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1MACROECONOMICS Paul Krugman | Robin Wells THIRD EDITIONECONOMICSandMACROECONOMICS Paul Krugman | Robin WellsChapter 5International Trade
2WHAT YOU WILL LEARN IN THIS CHAPTER How comparative advantage leads to mutually beneficial international tradeThe sources of international comparative advantageWho gains and who loses from international trade, and why the gains exceed the lossesHow tariffs and import quotas cause inefficiency and reduce total surplusWhy governments often engage in trade protection to shelter domestic industries from imports and how international trade agreements counteract thisWHAT YOUWILL LEARNIN THIS CHAPTER
3Comparative Advantage and International Trade Goods and services purchased from other countries are imports; goods and services sold to other countries are exports.Globalization is the phenomenon of growing economic linkages among countries.To understand why international trade occurs and why economists believe it is beneficial to the economy, we will first review the concept of comparative advantage.The following graph illustrates the growing importance of international trade.
5Production Possibilities and Comparative Advantage, Revisited Let’s repeat the definition of comparative advantage from earlier: A country has a comparative advantage in producing a good or service if the opportunity cost of producing the good or service is lower for that country than for other countries.The Ricardian model of international trade analyzes international trade under the assumption that opportunity costs are constant.
6Production Possibilities and Comparative Advantage, Revisited Autarky is a situation in which a country cannot trade with other countries.The following figure shows hypothetical production possibility frontiers for the United States and Colombia. We assume that: (1) there are only two goods and (2) the production possibility frontiers are straight lines.
7Comparative Advantage and the Production Possibility Frontier (a) U.S. Production Possibility Frontier(b) Mexico’s Production Possibility FrontierQuantity of airplanesQuantity of airplanes2,000Slope = –2U.S. production and consumption in autarkyMexico’s production and consumption in autarkySlope = –0.5C1,000US1,000Figure Caption: Figure 5-2: Comparative Advantage and the Production Possibility FrontierThe U.S. opportunity cost of each bundle of auto parts in terms of airplanes is 2: 2 airplanes must be forgone for every additional bundle of auto parts produced. The Mexican opportunity cost of each bundle of auto parts in terms of airplanes is 0.5: only 0.5 of an airplane must be forgone for every additional bundle of auto parts produced. So Mexico has a comparative advantage in auto parts and the United States has a comparative advantage in airplanes. In autarky, CUS is the U.S. production and consumption bundle and CM is the Mexican production and consumption bundle.CM500PPFPPFUSM5001,0001,0002,000Quantity of auto parts(bundles of 10,000)Quantity of auto parts(bundles of 10,000)
9The Gains from International Trade The Ricardian model of international trade shows that trade between two countries makes both countries better off than they would be in autarky—that is, there are gains from trade.The following tables and figures illustrate that specialization has the effect of increasing total world production of both goods and that each country can consume more of both goods than it did under autarky.
10Production and Consumption Under Autarky (a) United StatesProductionConsumptionQuantity of auto parts (bundles)500Quantity of airplanes1,000(b) Mexico(c) World (United States and Mexico)1,500
11Production and Consumption After Specialization and Trade (a) United StatesProductionConsumptionQuantity of auto parts (bundles)750Quantity of airplanes2,0001,250(b) Mexico(c) World (United States and Mexico)
12The Gains from International Trade (a) U.S. Production and Consumption(b) Mexico’s Production and ConsumptionQuantity of airplanesQuantity of airplanesMexico’s production and consumption in autarkyQU.S. production with tradeUS2,000U.S. consumption with tradeMexico’s consumption with tradeC’1,250USCPPF1,000US1,000MU.S. production and consumption in autarkyC’750VMexico’s production with tradeC500MFigure Caption: Figure 5-3: The Gains from International TradeTrade increases world production of both goods, allowing both countries to consume more. Here, each country specializes its production as a result of trade: the United States produces at QUS and Mexico produces at QM. Total world production of airplanes has risen from 1,500 to 2,000 and of auto parts from 1,500 bundles to 2,000 bundles. The United States can now consume bundle C′ US, and Mexico can now consume bundle C′ M—consumption bundles that were unattainable without trade.PPFQUMS5007501,0001,0001,2502,000Quantity of auto parts (bundles)Quantity of auto parts (bundles)
14Sources of Comparative Advantage The main sources of comparative advantage are:International differences in climateFor example: winter deliveries of Chilean grapes to the United StatesDifferences in technologyDifferences in factor endowmentsThe relationship between comparative advantage and factor availability is found in an influential model of international trade: the Heckscher–Ohlin model.
15Heckscher-Ohlin Model According to the Heckscher-Ohlin model, a country has a comparative advantage in a good whose production is intensive in the factors that are abundantly available in that country.A key concept in the model is factor intensity.The factor intensity of production of a good is a measure of which factor is used in relatively greater quantities than other factors in production.Oil refining is capital-intensive compared with clothing manufacture, because oil refiners use a higher ratio of capital to labor than clothing producers.
16Heckscher-Ohlin Model The Heckscher–Ohlin model shows how comparative advantage can arise from differences in factory endowments:goods differ in their factor intensity, and countries tend to export goods that are intensive in the factors they have in abundance.Trade in manufactured goods amongst developed countries is best explained by increasing returns to production.
17Supply, Demand, and International Trade The Effects of ImportsThe domestic demand curve shows how the quantity of a good demanded by domestic consumers depends on the price of that good.The domestic supply curve shows how the quantity of a good supplied by domestic producers depends on the price of that good.The world price of a good is the price at which that good can be bought or sold abroad.
18The Effects of ImportsWhen a market is opened to trade, competition among importers or exporters drives the domestic price to equality with the world price.If the world price is lower than the autarky price, trade leads to imports and a fall in the domestic price compared with the world price.There are overall gains from trade because consumer gains exceed the producer losses.
19Consumer and Producer Surplus in Autarky Price of auto partsDomestic supplyConsumer surplusAPAProducer surplusDomestic demandFigure Caption: Figure 5-5: Consumer and Producer Surplus in Autarky Consumer and Producer Surplus in AutarkyIn the absence of trade, domestic price is PA, the autarky price at which the domestic supply curve and the domestic demand curve intersect. The quantity produced and consumed domestically is QA. Consumer surplus is represented by the blue-shaded area, and producer surplus is represented by the red-shaded area.QQuantity of auto partsAConsumer surplus is represented by the blue-shaded area.Producer surplus is represented by the pink-shaded area.
20The Domestic Market with Imports Price of auto partsDomestic supplyAutarky priceAPAPWWorld priceDomestic demandFigure Caption: Figure 5-6: The Domestic Market with ImportsHere the world price of auto seats, PW, is below the autarky price, PA. When the economy is opened to international trade, imports enter the domestic market, and the domestic price falls from the autarky price, PA, to the world price, PW. As the price falls, the domestic quantity demanded rises from QA to QD and the domestic quantity supplied falls from QA to QS. The difference between domestic quantity demanded and domestic quantity supplied at PW, the quantity QD−QS, is filled by imports.QQQQuantity of auto partsDomestic quantity supplied with tradeSADDomestic quantity demanded with tradeImports
21The Effects of Imports on Surplus Price of auto partsChanges in surplusGainLossConsumer surplusX + ZDomestic supplyProducer surplus- XChange in total surplus+ ZWPAAXZPWYDomestic demandFigure Caption: Figure 5-7: The Effects of Imports on SurplusWhen the domestic price falls to PW as a result of international trade, consumers gain additional surplus (areas X+Z) and producers lose surplus (area X). Because the gains to consumers outweigh the losses to producers, there is an increase in the total surplus in the economy as a whole (area Z).QQQQuantity of auto partsSADImports
22The Effects of ExportsIf the world price is higher than the autarky price, trade leads to exports and a rise in the domestic price compared with the world price.There are overall gains from trade because producer gains exceed the consumer losses.The graph that follows shows the domestic market with exports.
23The Domestic Market with Exports Price of airplanesDomestic supplyWorld pricePWAPAAutarky priceDomestic demandFigure Caption: Figure 5-8: The Domestic Market with ExportsHere the world price, PW, is greater than the autarky price, PA. When the economy is opened to international trade, some of the domestic supply is now exported. The domestic price rises from the autarky price, PA, to the world price, PW. As the price rises, the domestic quantity demanded falls from QA to QD and the domestic quantity supplied rises from QA to QS. The portion of domestic production that is not consumed domestically, Q−Q, is exported.Domestic quantity demanded with tradeQQQDASDomestic quantity supplied with tradeQuantity of airplanesExports
24The Effects of Exports on Surplus Price of airplanesChanges in surplusGainLossConsumer surplus–XDomestic supplyProducer surplusX+ZWChange in total surplus+ ZPWZXPAAYDomestic demandFigure Caption: Figure 5-9: The Effects of Exports on SurplusWhen the domestic price rises to PW as a result of trade, producers gain additional surplus (areas X+Z) but consumers lose surplus (area X). Because the gains to producers outweigh the losses to consumers, there is an increase in the total surplus in the economy as a whole (area Z).QQQDASQuantity of airplanesExports
25International Trade and Wages Exporting industries produce goods and services that are sold abroad.Import-competing industries produce goods and services that are also imported.
26International Trade and Wages International trade tends to increase the demand for factors that are abundant in our country compared with other countries, and to decrease the demand for factors that are scarce in our country compared with other countries.As a result, the prices of abundant factors tend to rise, and the prices of scarce factors tend to fall as international trade grows.
27Effects of Trade Protection An economy has free trade when the government does not attempt either to reduce or to increase the levels of exports and imports that occur naturally as a result of supply and demand.Policies that limit imports are known as trade protection or simply as protection.Most economists advocate free trade, although many governments engage in trade protection of import-competing industries.The two most common protectionist policies are tariffs and import quotas. In rare instances, governments subsidize export industries.
28Effects of a Tariff A tariff is a tax levied on imports. It raises the domestic price above the world price, leading to a fall in trade and total consumption and a rise in domestic production.Domestic producers and the government gain, but consumer losses more than offset this gain, leading to deadweight loss in total surplus.
29The Effect of a Tariff Price of auto parts Domestic supply Price with tariffPTTariffPWDomestic demandFigure Caption: Figure 5-10: The Effect of a TariffA tariff raises the domestic price of the good from PW to PT. The domestic quantity demanded shrinks from QD to QDT, and the domestic quantity supplied increases from QS to QST. As a result, imports—which had been QD− QS before the tariff was imposed—shrink to QDT−QST after the tariff is imposed.World priceQQQQQuantity of auto partsSSTDTDImports after tariffImports before tariff
30A Tariff Reduces Total Surplus Changes in surplusGainLossConsumer surplus–(A+)+BCDPrice of auto partsProducer surplusAGovernment revenueCDomestic supplyChange in total surplus–(B+D)PTTariffABCDPWFigure Caption: Figure 5-11: A Tariff Reduces Total SurplusWhen the domestic price rises as a result of a tariff, producers gain additional surplus (area A), the government gains revenue (area C), and consumers lose surplus (areas A+B+C+D). Because the losses to consumers outweigh the gains to producers and the government, the economy as a whole loses surplus (areas B+D).Domestic demandQQQQQuantity of auto partsSSTDTImports after tariffDImports before tariff
31Effects of an Import Quota An import quota is a legal limit on the quantity of a good that can be imported.Its effect is like that of a tariff, except that revenues—the quota rents—accrue to the license-holder, not to the government.Now, let’s move on to the political economy of trade protection.
32The Political Economy of Trade Protection Arguments for Trade ProtectionAdvocates of tariffs and import quotas offer a variety of arguments. Three common arguments are:national securityjob creationthe infant industry argumentDespite the deadweight losses, import protections are often imposed because groups representing import-competing industries are smaller and more cohesive than groups of consumers.
33International Trade Agreements and the World Trade Organization To further trade liberalization, countries engage in international trade agreements.International trade agreements are treaties in which a country promises to engage in less trade protection against the exports of other countries in return for a promise by other countries to do the same for its own exports.Some agreements are for only a small number of countries, such as the North American Free Trade Agreement, which is among the United States, Canada, and Mexico.
34International Trade Agreements and the World Trade Organization The World Trade Organization (WTO) is a multinational organization that seeks to negotiate global trade agreements as well as adjudicate trade disputes between member countries.The European Union, or EU, is a customs union among 27 European nations.
35New Challenges to Globalization There are two concerns shared by economists:worries about the effects of globalization on inequalityworries that new developments, in particular the growth in offshore outsourcing, are increasing economic insecurityOffshore outsourcing takes place when businesses hire people in another country to perform various tasks.
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37SummaryInternational trade is of growing importance to the United States and of even greater importance to most other countries. Foreign trade has been growing rapidly, a phenomenon called globalization.The Ricardian model of international trade assumes that opportunity costs are constant. It shows that there are gains from trade: two countries are better off with trade than in autarky.
38SummaryThe Heckscher–Ohlin model shows how differences in factor endowments determine comparative advantage.Goods differ in factor intensity.Countries tend to export goods that are intensive in the factors they have in abundance.The domestic demand curve and the domestic supply curve determine the price of a good in autarky. When international trade occurs, the domestic price is driven to equality with the world price, the price at which the good is bought and sold abroad.
39SummaryIf the world price is below the autarky price, a good is imported. This leads to an increase in consumer surplus, a fall in producer surplus, and a gain in total surplus. If the world price is above the autarky price, a good is exported. This leads to an increase in producer surplus, a fall in consumer surplus, and a gain in total surplus.International trade leads to expansion in exporting industries and contraction in import-competing industries.
40SummaryMost economists advocate free trade, but in practice many governments engage in trade protection.A tariff is a tax levied on imports. An import quota is a legal limit on the quantity of a good that can be imported.Several popular arguments have been made in favor of trade protection, but in practice the main reason is probably political: import-competing industries are organized and well-informed about trade protection, while consumers are unaware of the costs they pay.
41SummaryMany concerns have been raised about the effects of globalization:Income inequality due to the surge in imports from relatively poor countriesOffshore outsourcing
42KEY TERMS Imports Import-competing industries Exports Free trade GlobalizationTrade protectionRicardian model of international tradeProtectionTariffAutarkyImport quotaFactor intensityInternational trade agreementsHeckscher–Ohlin modelDomestic demand curveNorth American Free Trade Agreement (NAFTA)Domestic supply curveEuropean Union (EU)World priceWorld Trade Organization (WTO)Exporting industriesOffshore outsourcing