MBMC International Trade and Trade Policy. MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade

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International Trade and Trade Policy

International Trade and Trade Policy

Chapter 16: International Trade and Trade Policy Slide 2

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Copyright c 2004 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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ExampleTwo good economy (Brazil) -- computers

and coffeeTwo workers who work 50 weeks/year

Carloso Can produce 100 pounds/week or 1 computer

Mariao Can produce 100 pounds/week or or 2 computers


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ExampleSlope of PPC (Maria)

Slope of PPC (Carlos)

putercoffee/com of s#50 wkcomputers/ 2

coffee/wk lbs 100- OC sMaria' computers

putercoffee/com of s#100 wkcomputers/ 1

coffee/wk lbs 100- OC Carlos' computers


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10,000

100

B

150

5,000

SlopeAC = Maria’s OCcomputers =- 50 pounds coffee/computer

C

A

SlopeCB = Carlos’ OCcomputers =- 100 pounds coffee/computer

Production Possibilities Curve for a Two-Worker Economy

Computers (number/year)

Co

ffee

(p

ou

nd

s/ye

ar)


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B

C

A

D

Maria produces computers

Maria and Pedro produces computers

All three workersproduce computers

Production Possibilities Curve for a Three-Worker Economy


Co

ffee

(p

ou

nd

s/ye

ar)


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Production Possibilities Curve for a Many-Worker Economy


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


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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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Brazil’s Consumption Possibilities with Trade


Co

ffee

(p

ou

nd

s/ye

ar)

100

B

150

10,000

C

A

5,000

Production possibilities Slope = -50 pounds coffee/computer


Without Trade•Brazil’s consumption possibilities = ACB•Assume production is at C•The OC of 50 lbs coffee = 1 computer•The OC of 1 computer = 100 lbs coffee


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Co

ffee

(p

ou

nd

s/ye

ar)

13,000

100

C

G

F

5,000

162.5

Consumption possibilities with tradeSlope = -80 pounds coffee/computer

With Trade• World market: 80 lbs coffee for 1

computer• Trade 100 computers for 8,000 lbs coffee +

5,000 lbs from Carlos = 13,000 lbs• Trade 80 lbs coffee for 1 computer or

5,000 lbs of coffee for 62.5 computers + 100 computers from Maria = 162.5 computers

• Consumption Possibilities = FCG


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Co

ffee

(p

ou

nd

s/ye

ar)

13,000

100

B

150

10,000

C

A

G

F

5,000

162.5

Consumption possibilities with tradeSlope = -80 pounds coffee/computer




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Consumption Possibilities Curve for a Many-Worker Economy


Co

ffee

(p

ou

nd

s/ye

ar)

B

C

A

G

FConsumptionpossibilities

Productionpossibilities

• Slope of FG = relative prices of coffee & computers on the world market

• Maximum consumption by producing at C (slope of PPC = FG) and trading for the desired combination on FG


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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 Brazil

Quantity of computers

Pri

ce o

f co

mp

ute

rs

pE

q

Domesticsupply

Domesticdemand

Closed economyequilibrium

qS qD

Worldprice

Imports


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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 Coffee in Brazil

Quantity of coffee

Pri

ce o

f co

ffee p

E

q

Domesticsupply

Domesticdemand

Closed economyequilibrium

qSqD

Worldprice

Exports


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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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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


Pri

ce o

f co

mp

ute

rs E

Domesticsupply

Domesticdemand

qS qD

World price

Importsbeforetariff

Production w/otariff


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The Market for Computers after the Imposition of an Import Tariff


Pri

ce o

f co

mp

ute

rs

qS

pT

E

q’S q’D qD

Domesticsupply

Domesticdemand

World price

World price plus tariff

Importsaftertariff

Production w/otariff

Tariff tax collection


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TariffsThe market for computers in Brazil:

Demand = QD = 3,000 - 0.5 PC

Supply = QS = 1,000 + 0.5 PC


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TariffsClosed economy

Equilibrium price:o 1,000 + 0.5 PC = 3,000 - 0.5PC

o PC = $2,000

Equilibrium quantity:o 1,000 + 0.5(2,000) = 2,000 computers


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TariffsOpen economy

P = world price = $1,500qS = 1,000 + 0.5(1,500) = 1,750

qD = 3,000 - 0.5(1,500) = 2,250Imports = 2,250 - 1,750 = 500 computers/yr


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TariffsTariff imposed

Tariff = $300/computerP = world price + tariff = $1,500 + $300 = $1,800

qs = 1,000 + (0.5)(1,800) = 1,900 computers/yr

qd = 3,000 = (0.5)(1,800) = 2,100Imports = 2,100 - 1,900 = 200Tariff revenue = $300/computer x 200

computers/yr = $60,000/yr


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The Market for Computers after the Imposition of an Import Quota


Pri

ce o

f co

mp

ute

rs

qS qD

Domesticsupply

Worldprice

Domesticdemand

Imports withopen economy


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The Market for Computers after the Imposition of an Import Quota


Pri

ce o

f co

mp

ute

rs

qS

pT

F

q’S q’D qD

Domesticsupply

Domesticsupplyplus quota

Worldprice

Domesticdemand

Importquota

•Impact of quota = impact of tariff•Revenue from quota goes to the producer


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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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Effects of an import QuotaWithout quota:

qS = 1,000 + 0.5PC

With a quota of 200 computersqS = 1,000 + 0.5PC + 200 = 1,200 + 0.5PC

qD = 3,000 - 0.5PC

Equilibrium = 1,200 + 0.5PC = 3,000 - 0.5 PC

Equilibrium price = $1,800


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Effects of an import QuotaWith a quota of 200 computers

Domestic quantity suppliedo 1,000 + 0.5($1,800) = 1,900 computers/yr

Domestic quantity demandedo 3,000 - 0.5 ($1,800) = 2,100 computers/yr

Imports = 2,100 - 1,900 = 200Revenue to the importers

o ($1,800 - $1,500) x 200 = $60,000


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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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Economic NaturalistWhat should Lula do about foreign trade?

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MBMC International Trade and Trade Policy. MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: International Trade