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Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Introduction
The benefits of trade
The costs of trade
Chapter 16: International Trade and Trade Policy
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Comparative Advantage
as 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 Economy
An economy that does not trade with the rest of the world
Open Economy
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Production Possibilities
Computers (number/year)
Coffee (pounds/year)
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 Possibilities
The combinations of goods and services that a country’s citizens might feasibly consume
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In a closed economy:
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
120,000
100,000
1,000
50,000
2,000
2,400
150,000
3,000
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Consumption
possibilities
Production
possibilities
Computers/year
Consumption possibilities of 150,000 is greater than PPC without trade
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
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Consumption
possibilities
Production
possibilities
Computers/year
Buy 1,000 computers with the $500,000
Pt F is possible with trade but not on the PPC
E
150,000
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
LM = consumption possibilities
Costa Rica can use trade to locate anywhere along LM
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
Consumption
possibilities
Production
possibilities
160,000
3,200
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Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy
Computers/year
Slope of the PPC = LM
Domestic and international opportunity costs of acquiring an extra computer (in terms of forgone coffee) are equal
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
Consumption
possibilities
Production
possibilities
160,000
3,200
G
M
L
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A Straight-Line Production Possibilities Curve
Tea (pounds/year
Coffee (pounds/year)
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
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
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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Consumption Possibilities With
and Without International Trade
What Do You Think?
Where should Islandia produce if the price of coffee and tea were the same?
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Consumption Possibilities With
With 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.
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Economic Naturalist
Does “cheap” foreign labor pose a danger to high-wage economies?
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Economic Naturalist
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 Naturalist
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 for
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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 for
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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 Trade
Countries 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 Trade
The 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
200
Domestic
supply
World
price
Domestic
demand
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 Trade
Winners
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Protectionism
The view that free trade is injurious and should be restricted
Tariff
Quota
A 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
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The Market for Computers after the Imposition of an Import Tariff
Computers per year
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Exercise 9.5
200
Domestic
supply
World
price
Domestic
demand
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
Quotas
Legal limit on the number or value of foreign goods that can be imported
Can be enforced by issuing permits
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The Market for Computers after the Imposition of an Import Quota
Computers per year
1,000
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The Market for Computers after the Imposition of an Import Quota
Computers per year
Producer surplus with quota = $640K/yr
Consumer surplus
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Quotas & Tariffs
Tariffs generate tax revenue.
Quotas generate revenue for the firms that hold an import license.
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Question
Why would the government ever impose a quota rather than a tariff?
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Economic Naturalist
Who benefited from and who was hurt by voluntary export restraints on Japanese automobiles in the 1980s?
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Other Barriers to Trade
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The Inefficiency of Protectionism
Trade 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
Outsourcing
A term increasingly used to connote having services performed by low-wage workers overseas
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Outsourcing
Outsourcing
Outsourcing 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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Outsourcing
Economic Naturalist
Paul 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?
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Outsourcing
Less rules-based jobs
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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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