Text of Chapter 1 Introduction Prepared by Iordanis Petsas To Accompany International Economics: Theory and...
Chapter 1 Introduction Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy International Economics: Theory and Policy, Sixth Edition by Paul R. Krugman and Maurice Obstfeld
Slide 1-2 International economics deals with economic interactions that occur between independent nations. There are several issues that recur throughout the study of international economics: - Gains from trade, The Pattern of Trade, Protectionism, How Much Trade?, The Balance of Payments, Exchange Rate Determination, International Policy Coordination, and the International Capital Market. The most important themes for this academic year (2011-2012) are: Gains from trade Protectionism The International Capital Market What is International Economics About?
Slide 1-3 What exactly do people gain when they trade with one another? Comparative advantages and specialization. As the theory of comparative advantage states, a country can increase its standard of living by specializing in what it can make at low opportunity cost and trading for what it can make only at high price. The theory of comparative advantage also shows that total production in both countries increases with specialization. Increased variety of goods. Free trade gives consumers in all countries greater variety from which to choose (German car versus American car). The Gains from Trade
Slide 1-4 Lower costs through economies of scale. Some goods can be produced at low cost only if they are produced in large quantitiesa phenomenon called economies of scale. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully. Increased competition. Opening up trade fosters competition and gives the invisible hand a better chance to work its magic. It restricts the ability of domestic companies to have market power, which in turn gives it the ability to raise prices above competitive levels. The gains from trade
Slide 1-5 Enhanced flow of ideas. With specialization and trade, the total sum of knowledge used in an economy increases tremendously and far exceeds that of any one brain. Without trade, the knowledge used by an entire economy is approximately equal to the knowledge used by one brain. The Gains from Trade
Slide 1-6 The Gains and Losses of An Exporting country. The main two conclusions: When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off, and domestic consumers of the good are worse off. Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers. THE WINNERS AND LOSERS FROM TRADE
Slide 1-7 What is International Economics About?
Slide 1-8 The Gains and Losses of an Importing Country. When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are worse off. Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.
Slide 1-9 Question (1): If the government allows a Isolandians to import and export textiles, what will happen to the price of textiles and the quantity of textiles sold in the domestic textile market? Answer: Once trade is allowed, the Isolandian price of textiles will be driven to equal the price prevailing around the world. If the world price is now higher than the Isolandian price, our price will rise. The higher price will reduce the amount of textiles Isolandians consume and raise the amount of textiles that Isolandians produce. Isoland will, therefore, become a textile exporter. This occurs because, in this case, Isoland has a comparative advantage in producing textiles. Conversely, if the world price is now lower than the Isolandian price, our price will fall. The lower price will raise the amount of textiles that Isolandians consume and lower the amount of textiles that Isolandians produce. Isoland will, therefore, become a textile importer. This occurs because, in this case, other countries have a comparative advantage in producing textiles. The Lessons for Trade Policy in Isoland country
Copyright 2003 Pearson Education, Inc.Slide 1-10 Question: Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses? Answer: The answer depends on whether the price rises or falls when trade is allowed. If the price rises, producers of textiles gain, and consumers of textiles lose. If the price falls, consumers gain, and producers lose. In both cases, the gains are larger than the losses. Thus, free trade raises the total welfare of Isolandians.
Question: Should a tariff be part of the new trade policy? Answer: A tariff has an impact only if Isoland becomes a textile importer. In this case, a tariff moves the economy closer to the no-trade equilibrium and, like most taxes, has deadweight losses. Although a tariff improves the welfare of domestic producers and raises revenue for the government, these gains are more than offset by the losses suffered by consumers. The best policy, from the standpoint of economic efficiency, would be to allow trade without a tariff. We hope you find these answers helpful as you decide on your new policy. Slide 1-11
Chapter 2: Arguments against International Trade (Protectionism) Trade and jobs. Trade does eliminate jobs, Because domestic factories cannot compete with foreign industries. Child labor. Another justification of restricting trade is that some companies in the exported country have employed child workers to produce its products. Thus, some claim that importing any goods that made by children under the age of 15 must be prohibited. Slide 1-13
Trade and National Security. some argue that restrictions are necessary to avoid any imported goods which may badly affect the health of people (In 1918, more than a quarter of the U.S. population got sick with flu and more than 500,000 died). Key Industries. Another argument is the "it is better to produce computer chips than potato chips" argument. The idea is that the production of computer chips is a key industry because it generates spillovers, benefits that go beyond the computer chips themselves. Slide 1-14
Strategic Trade Protectionism. Sometimes, the government use tariffs and quotas to help domestic firms to act like a cartel when they sell to international buyers. Oddly, the way to do this is to limit or tax exports. A tax or limit on exports reduces exports but can drive up price enough so that net revenues increase. Slide 1-15
The Instruments of Trade Policy The tariff. A tariff is simply a tax (duty) levied on a product when it crosses national boundaries. The most widespread tariff is the import tariff, which is a tax levied on an imported product. A less common tariff is an export tariff, which is a tax imposed on an exported product. Export tariffs have often been used by developing nations. Two purposes of tariff: A protective tariff: it is designed to reduce the amount of imports entering a country, thus insulating import-competing producers from foreign competition. A revenue tariff: it is imposed for the purpose of generating tax revenues and may be placed on either exports or imports. Slide 1-16
Other Instruments of Trade Policy Export Subsidies. An export subsidy is a payment to a firm or individual that ships a good abroad. Import Quotas. An import quota is a direct restriction on the quantity of some good that may be imported. The restriction is usually enforced by issuing licenses to some group of individuals or firms. For example, the United States has a quota on imports of foreign cheese. The only firms allowed to import cheese are certain trading companies; the size of each firm's quota is based on the amount of cheese it imported in the past. Slide 1-17
Trade Policy in Developing Countries Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy International Economics: Theory and Policy, Sixth Edition by Paul R. Krugman and Maurice Obstfeld
Slide 11-20 Infant Industry argument 1- According to the infant industry argument, developing countries have a potential comparative advantage in manufacturing, but new manufacturing industries in developing countries cannot initially compete with well-established manufacturing in developed countries. Thus, it makes sense, according to this argument, to use tariffs or import quotas as temporary measures to get industrialization started. Comparative advantage (Manufacture) . (Make sense) (tariffs) (Import qoutas) ( ) .
2- Another reason why infant industry protection may be a good idea is imperfect capital markets: developing cou