Chapter 17 - International trade. In this chapter you will learn: What the definition is and root causes of comparative advantage? How to determine whether a country will become a net‐importer/exporter of a good? How to calculate change in surplus under trade? What the effects of tariffs and quotas are on quantity, price, and welfare?...
Chapter17 InternationalTrade â2014byMcGrawHillEducation Whatwillyoulearninthischapter? ã Whatthedefinitionisandrootcausesof comparativeadvantage ã Howtodeterminewhetheracountrywillbecome a net‐importer/exporter of a good • How to calculate change in surplus under trade • What the effects of tariffs and quotas are on quantity, price, and welfare • What the effects of trade are on factor distribution of income • Whatthechallengesareofestablishing environmentalorlaborstandardsininternational markets â2014byMcGrawHillEducation Whytrade?Areview ã Recallthatvoluntaryexchangesgeneratesurplus,leaving bothparticipantsbetteroffthantheywerebefore ã In exchange, a country is said to have an absolute advantage if it can produce more of a good or service than other countries, given similar resources • In exchange, a country is said to have a comparative advantage if it can produce a good or service at a lower opportunity cost than other countries – Each country produces the goods in which it has a comparative advantage ã Bothcountriescanhavegainsfromtradewhenthey specializeinproducingthegoodsandservicesforwhich theyhavecomparativeadvantages,respectively,andengage intrade â2014byMcGrawHillEducation Whytrade?Areview • Suppose that the U.S. and China produce wheat and T‐shirts • Their production capabilities are summarized as followed Country Wheat produced (billions) United States Without trade (billions) Wheat consumed T-shirts consumed (billions) (billions) 0.3 0.3 China 2 Total 1.3 1.3 United States With trade T-shirts produced 3.5 1.1 0.8 China 2.4 1.2 Total 3.5 3.5 ã Withoutspecializationandtrade,theyareabletoproduceontheir PPF,butarestillinefficientlyusingtheirresources ã Withspecializationandtrade,theycoordinatetheirproductionand producemoregoods â2014byMcGrawHillEducation The roots of comparative advantage • Given that the business of trade is conducted almost entirely by firms and individuals, not by governments, how do firms in one country know their comparative advantage relative to firms in another country? • Firms produce the goods and services in which they have a comparative advantage by responding to input and output prices and choosing to produce the good that earns the highest profits • The characteristics that affect the costs of production are: Technology Factor endowment Natural resources and climate • Countries do not fully specialize because of: – Trade agreements between countries that may stymie specialization – Differences in the natural resources, climate, and relative factor endowment of different areas © 2014 by McGraw‐Hill Education From autarky to free trade An economy that is self‐contained and does not engage in trade with outsiders is an autarky economy Price ($) 50 Domestic supply 45 40 35 30 25 20 15 10 Domestic demand 50 100 150 200 250 300 350 400 450 500 550 600 Quantity of shirts (millions) â2014byMcGrawHillEducation ã Underautarky,aneconomydoes notexportorimportanygoods orservices Imports are goods and services that are produced in other countries and consumed domestically – Exports are goods and services that are produced domestically and consumed in other countries • The domestic price and quantity is determined by the intersection of the domestic supply and domestic demand curves From autarky to free trade When an economy decides to engage in trade, the domestic price and quantity change Price ($) Domestic supply 25 Autarky domestic price 15 World price Imports Domestic demand 180 300 420 Quantity of shirts (millions) • If the world price is less than autarky domestic price: – Domestic price decreases to equal the world price – Excessdemand occurs ã Imports makeupthe differencebetweendomestic supplyanddemand, eliminatingtheshortage â2014byMcGrawHillEducation From autarky to free trade Consumer and producer surpluses are affected Surplus under autarky Surplus after trade Price ($) Price ($) Domestic supply Domestic supply A A Producer surplus 25 B 25 Consumer surplus B C 15 D 0 300 Quantity of shirts (millions) World price D Domestic demand Imports Domestic demand 420 180 Quantity of shirts (millions) After trade: • Consumer surplus increases to A + B + C • Producer surplus decreases to D • Total surplus increases by C Under autarky: • ConsumersurplusisA ã ProducersurplusisB+D â2014byMcGrawHillEducation Fromautarkytofreetrade ã Producersexporttheirgoodsandservices whentheworldpriceisgreater thanthe domestic price Price ($) Domestic supply Exports World price 260 200 Autarky domestic price Domestic demand 40 60 • If the world price is greater than autarky domestic price: – Domestic price increases to equal the world price – Excess supply occurs • Exports make up the difference between domestic supply and demand, eliminating the surplus 80 Quantity of wheat (millions of tons) © 2014 by McGraw‐Hill Education From autarky to free trade Consumer and producer surpluses are again affected Price ($) Price ($) Domestic supply Exports A A 260 B C F 200 Producer surplus 200 Consumer surplus B C F Domestic supply World price E E Domestic demand Domestic demand D 60 Quantity of wheat (millions of tons) 40 80 60 Quantity of wheat (millions of tons) After trade: • Consumer surplus decreases to A • Producer surplus increases to B + C + D + E + F • Total surplus increases by D Under autarky: • Consumer surplus is A + B + C • Producer surplus is E + F © 2014 by McGraw‐Hill Education 10 Active Learning: Becoming a net‐importer or a net‐exporter Given the figure below, determine whether the country is a net‐exporter or net‐importer Price ($) Domestic supply Pw World price P* Autarky domestic price Domestic demand Qd Q* Qs Quantity of planes (thousands) © 2014 by McGraw‐Hill Education 11 Big economy, small economy • The previous analysis assumed that the domestic country was a price‐taker in the world market • If a country is relatively ‘big’, then it can influence the world price Price ($) World supply World supply after U.S trades Pre-U.S world price 17 Price after U.S trade 15 • When the U.S. moves from autarky to free trade, the world demand curve shifts to the right because U.S. consumers have entered the market – World demand shifts right – World supply shifts right World Demand 1,625 World demand after U.S trades • On net, because world demand shifted more than world supply, the world price increases 2,350 Quantity of shirts (millions) © 2014 by McGraw‐Hill Education 12 Big economy, small economy For many goods, the price goes down, and the country as a whole is better off, but producers lose out Before market entry Price ($) After market entry Domestic supply Price ($) Domestic supply 25 World price 15 New world price Old world price 17 15 Domestic demand Domestic demand 300 Quantity of shirts (millions) Under autarky: • Domestic price is higher than world price © 2014 by McGraw‐Hill Education 200 400 Quantity of shirts (millions) After trade: • Domestic price falls to world price • Because of relative size, entry of big country causes world price to rise above old world price 13 Restrictions on Trade • The previous analysis indicates that imposing or lifting restrictions on trade can have different impacts on different groups of people • Laws limiting trade are referred to as trade protection – Protectionism is a preference for policies that limit trade – Tradeliberalization ispoliciesandactionsthat reducetraderestrictions â2014byMcGrawHillEducation 14 Tariffs ã Atariff isataxtargetedatcertainimports ã The purpose is to reduce the quantity of imports to protect domestic producers Price ($) Domestic supply Imports with tariff World price + $75 tariff 325 World price 250 Imports without tariff 14 • A tariff has two effects: – Increases the world price for domestic consumers – Decreases the amount of shortage made up by imports Domestic demand 25 30 Quantity of steel (tons) © 2014 by McGraw‐Hill Education 15 Domestic welfare effects of a tariff There are substantial welfare effects of imposing a tariff Price ($) Price ($) Producer surplus Government revenue Consumer surplus Deadweight loss A A 400 250 G C D B E F Old world price Imports 325 C 250 G 30 Quantity of steel (millions of tons) Under trade without a tariff on imports: • Consumer surplus is A + B + C +D + E+ F • Producer surplus is G D B E World price + $75 tariff Old world price F Imports 14 25 30 Quantity of steel (millions of tons) Under trade with a tariff on imports: • Quantity of imports decreases • Newworldpriceishigher ã ConsumersurplusisA+B ã ProducersurplusisC+G ã GovernmenttaxrevenueisE ã DeadweightlossisD+F â2014byMcGrawHillEducation 16 Quotas • A quota is a limit on the amount of a particular good that can be imported • Quota rents are profits earned by foreign firms or governments under a quota Price ($) Domestic supply A quota has a few effects: Quota = 500 million • Decreases imports Producer surplus • Increases import price Consumer surplus • Increases producer surplus Deadweight loss by C A • Decreases consumer surplus Quota rents by C + D + E + F B New world price 32 • Foreign companies earn C E D F $7 price increase 25 Old World price quota rents of E Domestic demand • Deadweight loss of D + F G occurs 500 640 1,140 1,350 Quantity of jeans (millions) â2014byMcGrawHillEducation 17 ActiveLearning:Restrictionstotrade Atariffof$tperunitisimposedonforeigncopper ã Complete the welfare table Price ($) Measure Before After Change CS A Pw + t C Pw G D B E New world price F Old world price Imports PS Gov’t Rev DWL 14 25 30 Quantity of copper (millions of tons) © 2014 by McGraw‐Hill Education 18 International labor and capital • Although countries gain from trade liberalization, certain segments of the population lose out • As a rule of thumb, free trade increases demand for factors of production that are domestically abundant, and it decreases the supply of factors that are domestically scarce – Causes factor prices to converge across countries – Owners of domestically scarce factors of production lose due to increased competition, and owners of domestically abundant factors gain from increased demand â2014byMcGrawHillEducation 19 TheWTO,trademediation,andimport standards ã Eachcountryhasitsownsetoflawsandpoliciesgoverning theeconomy Safetypolicies,laborstandards,environmentalregulations,taxes, laws about corporate finance, and governance – Source of friction in international trade • The World Trade Organization (WTO) is an international organization designed to monitor and enforce trade agreements while also promoting free trade • Import standards and the fair trade movement are ways in whichcountriestrytodealwithvariationsincrosscountry standards ã Similarly,thefairtrademovementattemptstoinformand influenceconsumerschoicesbycertifyingandlabeling goodswhoseproductionmeetscertainconditions â2014byMcGrawHillEducation 20 Embargoes:Tradeasforeignpolicy ã Countries may use trade as a tool for foreign policy • An embargo is a restriction or prohibition of trade in order to put political pressure on a country • Examples include: – The 2009 United Nations Security Council international weapon trading ban with North Korea as a response to nuclear testing – Broad inter‐war embargo on Iraq included cars and shirts in an effort to push Iraqi civilians to act © 2014 by McGraw‐Hill Education 21 Summary • Comparative advantage is the ability to produce a good or service at a lower opportunity cost than others can • Characteristics such as climate, natural resources, factor endowment, and technology determine which goods and services a country will have a comparative advantage at producing • When countries moves from autarky (no trade) to trade: – If the world price domestic price, then the country will be a net‐exporter of that good or service © 2014 by McGraw‐Hill Education 22 Summary • When markets function well, total surplus increases if a country opens trade – Net‐importer: Consumers gain surplus from buying larger quantities at lower prices; producers lose surplus from selling less at lower prices – Net‐exporter: Consumers lose surplus from buying smaller quantities at higher prices; producers gain surplus from selling more at higher prices • A tariff is a tax on imports, and it causes inefficiency and deadweight loss – Raises domestic price of a good, reduces quantity demanded, increases quantity supplied domestically, and reduces quantity imported © 2014 by McGraw‐Hill Education 23 Summary • Import quotas limit the amount of a particular good that can be imported – Effect of the quota on domestic price and quantity is similar to the effect of a tariff. It differs on who captures the rent • In general, trade increases demand for factors domestically abundant, and increases the supply of factors that are domestically scarce • Each country has its own set of laws and policies governing the economy – Policy‐makers and consumers may apply explicit laws about imports and voluntary purchasing decisions in order to deal with the inconveniences © 2014 by McGraw‐Hill Education 24 ... Source of friction in? ?international? ?trade • The World? ?Trade? ?Organization (WTO) is an ? ?international? ? organization designed to monitor and enforce? ?trade? ? agreements while also promoting free? ?trade • Importstandardsandthefairtrademovementarewaysin... or lifting restrictions on? ?trade? ?can have different impacts on different groups of people • Laws limiting? ?trade? ?are referred to as? ?trade? ? protection – Protectionism is a preference for policies that limit trade Tradeliberalization... (billions) United States Without trade (billions) Wheat consumed T-shirts consumed (billions) (billions) 0.3 0.3 China 2 Total 1.3 1.3 United States With trade T-shirts produced 3.5 1.1 0.8 China