Copyright (c) 2000 by Harcourt Inc. All rights reserved. Next page Slides to Accompany “Economics: Public and Private Choice 9th ed.” James Gwartney, Richard.

Copyright (c) 2000 by Harcourt Inc. All rights reserved. Next page Slides to Accompany “Economics: Public and Private Choice 9th ed.” James Gwartney, Richard Stroup, and Russell Sobel Gaining from International Trade Chapter 17

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Cross Country Differences in Size of the Trade Sector n The size of the trade sector varies substantially across countries. n The trade sectors as a share of the economy will tend to be larger for small countries than for large countries.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. The Trade Sector of the United States n The size of the trade sector has grown rapidly in recent years. n Both exports and imports were approximately 7% of the economy in 1980. In 1998, exports accounted for 13% of GDP output, while imports summed to 16.1%. n Canada, Mexico, and Japan are the leading trading partners of the United States.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. The Growth of the U.S. Trade Sector: 1960-1998 0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 Imports as a Share of Real GDP 19601965197019751980198519901995 0.16 16.2 % 19601965197019751980198519901995 Exports as a Share of Real GDP 0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 13.0 % 0.16 During the past several decades, international trade has grown more rapidly than total output. The growth of the trade sector has been exceedingly rapid since 1980. Imports rose from 7 percent of GDP in 1980 to 16.1 percent in 1998. During the same period, exports rose from 7 percent to 13 percent of GDP.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. n International trade leads to mutual gain because it allows each country to specialize more fully in the production of those things that it does best. n Trade permits each country to use more of its resources to produce those goods that it can produce at a relatively low cost. n With trade, it will be possible for the trading partners to consume a bundle of goods that it would be impossible for them to produce domestically. Gains from Specialization and Trade n Law of Comparative Advantage: -- A group of individuals, regions, or nations can produce a larger joint output if each specializes in the production of goods in which it is a low- opportunity cost producer and trades for goods for which it is a high opportunity cost producer.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Country United States Japan Change in Total Output Output Per Worker Day Potential Change In Output* Food (1) Clothing (2) Clothing (4) Food (3) Gains from Specialization and Trade n As long as the relative production costs of the two goods differ between two countries—for example, U.S. and Japan—gains from trade will be possible. 21 39 +6-3 +9 +3-6 Consider the example above where columns (1) and (2) indicate daily output of either food or clothing in the U.S. and Japan. If the U.S. moves 3 workers from the clothing industry to the food industry, it would produce 6 more units of food and only 3 fewer of clothing. If Japan moves 1 worker from the food industry to the clothing industry, clothing output would increase by 9 units while food declines by only 3 units. With such a reallocation of labor, the U.S. and Japan are able to increase their aggregate output of both food (+ 3 units) and clothing (+ 6 units).

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. F ood millions of units U nited S tates 100200300400 100 200 300 M J apan 150 300 450 S 250 150 50 375 225 75 Production possibilities, U.S. US 1 J 1 N Production possibilities, Japan F ood millions of units 400 C lothing millions of units Here we illustrate the daily production of a U.S. labor force of 200 million workers and a Japanese of 50 million, given the cost of producing food and clothing presented in the previous slide. In the absence of trade, consumption possibilities will be restricted to points such as US 1 in the United States and J 1 in Japan. Each of these points lay along the production possibilities curve of the respective nation. Production Possibilities of the US & Japan before Specialization and Trade R

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. U nited S tates J apan Consumption Possibilities with Trade 100200300400 100 200 300 M 150 300 450 S R 250 150 50 375 225 75 US 1 J 1 N O 200300400 C lothing millions of units With specialization and trade, consumption possibilities can be expanded. Consumption possibilities of Japan with trade Consumption possibilities of U.S. with trade T If the U.S. can trade food for clothing (1-for-1), it can specialize in the production of food and consume along the ON line (rather than its original production-possibilities constraint, MN). Similarly, when Japan trades clothing for food (1-for-1), it can specialize in the production of clothing and consume any combination along the RT line (rather than its original, RS). F ood millions of units

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 100200300400 100 200 300 M 150 300 450 S R 250 150 50 375 225 75 US 1 J 1 N O 200300400 U nited S tates J apan Consumption Possibilities with Trade C lothing millions of units For example, with specialization and trade, the US could increase its consumption from US 1 to US 2, gaining 50 million units of clothing and 100 million units of food. US Imports US Exports J 2 ( 200 F ood, 250 C lothing ) Japanese Exports Japanese Imports T Simultaneously, Japan could increase consumption from J 1 to J 2, a gain of 125 million units of food and 25 million units of clothing. F ood millions of units ( 200 F ood, 200 C lothing ) 2 US

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. u Economies of Scale: -- International trade allows both domestic producers and consumers to gain from reductions in per-unit costs that often accompany large-scale production, marketing, and distribution. u More Competitive Markets: -- International trade promotes competition in domestic markets and allows consumers to purchase a wide variety of goods at economical prices. n In addition to the gains derived from specialization in areas of comparative advantage, international trade leads to gains from: Gains from Specialization and Trade

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 1. State the law of comparative advantage in your own words. Questions for Thought: 2. Under what conditions can a nation gain from international trade? 3. Do you think the 50 states of the United States would be better off if each imposed trade barriers limiting trade across state boundaries? Do you think the countries of North and South America would be better off if there were no trade restrictions limiting trade across national boundaries? Explain your response.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Exports and Imports Are Linked n U.S. exports provide Americans with the foreign exchange required to purchase imports. n Similarly, U.S. imports provide foreigners with the U.S. dollars required to buy things from Americans. n Therefore, restrictions that limit one will also limit the other.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. P n D d P w Q n Q c Q p S oybeans (bushels) a b c S d P w Q w P rice S oybeans (bushels) P rice S w D w S w U.S. MarketWorld Market Where U.S. Producers have a Comparative Advantage, Producers Benefit from Exports The price of soybeans and other internationally traded commodities is determined by the forces of supply and demand in the world market. If U.S. soybean producers were prohibited from selling to foreigners, the domestic price would be P n. Free trade permits the U.S. soybeans producers to sell Q p units at the higher world price of P w.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. P n Q c a D d P w Q n Q p S oybeans (bushels) b c S d P w Q w P rice S oybeans (bushels) P rice S w D w U.S. MarketWorld Market At the world price of P w, the quantity (Q p – Q c ) is exported. Compared to the no-trade situation, the producers’ gain from the higher price (P w -b-c-P n ) exceeds the cost imposed on domestic consumers (P w -a-c-P n ) by the triangle a-b-c. S w U.S. exports Where U.S. Producers have a Comparative Advantage, Producers Benefit from Exports Where U.S. producers have a comparative advantage, U.S. producers benefit from exports.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. D d Q n S oybeans (bushels) S d P w Q w P rice S oybeans (bushels) P rice S w D w U.S. MarketWorld Market Where Foreign Producers have a Comparative Advantage, U.S. Consumers Benefit from Imports a P n In the absence of trade, the domestic price of shoes would be P n. Since many foreign producers have comparative advantages in the production of shoes, international trade leads to lower prices (P w ). Consider the international market for manufacturing shoes.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. a D d P w Q n Q p Q c S oybeans (bushels) b c S d P w Q w P rice S oybeans (bushels) P rice S w D w U.S. MarketWorld Market S w U.S. imports Where Foreign Producers have a Comparative Advantage, U.S. Consumers Benefit from Imports P n At the price P w, U.S. consumers demand Q c units of which (Q c – Q p ) are imported. Compared to no-trade, consumers gain P n -a-b-P w, while domestic producers lose P n -a-c-P w. A net gain of a-b-c results. Where foreign producers have a comparative advantage, U.S. consumers benefit from imports.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Summary: Supply, Demand, and Gains from Trade n International trade and specialization result in lower prices (and higher domestic consumption) for imported products and higher prices (and lower domestic consumption) for exported products. n Trade permits the residents of each nation to concentrate on the things they do best (produce at a low cost), while trading for those they do least well.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. the tariff generates T tax revenues for the government... Trade Restrictions Promote Inefficiency. and Reduce Potential Gains from Trade: - - Impact of a Tariff. Q uantity (automobiles) Q d 1 D omestic s upply P w T UV Q 1 S Imports after tariff P rice D omestic D emand Initial imports P + t w Tariff = t Consider the impact of tariff on autos. In the absence of a tariff, the world price of automobiles is P w. At P w U.S. consumers purchase Q 1 units... Q d1 from domestic producers and... Q 1 - Q d1 from foreign producers. A tariff ( t ) makes it more costly for Americans to purchase automobiles from foreigners. Domestic prices increase to (P w + t). Total U.S. purchases fall from Q 1 to Q 2. U.S. purchases from domestic producers increase from Q d1 to Q d2... imports fall to Q 2 – Q d2. Producers gain the area S... the areas U and V are deadweight losses due to the reduction in allocative efficiency. Consumers lose it all (S + U + T + V) in the form of higher prices and a reduction of consumer surplus. Q 2 Q d 2

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Domestic producers gain the area S. The area T goes to foreign producers granted permission to import and sell in the U.S. While total U.S. purchases fall from Q 1 to Q 2, U.S. purchases from domestic producers increase from Q d1 to Q d2... Trade Restrictions Promote Inefficiency. and Reduce Potential Gains from Trade: - - Impact of a Quota. Q uantity (automobiles) Q d 1 D omestic s upply P w T UV Q 1 S Import Quota: Q 2 – Q d2 P rice D omestic D emand Initial imports P 2 Consider the impact of a quota on peanuts. In the absence of trade restraints, the world price of peanuts (P w ) would also be the domestic price. At P w U.S. consumers would purchase Q 1 units... Q d1 from domestic producers and... and Q 1 - Q d1 imported from foreign producers. A quota limiting imports to Q 2 – Q d2 would push up the domestic price to P 2. imports fall to Q 2 – Q d2. Again the areas U and V are deadweight losses and consumers lose (S + U + T + V) in the form of higher prices and a reduction of consumer surplus. Q 2 Q d 2 Note: the government derives no revenue from quotas.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Why do Nations Adopt Trade Restrictions? n National Defense Argument n Dumping: -- The sale of goods abroad at a price below their cost (and below their price in the domestic market of the exporting nation.) u Dumping is illegal under U.S. law u When considering the merits of anti-dumping restrictions, remember that: F firms with large inventories may find it in their interest to offer goods at prices below their cost of production F domestic firms are permitted to engage in this practice, and, F the lower prices benefit domestic consumers.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Why do Nations Adopt Trade Restrictions? n Infant Industry Argument n Special Interests and Trade Restrictions u Trade restrictions provide highly visible, concentrated benefits for a small groups of people, while imposing widely dispersed costs that are often difficult to identify on the general citizenry. u Politicians have a strong incentive to favor special interest issues, even if they conflict with economic efficiency. u The special-interest groups provide the primary source for trade restrictions.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Do Trade Restrictions Protect Jobs and Promote Employment? n If foreigners are unable to sell as much to Americans, then they will have fewer dollars with which to buy from Americans. Therefore, when the volume of imports declines there will be an automatic secondary effect—foreigners will have fewer dollars with which to buy American goods. n Trade restrictions do not “save” jobs, they merely reshuffle them. Restrictions will mean more Americans working in areas where we do not have a comparative advantage.

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Countries with Fewer Trade Restrictions are Generally More Prosperous Size of trade Sector as a % of GDP 1995 Growth of Per-capita GDP 1980–1997 Average tax Rate on International Trade Black-market Exchange-rate Premium 19801995 1980 Low trade restrictions: Singapore Hong Kong Panama Malaysia Ireland Taiwan South Korea Portugal Indonesia Greece Average: 166.0% 72.7% 0.5 3.1 7.7 3.0 3.6 4.1 2.1 2.9 3.2 3.1 148.9 94.0 90.6 71.8 43.3 33.7 30.5 25.6 21.8 0.1 0.3 1.4 2.1 1.5 2.0 0.1 2.2 0.1 1.1 5.4 4.7 0.5 4.0 4.2 5.9 7.5 2.8 4.8 1.3 4.1 0 0 0 0 0 1 5 2 2 7 2 0 0 0 0 0 0 0 0 2 0 0 Source: James Gwartney and Robert Lawson, Economic Freedom of the World:1997 Annual Report (Washington, D.C.: Cato Institute, 1997). Here we indicate the 10 less developed countries with the lowest trade restrictions. Note that the per-capita growth rate of these countries averaged 4.1% (from 1980 - 1997).

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Countries with Fewer Trade Restrictions are Generally More Prosperous Size of trade Sector as a % of GDP 1995 Growth of Per-capita GDP 1980–1997 Average tax Rate on International Trade Black-market Exchange-rate Premium 19801995 1980 High trade restrictions: Rwanda India Burundi Iran Bangladesh Cameroon Sierra Leone Madagascar Dominican Republic Syria Average: 6.6% 20.4% 13.3 15.5 18.1 17.0 13.4 11.0 13.3 8.5 9.2 7.1 12.6 11.4 14.8 16.2 18.3 20.1 23.7 27.4 27.8 37.5 14.6 12.7 13.6 5.6 12.1 7.7 8.5 12.2 4.0 9.9 -3.4 3.0 -1.7 1.0 2.4 -0.9 -3.5 -1.8 -0.4 0.4 -0.5 67 5 45 164 111 2 62 51 37 35 58 105 8 44 115 28 1 2 2 2 301 61 Source: James Gwartney and Robert Lawson, Economic Freedom of the World:1997 Annual Report (Washington, D.C.: Cato Institute, 1997). Here we indicate the 10 less developed countries with the highest trade restrictions. Note that the per-capita growth rate of these countries averaged -0.5% (from 1980 - 1997).

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Countries with Fewer Trade Restrictions are Generally More Prosperous Size of trade Sector as a % of GDP 1995 Low trade restrictions: Singapore Hong Kong Panama Malaysia Ireland Taiwan South Korea Portugal Indonesia Greece Average: 166.0% 72.7% 0.5 3.1 7.7 3.0 3.6 4.1 2.1 2.9 3.2 3.1 148.9 94.0 90.6 71.8 43.3 33.7 30.5 25.6 21.8 Growth of Per-capita 1980–1997 Average tax Rate on International Trade Black-market Exchange-rate Premium 19801995 1980 0.1 0.3 1.4 2.1 1.5 2.0 0.1 2.2 0.1 1.1 5.4 4.7 0.5 4.0 4.2 5.9 7.5 2.8 4.8 1.3 4.1 0 0 0 0 0 1 5 2 2 7 2 0 0 0 0 0 0 0 0 2 0 0 High trade restrictions: Rwanda India Burundi Iran Bangladesh Cameroon Sierra Leone Madagascar Dominican Republic Syria Average: 6.6% 20.4% 13.3 15.5 18.1 17.0 13.4 11.0 13.3 8.5 9.2 7.1 12.6 11.4 14.8 16.2 18.3 20.1 23.7 27.4 27.8 37.5 14.6 12.7 13.6 5.6 12.1 7.7 8.5 12.2 4.0 9.9 -3.4 3.0 -1.7 1.0 2.4 -0.9 -3.5 -1.8 -0.4 0.4 -0.5 67 5 45 164 111 2 62 51 37 35 58 105 8 44 115 28 1 2 2 2 301 61 Source: James Gwartney and Robert Lawson, Economic Freedom of the World:1997 Annual Report (Washington, D.C.: Cato Institute, 1997). GDP

Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 1. “Exports are good. They create jobs and help make America prosperous. On the other hand, imports destroy jobs and reduce our standard of living.” Do you agree or disagree with this statement? Questions for Thought: 2. How do tariffs and quotas differ? Can you think of any reason why foreign producers might prefer a quota rather than a tariff? 3. “When a high-wage country trades with a low- wage country, the wages of workers in the high- wage country will be pulled down.” Indicate why you either agree or disagree with this view.

Copyright (c) 2000 by Harcourt Inc. All rights reserved. Next page Slides to Accompany “Economics: Public and Private Choice 9th ed.” James Gwartney, Richard.

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Copyright (c) 2000 by Harcourt Inc. All rights reserved. Next page Slides to Accompany “Economics: Public and Private Choice 9th ed.” James Gwartney, Richard.

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Presentation on theme: "Copyright (c) 2000 by Harcourt Inc. All rights reserved. Next page Slides to Accompany “Economics: Public and Private Choice 9th ed.” James Gwartney, Richard."— Presentation transcript:

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