Good or service purchased from abroad.

INTERNATIONAL TRADE OVERVIEW

What determines whether a country imports or exports a good?

Who gains and who loses from free trade among countries?

What are the arguments that people use to advocate trade restrictions?

INTERNATIONAL TRADE

If the country decides to engage in international trade, will it be an importer or exporter?

The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good.

The world price refers to the prevailing price in the world markets.

A country will either be an exporter or an importer of the good.

WORLD PRICE AND COMPARATIVE ADVANTAGE

• If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporter of the good.

• If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good.

WORLD PRICE AND COMPARATIVE ADVANTAGE

Specialization

Productive resources concentrate on narrow range of tasks or production of a limited variety of goods and services.

Permits greater levels of production than would be attained without specialization.

By concentrating on one productive activity, resource can be used more efficiently and greater efficiency results in greater output without raising costs.

COMPARATIVE ADVANTAGE & INTERNATIONAL TRADE

Comparative Advantage

A country has lower opportunity cost of producing a good or service than does another country.

If countries produce and trade on the basis of their comparative advantages, the world will have more goods and services than it otherwise would.

COMPARATIVE ADVANTAGE & INTERNATIONAL TRADE

COMPARATIVE ADVANTAGE & INTERNATIONAL TRADE

Assume that Mexico can produce 500 lamps or 100 gallons of gasoline with 1 unit of resources and that Venezuela can produce 25 lamps or 100 gallons of gasoline with 1 unit of resources. Identify:

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The opportunity cost for Mexico in producing 1 lamp• 1/5 gallons of gasoline

The opportunity cost to Venezuela of producing 1 lamp• 4 gallons of gasoline

The country with the comparative advantage in lamp• Mexico

Assume that Mexico can produce 500 lamps or 100 gallons of gasoline with 1 unit of resources and that Venezuela can produce 25 lamps or 100 gallons of gasoline with 1 unit of resources. Identify:

The opportunity cost for Mexico in producing 1 gallon of gasoline • 5 lamps

The opportunity cost for Venezuela in producing 1 gallon of gasoline

• ¼ lampsThe country with the comparative advantage in gasoline

• Venezuela

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Previously, Mexico can produce 500 lamps or 100 gallons of gasoline while Venezuela can produce 25 lamps or 100 gallons of gasoline , both with 1 unit of resources. Now, assume that Mexico and Venezuela each has 2 units of resources, and each uses 1 unit for the production of lamps and the other for the production of gasoline.

How many lamps to be produced by both in total?How many gallons of gasoline to be produced by both in total?

If each country uses its 2 units of resources to produce the good in which it has the comparative advantage:

What will Mexico produce, and how much?What will Venezuela produce, and how much?

• 525 lamps

• 200 gallons of gasoline

• 1000 lamps• 200 gallons gasoline

TRY THIS

Goods and services can be exported and imported by anyone in any country with no restrictions.

Arguments for Free-Trade :

i. Trade, Specialization, and Efficiency Permits the markets in which goods and

services are bought and sold to expand, and this increase will lead to more specialization.

Specialization leads to efficiency, and this allows more goods and services to be produced.

FREE TRADE

Arguments for Free-Trade :

ii. Increased Availability of Goods & Lower PricesLeads to larger quantities of goods from which to choose and to lower prices.

iii. Trade & CompetitionIncreases competition in markets and the price therefore moves toward cost.

FREE TRADE

Protectionism view that it is in the best interest of a country to restrict free trade.

Trade-Restricting Policies

i. Quotaii. Embargoiii. Tariff

PROTECTIONISM

PROTECTIONISM - QUOTA

Quota - Restriction or limit on the quantity of an item that can be imported into a country to protect domestic industries so that the demand for local products could be maintained

The Effects of an Import Quota Because the quota raises the domestic price above

the world price, domestic buyers are worse off, and domestic sellers of the good are better off.

License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.

Embargo - Ban on trade for a particular commodity or with a particular country, normally motivated by political, economic, moral or environmental reasons

The Effects of embargo

Reduce, and to some extend, zero imports –exports of ban goods, or goods from banned countries

PROTECTIONISM - EMBARGO

PROTECTIONISM - TARIFFS

Tariff - Tariffs are taxes on imported goods with the aim to protect domestic industries  

The Effects of a Tariff

Tariffs increase the prices of imported goods, but the domestic producers are not forced to reduce prices

Tariffs raise the price of imported goods above and thus reduces the quantity of imports

Arguments for Protectionismi. Protection of Infant Industries

Government should impose trade restrictions to protect an industry in the early stages of development.

ii. Protection of Domestic Employment & Output Trade restrictions reduce foreign goods

competition in domestic markets, increase employment and output in the domestic markets.

iii. Diversification Prevents dependencies on foreign goods.

iv. National Security Diversification is needed in anticipation of

possible interruptions of foreign supplies.

PROTECTIONISM

TRADE AGREEMENTS

• Unilateral: when a country removes its trade restrictions on its own.

• Multilateral: a country reduces its trade restrictions while other countries do the same.

International Monetary Fund (IMF)

Organization of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.

Provides loans and other financial assistance to countries

INTERNATIONAL MONETARY FUND (IMF)

European Union (EU)

Single unified market formed by the majority of Western European nations.

Economic and political union of 27 member states that are located primarily in Europe.

Developed a single market through a standardised system of laws that apply in all member states.

EUROPEAN UNION (EU)

The North American Free Trade Agreement (NAFTA) is an example of a multilateral trade agreement.

In 1993, treaty creates a unified market involving the United States, Canada, and Mexico.

NAFTA lowered the trade barriers among these countries.

NAFTA

• The General Agreement on Tariffs and Trade (GATT) refers to a continuing series of negotiations in the international forum among many of the world’s countries with a goal of promoting free trade.

• GATT has successfully reduced the average tariff among member countries from about 40% after WWII to about 5% today.

World Trade Organization (WTO) - Organization founded in 1995 to take over responsibilities of GAAT.

GATT & WTO

Justify in support of free trade.

• Specialization and Efficiency - more specialization leads to efficiency, as this allows more of specialized goods and services to be produced

• Availability of Goods with Lower Prices - larger quantities of goods from which to choose and to lower prices.

• Competition - increases competition in markets and the price therefore moves toward cost.

TEST YOUR UNDERSTANDING