Objectives

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Objectives

• After studying this chapter, you will able to
• Describe the trends and patterns in international
  trade
• Explain comparative advantage and the economic
  implications of free trade
• Explain why international trade restrictions
  reduce the volume of imports and exports, and
  reduce our consumption possibilities

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Patterns and Trends in International Trade

• Trade in Goods
• Manufactured goods represent 55 percent of U.S.
  imports and 68 percent of exports.
• Raw materials and semi-manufactured materials
  represent 14 percent of U.S. exports and 15
  percent of imports.
• The largest export item from the United States is
  capital goods and the largest import item is
  automobiles.

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Patterns and Trends in International Trade

• Trade in Services
• International trade in services such as travel,
  transportation, and insurance is large and
  growing.
• Geographical Patterns of International Trade
• Trading relation US-Canada is the largest in the
  world (446 billion dollars per year, and
  growing)
• Mexico is the second largest trading partner of
  the US (Mexico US trade 266 billion per year,
  and growing)

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Patterns and Trends in U.S. international trade

• Trends in the Volume of Trade
• In 1960, the United States exported 3.5 percent
  of its total output and imported 4 percent of the
  total amount that Americans spent on goods and
  services.
• In 2005, the United States exported 10 percent of
  its total output and imported 16 percent of the
  total amount that Americans spent on goods and
  services.
• International trade is expanding rapidly (each
  year there are new record numbers for exports and
  imports)

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Patterns and Trends in International Trade

• Net Exports
• The value of exports minus imports is called net
  exports.
• During the third quarter of 2006, imports
  exceeded exports in the United States, so net
  exports were negative 810 billion (trade
  balance)

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Some people do not like free trade agreements
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What can you say about the economic impact of
trade?

• The benefits of trade
• The costs of trade
• The economic impact of trade restrictions

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What drives countries to trade?

• Comparative advantage is the fundamental force
  that generates trade between nations.
• The basis for comparative trade is divergent
  opportunity costs between countries.
• Nations can increase their consumption of goods
  and services when they allocate resources to the
  production of those goods and services for which
  they have a comparative advantage.

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Production and Consumption Possibilities and the
Benefits of Trade

• A countrys PPC (Production Possibilities Curve)
  shows the quantities of different goods that its
  economy can produce.
• Consumption Possibilities combinations of goods
  and services that a countrys citizens might
  feasibly consume.

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Production and Consumption Possibilities

• Two good economy -- computers and coffee
• Two workers who work 50 weeks/year
• Carlos
• Can produce 100 pounds or 1 computer per week
• Maria
• Can produce 100 pounds or 2 computers per week

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How to construct the PPC?

• Find the extremes (maximum feasible production
  for each type of good).
• Start at one of the extremes (assume all
  productive resources are devoted to producing one
  type of good say is the y-axis good)
• What is the best way of producing some units of
  the x-axis good?

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How to construct PPC (2)

• The agent with the comparative advantage (lowest
  cost) should produce the x-axis good.
• Once you exhaust the time available to this
  individual, find the agent with the second lowest
  cost.
• And so on

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Production Possibilities Curve for a Two-Worker
Economy
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Production Possibilities Curve for a
Three-Worker Economy
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Production and Consumption Possibilities and the
Benefits of Trade

• In a closed economy
• Societys production possibilities consumption
  possibilities.

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Closed economy consumption possibilities
production possibilities
Computers (number/year)
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Open economy consumption possibilities
Computers (number/year)
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Implications of opening to trade
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Are the gains of one country the losses of
another?
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The consumers of the two countries win as a
result of free trade!
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International Trade Restrictions

• Governments restrict international trade to
  protect domestic producers from competition by
  using two main tools
• Tariffs
• Nontariff barriers
• A tariff is a tax that is imposed by the
  importing country when an imported good crosses
  its international boundary.
• A nontariff barrier is any action other than a
  tariff that restricts international trade.

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International Trade Restrictions

• The History of Tariffs
• This figure shows the average tariff rate over
  the last 70 years.
• Average tariffs reached their peak of 20 percent
  in 1933.

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The Case Against Protection

• Despite the fact that free trade promotes
  prosperity, trade is restricted.
• It is often argued that international trade
  should be restricted to
• Protect infant industries
• Punish dumping
• Save jobs
• Allow us to compete with cheap foreign labor
• Prevent rich nations from exploiting poor ones

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The Case Against Protection

• The Infant Industry Argument
• The infant-industry argument is that it is
  necessary to protect a new industry from import
  competition to enable it to grow into a mature
  industry that can compete in world markets.

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The Case Against Protection

• The Dumping Argument
• Dumping occurs when foreign a firm sells its
  exports at a lower price than its cost of
  production.
• Dumping is seen as a justification for a tariff
  to prevent a foreign firm driving domestic firms
  out of business and then raising its price.
• Problem
• It is virtually impossible to determine a firms
  costs

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The Case Against Protection

• Saves Jobs
• The idea that buying foreign goods costs domestic
  jobs is wrong.
• It destroys some jobs and creates other better
  jobs.
• It also increases foreign incomes and enables
  foreigners to buy more domestic production.
• Protection to save particular jobs is very costly.

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The Case Against Protection

• Allows us to Compete with Cheap Foreign Labor
• The idea that a high-wage country cannot compete
  with a low-wage country is wrong.
• Low-wage labor is less productive than high-wage
  labor.

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The Case Against Protection

• Prevents Rich Countries from Exploiting Poorer
  Countries
• The idea that trade restrictions prevent rich
  countries from exploiting poorer countries is
  wrong.
• Free trade is the best way of raising wages and
  improving working conditions in poor countries.

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The Case Against Protection

• The most compelling argument against protection
  is that it invites retaliation.
• We have seen it today as the world reacts to high
  U.S. tariffs on steel and agriculture.

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Why Is International Trade Restricted?

• The two key reasons why international trade is
  restricted are
• Tariff revenue
• Rent seeking

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Why Is International Trade Restricted?

• Tariff Revenue
• It is costly for governments to collect taxes on
  income and domestic sales.
• It is cheaper for governments to collect taxes on
  international transactions because international
  trade is carefully monitored.
• This source of revenue is especially attractive
  to governments in developing nations.

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Why Is International Trade Restricted?

• Rent Seeking
• Rent seeking is lobbying and other political
  activities that seek to capture the gains from
  trade.
• Despite the fact that protection is inefficient,
  governments respond to the demands of those who
  gain from protection and ignore the demands of
  those who gain from free trade because protection
  brings concentrated gains and diffused losses.

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Why Is International Trade Restricted?

• Compensating Losers
• The gains from free trade exceed the losses, and
  sometimes free trade agreements address the issue
  of the distribution of gains from trade by
  compensating those who lose from free trade.
• For example, under NAFTA, a 56 million fund was
  created to support and retrain workers who lot
  their jobs from foreign competition resulting
  from the agreement.