International trade

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International trade

• Today Winners and losers of various
  international trade policies

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Today More on international trade

• Addressing concerns about trade
• Review of comparative advantage
• Examining consumption possibilities
• Without trade
• With trade
• Supply and demand analysis of trade
• Tariffs and Quotas
• Outsourcing

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Addressing concerns about trade

• A majority of Americans, including 60 percent of
  Republicans, now believe free trade is bad for
  the U.S. economy, according to recent NBC
  News-Wall Street Journal polls.
• (Source Trade jitters, anti-China sentiment
  rouse US voters, Reuters, Nov. 14, 2007)
• Why do so many Americans have this opinion about
  trade?

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Trade has costs and benefits

• When another country can produce goods lower than
  in the United States, two things happen
• Jobs are lost in the United States
• Consumers pay lower prices for the good that is
  now imported
• The news media usually focuses on the jobs issue
  more than about prices

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Why is media coverage skewed?

• Any job lost seriously deteriorates the quality
  of life of an individual
• Most people dont care to read headlines
  advertising The price of rice goes down by two
  cents per pound
• However, small gains on many products lead to
  substantial increases in the purchasing power of
  the dollar

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Suppose there is protectionism elsewhere

• The United States is a leading exporter of fresh
  fruit (see on-line reading list for source)
• Suppose that other countries outlawed the import
  of fresh fruit
• US jobs lost
• Decrease in price of fruit in the US
• Increase in the price of fruit in other countries

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Another issue Lead in toys

• Recently, many toys manufactured in China have
  been recalled due to unsafe levels of lead
• This has raised concerns about the viability of
  toy exports
• China will stop exporting toys if the world does
  not view the toys as safe enough, given the price

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Monitoring is costly

• Monitoring toys for lead is costly, adding to the
  cost of toys purchased
• However, testing costs may be small relative to
  the additional revenues that can be generated if
  safe toys can be guaranteed

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Another example American cars

• Over the last 30 years, American cars have often
  been looked at as inferior compared to some
  foreign models
• With competition from trade, domestic car
  producers must keep costs down and quality up in
  order to successfully sell cars in the domestic
  market
• The same thing goes for foreign toys
• If quality control standards are not maintained
  abroad, people will buy their toys domestically

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Trade issues

• There are many other issues that are related to
  trade
• If you would like an in-depth analysis of trade,
  you can enroll in a class that deals with trade
• Today, we will talk about the basic issues of
  trade, and who the winners and losers are

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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

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Comparative advantage Same numbers, different
names
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Comparative advantage

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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Market for cars, w/o trade

• Suppose that without trade, 40,000 cars are sold
  at a price of 14,000

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Market for cars, w/o trade

• Consumer surplus is blue shaded area
• Producer surplus is red shaded area

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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

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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
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Surplus with trade

• Consumer surplus increases substantially
• Producer surplus decreases, but does not change
  as much as consumer surplus does

Imports
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Without imports (left)With imports (right)
Imports
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Net gain
Imports
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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 (See Figure 9.7 for an example)
• Consumer surplus decreases when trade occurs
• Producer surplus increases when trade occurs
• Overall, total surplus increases

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Tariffs and quotas

• Even when trade is not prohibited, countries
  sometimes 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

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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

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What happens when we impose a tariff?

• Total surplus without tariffs
• Shaded area

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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

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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

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Total surplus and tariff money collected

• Consumer surplus (CS)
• Producer surplus (PS)
• Tariff revenue generated
• What is missing?

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Total surplus and tariff money collected

• CS
• PS
• Tariffs
• What is missing?
• Two triangles are lost with the imposition of
  tariffs

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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
• See Economic Naturalist 9.2 to see an example of
  why there is pressure to impose tariffs
• Consumer surplus is lower with the tariff
  (relative to open global trade)

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Quotas

• Quotas are similar to tariffs, except
• Domestic supply plus quota determines supply
  available in a countrys market
• Equilibrium in this example is price of 125,
  80,000 TVs

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What else is different with quotas?

• With quotas, no revenues are directly generated
• Those with right to import and export gain
  economic rents
• Example See Economic Naturalist 9.3 for groups
  that benefited with voluntary export
  restraints, which is a form of quota

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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

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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

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How to make sure your job does not get outsourced

• Make sure it requires a lot of face-to-face
  contact
• Construction work
• Repair labor
• Health care
• Make sure that you have skills that nobody else
  has

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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

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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 countrys economy