International Trade SFLS part2

PowerPoint Presentation

International Trade Part 2

International Trade:3.) Graphing International Trade1.) Specialization & Comparative Advantage2.) PPC and Trading Possibilities4.) Terms of Trade5.) Arguments about International Trade

6.) Some ways to restrict International Trade

International Trade Graph

A country has a comparative advantage in a good if it produces the good at lower opportunity cost than other countries. Countries can gain from trade if each exports the goods in which it has a comparative advantage. Now we apply the tools of welfare economics to see where these gains come from and who gets them. 03.) Graphing International Trade

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The World Price and Comparative AdvantagePW = the world price of a good, in world marketsPD = domestic price without trade (autarky )

If PD < PW, - country has (CA) in the good- under free trade, country exports the goodIf PD > PW, - country does not have (CA) - under free trade, country imports the goodThings to define on the graph first:

1. The Small Economy Assumption0Things to define on the graph first:Assumptions :

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1. The Small Economy Assumption0Things to define on the graph first:Assumptions :- A small economy is a price taker in world markets: Its actions have no effect on PW. Not always true especially for the U.S. And China but makes understanding easier without changing its lessons. - When a small economy engages in free trade, PW is the only relevant price: No seller would accept less than PW, since they could sell the good for PW in world markets. No buyer would pay more than PW, since they could buy the good for PW in world markets.

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Without Trade, PD = $4 Q = 500PW = $6 With Free Trade, - domestic consumers demand 300 -domestic producers supply 750Exports = 450

PQD

S

$6

$4500

300Soybeans

exports

7500Exporting Soybeans example

77Students may not be aware of the economic importance of soybeans. In fact, soybeans are big business in the U.S. In 2007,U.S. farmers produced 2.6 billion bushels of soybeans. The average price was $10.40/bushel, for a total of $26.8 billion. Soybeans provided 71% of the edible consumption of fats and oils in the U.S.The U.S. exported 1.0 billion bushels of soybeans, earning $12.9 billion from exports. This amounts to 37% of international trade in soybeans. The biggest purchasers of U.S. soybeans are: China ($4.1 billion), Mexico ($1.1 billion), Japan ($1.1 billion), and Europe ($1.0 billion). Source: American Soybean Association, http://www.soystats.com/2008

Before covering this slide, alert your students that, in just a moment, they will be asked to do some analysis very similar to the analysis shown on this and the following slide.

In this case, PD < PW, so this country will export soybeans.

The quantity of exports is simply the difference between the domestic quantity supplied and the domestic quantity demanded at the world price.

Without Trade,CS = A + BPS = CTotal surplus = A + B + CWith Free Trade, CS = APS = B + C + DTotal surplus = A + B + C + D

PQD

S

$6

$4

Soybeans

exports

ABDC

gains from trade0Exporting Soybeans example

88Trade benefits soybean producers because they can sell at a higher price. Producer surplus rises by the area B + D.

Trade makes domestic buyers worse off because they have to pay a higher price. Consumer surplus falls by the area B.

The gains to producers are greater than the losses to consumers, so trade increases total welfare: total surplus rises by the amount D.

Without Trade,PD = 3000Q = 400

In World Markets, PW = 1500

PQD

S

$1500

200

$3000400

600Cars

0Importing Cars example

9The two preceding slides show students the analysis of trade when the country exports. The next step is to cover the analysis of trade when the country imports the good.

Instead of lecturing on this material, I suggest you have students work on this exercise, which students to do this analysis themselves. Its an activity that breaks up the lecture and gives students a chance to apply the techniques youve just presented.

I suggest you have students work on it in pairs. Give them about 5 minutes, then go over the answers on the following two slides.

While students are working, circulate around the room and offer to assist any students that ask for help. This will also give you a sense of how well students are understanding the material.

If you prefer to lecture on the material instead, replace these slides with the two hidden slides that immediately follow the CHAPTER SUMMARY at the end of this file. You will then have to unhide those slides by unselecting Hide Slide from the Slide Show drop-down menu.

With Free Trade, - domestic consumers demand 600 - domestic producers supply 200 Imports = 400

PQD

S

1500

200

3000

600Cars

imports

0A Country That Imports TVsWithout Trade,PD = 3000, Q = 400In world markets, PW = 1500

10PD > PW, so this country will import plasma TV sets from abroad.

The quantity of imports is simply the difference between the quantity demanded by domestic consumers and the quantity supplied by domestic firms at the world price.

Without Trade, CS = APS = B + CTotal surplus = A + B + CWith Free Trade, CS = A + B + DPS = CTotal surplus = A + B + C + D

PQD

S

1500

3000

CarsABDC

gains from trade

imports0A Country That Imports TVs

11Trade benefits consumers in this case because it allows them to buy plasma TVs at lower prices, so more consumers can afford plasma TVs if imports are allowed. The gains to consumers appear on the graph as the area (B+D), which represents the increase in consumer surplus when the country allows trade.

In this example, trade harms domestic producers because they now must sell their plasma TVs at a lower price. As a result, they produce a smaller quantity, earn less revenue, and likely let go of some of their workers. These losses are represented on the graph by the area B , which represents the fall in producer surplus resulting from trade.

As the graph shows, the gains to consumers outweigh the losses to producers: total surplus increases by the amount D, which represents the gains from trade in plasma TV sets.

total surplusproducer surplusconsumer surplusdirection of traderisesfallsrisesimportsPD > PWrisesrisesfallsexportsPD < PW

Summary: The Welfare Effects of TradeWhether a good is imported or exported, trade creates winners and losers. But the gains exceed the losses. 0

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3.5) Trade Graph Results 6.) Some ways to restrict International Trade

0Importing Country Results:

Consumers are Winners!3.5) Trade Graph Results Lower prices and more variety!

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0Importing Country Results:Producers are Losers! 3.5) Trade Graph Results More competition, lower prices, less customers.

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0Exporting Country Results:Producers are Winners! 3.5) Trade Graph Results Higher prices outside country, more customers!

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0Exporting Country Results:Consumers are Losers! 3.5) Trade Graph Results Higher prices outside country, so prices for you are higher.

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0Winners:Losers:Consumers in importing countryProducers in importing countryConsumers in exporting countryProducers in exporting country

3.5) Trade Graph Results

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0- An easy way to measure trade between countries. (if your getting a good deal or not)?4.) Terms of TradeTerms of Trade- A ratio of the indexed prices of exports and imports in a country.

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04.) Terms of TradeTerms of Trade- A ratio of the indexed prices of exports and imports in a country.-List of all the prices put together. Index Index price of exports Index price of imports

X 100Base year is 100Equation:

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04.) Terms of TradeTerms of Trade- A ratio of the indexed prices of exports and imports in a country.For example, if a country exports 50 dollars worth of product in exchange for 100 dollars worth of imported product, that country's terms of trade are 50/100 = 0.5.If its over 100 you get better price for your exports then what you pay for imports.If its under 100 you get worse price for your exports then you pay for imports.

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04.) Terms of TradeTerms of Trade- A ratio of the indexed prices of exports and imports in a country.- It can be used as a comparison of prices over time.Terms of Trade Usefulness Terms of Trade Limitations - Does not tell us about the volume of the countries' exports, only relative changes between countries over time.

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0Reasons for:Reasons against:1.) Comparative Advantages2.) Variety 3.) Technology 4.) Government Policy 1.) Jobs 2.) National Security 3.) Infant-Industries4.) Unfair competition 6.) Correct Balance of Payments Disequilibrium7.) Control the consumption of Demerit Goods5.) The protection-as-bargaining-chip argument5.) Arguments about International Trade

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0Reasons for:Reasons against:1.) Comparative Advantages2.) Variety 3.) Technology 4.) Government Policy 1.) Jobs 2.) National Security 3.) Infant-Industries4.) Unfair competition 6.) Correct Balance of Payments Disequilibrium7.) Control the consumption of Demerit Goods5.) The protection-as-bargaining-chip argument5.) Arguments about International TradeMost economists agree that these are all bad reason. However people use them all the time.

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0Reasons for1. ) Comparative Advantages- Produce more with lower costs and produce on a larger scale.

5.) Arguments about International Trade

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0Reasons forComparative advantages2.) Variety - More cool stuff to buy!


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0Reasons forComparative advantagesVariety 3.) Technology -Learn new things and can make even more cool stuff!


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0Reasons forComparative advantagesVariety Technology 4.) Government Policy -To diversify in case of shocks


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0Reasons forComparative AdvantagesVariety Technology Increase total welfare for your country and peopleGovernment Policy 5.) Arguments about International Trade

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Why All the Opposition to Trade?The winners from trade could compensate the losers and still be better off. Yet, such compensation rarely occurs.The losses are often highly concentrated among a small group of people, who feel them more strongly. The gains are often spread thinly over many people, who may not see how trade benefits them.Hence, the losers have more incentive to organize and lobby for restrictions on trade. Easy to see losersHard to see winners 0

3333In December 2005, thousands of protestors gathered outside the meeting place of the World Trade Organization talks in Hong Kong. Some protests turned violent, and police made 900 arrests.

Mankiw addresses the issue of opposition to trade very nicely in the Ask the Author video for Chapter 3.

The Ask the Author videos are available at the textbook website. You may need a username and password; you can get them from your Cengage/South-Western sales rep.

There is one Ask the Author video clip per chapter. Each video is about 2 minutes. In each, Mankiw addresses a question submitted by a student. I encourage you to check out these videos and consider showing some of them in your class.

The videos for Chapter 3 and Chapter 9 both go very nicely with the material in this PowerPoint.

0Reasons Against- Trade destroys jobs in the industries that compete against imports.1.) Jobs 5.) Arguments about International Trade

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0Reasons Against- Trade destroys jobs in the industries that compete against imports.1.) Jobs 5.) Arguments about International TradeEconomists response:Total unemployment does not rise as imports rise, because job losses from imports are offset by job gains in export industries.

Even if all goods could be produced more cheaply abroad, the country need only have a comparative advantage to have a viable export industry and to gain from trade.

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U.S. Imports & Unemployment, Decade averages, 1956-2005

0%2%4%6%8%10%12%14%16%1956-651966-751976-851986-951996-2005Imports (% of GDP)Unemployment (% of labor force)

0During this time international trade has exploded, but it doesnt mean everyone lost their job.In fact there are more jobs then ever!

3636By using decade averages, the short-term noise and fluctuations average out, which makes the long-term trends easier to see.

In most periods, rising imports are accompanied by falling, not rising, unemployment.

Note: This data does not appear in the textbook. I include it here because I think it is effective. But it is not supported in the Test Bank or Study Guide, so please feel free to omit this and the preceding slide if you wish.

Data source: FRED database, St Louis Federal Reserve, http://research.stlouisfed.org/fred2/ and my calculations. (I constructed imports as a percentage of GDP from quarterly, nominal, seasonally adjusted data. Then I computed simple averages of the two series over each of the decades shown in the graph.)

0Reasons AgainstJobs 2.) National Security - An industry vital to national security should be protected from foreign competition to prevent dependence on foreigners.

Ex China will not let America build their aircraft carriers even though America has the (CA) in making them.5.) Arguments about International Trade

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0Reasons AgainstJobs 2.) National Security - An industry vital to national security should be protected from foreign competition to prevent dependence on foreigners.

5.) Arguments about International TradeEconomists response:Fine, as long as we base policy on true security needs. But producers may exaggerate their own importance to national security to obtain protection from foreign competition.

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0Reasons AgainstJobs National Security 3.) Infant-IndustriesSunrise- industries

- A new industry argues for temporary protection until it is mature and can compete with foreign firms. 5.) Arguments about International Trade

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China prevents many Hollywood movies from being seen in China.

Because the government wants to help build the Chinese movie industry.

0Reasons AgainstJobs National Security 3.) Infant-IndustriesSunrise- industries

- A new industry argues for temporary protection until it is mature and can compete with foreign firms. 5.) Arguments about International TradeEconomists response:Difficult for govt to determine which industries will eventually be able to win. to compete and whether benefits of establishing these industries exceed cost to consumers of restricting imports. Besides, if a firm will be profitable in the long run, it should be willing to incur temporary losses.

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0Reasons AgainstJobs National Security Infant-Industries4.) Unfair Competition Dumping- Producers argue their competitors in another country have an unfair advantage,

example - due to govt subsidies. Dumping 5.) Arguments about International Trade

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Right now many countries are blaming China for sells steel below the cost is takes to produce it, because the Chinese government wants to support the Chinese steel industry, and other countries suffer because China is not playing by the WTO rules.

0Reasons AgainstJobs National Security Infant-Industries4.) Unfair Competition Dumping- Producers argue their competitors in another country have an unfair advantage,

5.) Arguments about International TradeEconomists response:Great! Then we can import extra-cheap products subsidized by the other countrys taxpayers. The gains to our consumers will exceed the losses to our producers.

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0Reasons Against5.) Arguments about International Trade5.) The protection-as-bargaining-chip argumentExample: The U.S. can threaten to limit imports of French wine unless France lifts their quotas on American beef. Economists response:Suppose France refuses. Then the U.S. must choose between two bad options: A) Restrict imports from France, which reduces welfare in the U.S.B) Dont restrict imports, which reduces U.S. credibility.

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Ways to control importation:Tariffs and Quotas

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- a tax on imports Example: Cotton shirtsPW = $20Tariff: T = $10/shirtConsumers must pay $30 for an imported shirt. So, domestic producers can charge $30 per shirt. In general, the price facing domestic buyers & sellers equals (PW + T ). 06.) Some ways to restrict International TradeTariff

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$30PW = $20Free trade:buyers demand 80sellers supply 25imports = 55T = $10/shirtprice rises to $30buyers demand 70sellers supply 40imports = 30

PQD

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$20

25Cotton shirts40

70

80

imports

imports06.) Some ways to restrict International Trade

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$30Free tradeCS = A + B + C + D + E + FPS = GTotal surplus = A + B + C + D + E + F + GTariffCS = A + BPS = C + GG Revenue = EDWL = D + FTotal surplus = A + B + C + E + G

PQD

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$20

25Cotton shirts40

ABDEGFC

70

80deadweight loss = D + F06.) Some ways to restrict International Trade

5252The tariff benefits domestic producers by allowing them to sell for a higher price. Producer surplus increases by C.

The tariff makes consumers worse off because they have to pay a higher price. Consumer surplus falls by C + D + E + F.

The tariff generates revenue for the government equal to E.

The losses from the tariff exceed the gains, so total welfare falls. The tariff reduces total surplus by (D + F).

$30DWL

D = deadweight loss from the overproduction of shirtsF = deadweight loss from the under-consumption of shirts

PQD

S

$20

25Cotton shirts40

ABDEGFC

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5353A tariff is a tax. Like the taxes we studied in the preceding chapter, the tariff causes a deadweight loss because it distorts incentives.

Here, the tariff causes the economy to devote more resources to a good that could be produced at lower opportunity cost in other countries. This causes a deadweight loss, represented on the graph by the area D.

Also, the tariff gives consumers an incentive to purchase a smaller quantity. The result is a deadweight loss (area F on graph).

- a tax on imports 06.) Some ways to restrict International TradeTariff Quota - is a limit on imports of a good. Mostly has the same effects as a tariff:Raises price, reduces quantity of imports.- A tariff creates revenue for the govt. A quota creates profits for the foreign producers of the imported goods, who can sell them at higher price.

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So to Summarize

International Trade:3.) Graphing International Trade1.) Specialization & Comparative Advantage2.) PPC and Trading Possibilities4.) Terms of Trade5.) Arguments about International Trade6.) Some ways to restrict International Trade

AbsoluteAdvantage 1.) Specialization & Comparative AdvantageComparativeAdvantage (CA)- the ability to produce at a lower opportunity cost then someone else.- You produce what you have (CA) in and trade for the other things that you dont.

4,000

100

5,000

2,000

1,000

3,000

500

200

300

4000ComputersWheat (tons)U.S. Consumption With Trade

0

2700270= amount consumed0110+ imported7000 exported3400160produced

wheatcomputers

With trade, can consume outside the PPC

5858The red point again represents production.

Trade un-tethers consumption from production. The light blue point represents consumption. Notice that the consumption point is above the PPF. Without trade, it would not be possible to consume this combination of the two goods!

In a sense, international trade is like technological progress: it allows society to produce quantities of goods that would otherwise not be possible.

Without Trade,CS = A + BPS = CTotal surplus = A + B + CWith Free Trade, CS = APS = B + C + DTotal surplus = A + B + C + D

PQD

S

$6

$4

Soybeans

exports

ABDC

gains from trade0Exporting Soybeans example

5959Trade benefits soybean producers because they can sell at a higher price. Producer surplus rises by the area B + D.

Trade makes domestic buyers worse off because they have to pay a higher price. Consumer surplus falls by the area B.

The gains to producers are greater than the losses to consumers, so trade increases total welfare: total surplus rises by the amount D.

Without Trade, CS = APS = B + CTotal surplus = A + B + CWith Free Trade, CS = A + B + DPS = CTotal surplus = A + B + C + D

PQD

S

1500

3000

CarsABDC

gains from trade

imports0A Country That Imports TVs

60Trade benefits consumers in this case because it allows them to buy plasma TVs at lower prices, so more consumers can afford plasma TVs if imports are allowed. The gains to consumers appear on the graph as the area (B+D), which represents the increase in consumer surplus when the country allows trade.

In this example, trade harms domestic producers because they now must sell their plasma TVs at a lower price. As a result, they produce a smaller quantity, earn less revenue, and likely let go of some of their workers. These losses are represented on the graph by the area B , which represents the fall in producer surplus resulting from trade.

As the graph shows, the gains to consumers outweigh the losses to producers: total surplus increases by the amount D, which represents the gains from trade in plasma TV sets.

0Winners:Losers:Consumers in importing countryProducers in importing countryConsumers in exporting countryProducers in exporting country

3.5) Trade Graph Results

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2.5) Real World Limitations1.) PPF are not linear Production costs are not constant 2.) Prices, Inflation , Exchange rates change the equation3.) Other costs are not included ex - Transportation costsEven though this is far from realistic it still is the starting point that explains that trade is good!4.) Trade Barriers

04.) Terms of TradeTerms of Trade- A ratio of the indexed prices of exports and imports in a country.-List of all the prices put together. Index Index price of exports Index price of imports

X 100Base year is 100Equation:

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- a tax on imports Example: Cotton shirtsPW = $20Tariff: T = $10/shirtConsumers must pay $30 for an imported shirt. So, domestic producers can charge $30 per shirt. In general, the price facing domestic buyers & sellers equals (PW + T ). 06.) Some ways to restrict International TradeTariff

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- a tax on imports 06.) Some ways to restrict International TradeTariff Quota - is a limit on imports of a good. Mostly has the same effects as a tariff:Raises price, reduces quantity of imports.- A tariff creates revenue for the govt. A quota creates profits for the foreign producers of the imported goods, who can sell them at higher price.

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$30Free tradeCS = A + B + C + D + E + FPS = GTotal surplus = A + B + C + D + E + F + GTariffCS = A + BPS = C + GG Revenue = EDWL = D + FTotal surplus = A + B + C + E + G

PQD

S

$20

25Cotton shirts40

ABDEGFC

70


6767The tariff benefits domestic producers by allowing them to sell for a higher price. Producer surplus increases by C.

The tariff makes consumers worse off because they have to pay a higher price. Consumer surplus falls by C + D + E + F.

The tariff generates revenue for the government equal to E.

The losses from the tariff exceed the gains, so total welfare falls. The tariff reduces total surplus by (D + F).

The End

Thank you

Education

International Trade SFLS part2