CH.20 International Trade 1: Absolute and Comparative Advantage 2: Trade Restrictions and role of the World Trade Organization tariffs Import quotas Export subsidies 3: The Benefits of Reducing Barriers to International Trade 4: Trade agreements in the post-WWII era 5: Free trade, Trade restrictions and Fair trade

20.1 Absolute and Comparative Advantage The evidence that international trade confers overall benefits on economies is pretty strong. Absolute advantage - When one country can use fewer resources to produce a good compared to another country; When a country is more productive compared to another country. Comparative advantage - when a country can produce a good at a lower cost in terms of other goods.

Production Possibilities Frontiers Before Trade (a) Saudi Arabia can produce 100 barrels of oil at maximum and zero corn (point A). Or 25 bushels of corn and zero oil (point B). It can also produce other combinations of oil and corn if it wants to consume both goods, such as at point C. All points above the frontiers are impossible to produce given the current level of resources and technology.

Production Possibilities Frontiers Before Trade, Continued (b) If the United States produces only oil, it can produce at maximum, 50 barrels and zero corn (point A’). Or at the other extreme, it can produce a maximum of 100 bushels of corn and no oil (point B’). Other combinations of both oil and corn are possible, such as point C'.

Sources of Comparative Advantage The main sources of comparative advantage are: International differences in climate e.g. winter deliveries of Chilean grapes to the U.S. Differences in technology Factor endowments The relationship between comparative advantage and factor availability is found in an influential model of international trade, the Heckscher–Ohlin model. Krugman/Wells, Principles of Macroeconomics. Worth Publishers. 2009

Opportunity Cost and Comparative Advantage The slope of the production possibility frontier illustrates the opportunity cost of producing oil in terms of corn. Since Saudi Arabia gives up the least (in terms of corn) to produce a barrel of oil, it has a comparative advantage in oil production. The United States gives up the least (in terms of oil) to produce a bushel of corn, so it has a comparative advantage in corn production.

Mutually Beneficial Trade Even when one country has an absolute advantage in all goods and another country has an absolute disadvantage in all goods, both countries can still benefit from trade. Trade allows each country to take advantage of lower opportunity costs in the other country. Gains from on both sides result from pursuing comparative advantage and producing at a lower opportunity cost. The theory of comparative advantage: trade should happen between economies with large differences in opportunity costs of production. But roughly half of all world trade involves shipping goods between fairly similar high-income economies of the United States, Canada, the European Union, Japan, Mexico, and China.

20.4 The Benefits of Reducing Barriers to International Trade Trade restrictions: Tariffs - taxes that governments place on imported goods. Traditionally, tariffs were used simply as a political tool to protect certain vested economic, social, and cultural interests. Import quotas Limits on the quantity of a product that can be imported from another country over a given period of time. Export subsidies Monetary incentives provided by a government to cover some or all of the cost of producing more of a product for export. Export subsidies have the effect of lowering the cost of production

Effects 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. Krugman/Wells, Principles of Macroeconomics. Worth Publishers. 2009

The World Trade Organization was established in 1995 with the goal of monitoring the many trade agreements that nations had entered into. The world’s nations meet through the WTO to negotiate how they can reduce barriers to trade, such as tariffs. When trade disputes occur between nations and formal complaints are filed, the WTO attempts to reach a resolution. The World Trade Organization (WTO) is committed to lowering barriers to trade.

International 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. Krugman/Wells, Principles of Macroeconomics. Worth Publishers. 2009

Declining Tariffs The United States began basing its trade policy on international agreements in the 1930s, and global trade negotiations began soon after World War II. The success of these agreements in reducing trade protection is illustrated by the following figure. U.S. tariff rates were very high in the early 1930s but have steadily fallen since then. This move toward relatively free trade has been achieved in large part through international trade agreements. Krugman/Wells, Principles of Macroeconomics. Worth Publishers. 2009 12

Tariffs reached a peak in the early 1930s Tariffs reached a peak in the early 1930s. From then on, tariff rates have steadily ratcheted down, with U.S. moves matched in other advanced countries. At this point world trade in manufactured goods is subject to low tariffs and relatively few import quotas, with clothing the main exception. Agricultural products are subject to many more restrictions, reflecting the political power of farmers in advanced countries. Krugman/Wells, Principles of Macroeconomics. Worth Publishers. 2009 13

The recently imposed tariffs on solar panels from China: what problems does this pose for the economy, consumers and the U.S. solar industry? NY Times article: Trump’s Solar Tariffs Cause a Scramble in the Industry 1. What have been some of the impacts of the recently imposed tariffs on solar panels imported from China?   2. How are the tariffs affecting the solar industry in the U.S.? 3. How will costs to consumers be affected ? 4. What is the expected impact on the move toward clean energy in the U.S.? 5. How could competition within the clean energy market be affected?  planned merger- SolarWorld Americas and SunPower 6. Impact on industry growth projections??

Open Economy Macroeconomics Evolution of trade policy from trade protections toward fewer restrictions (tariffs, quotas) during the last four decades – U.S. economy is an open economy Most world economies are open – involved in trade in goods and services Financial exchanges with one another Closed economies – no interactions in trade or finance No economy today is completely closed, although some countries have enacted embargoes in trade activity with other nations. One way to understand the exchanges between economies is through the Balance of Payments The balance of payments is a recording of a country’s trade with other countries

Current account: Records current or short-term flows of funds into and out of a country (Net exports, net income, net transfers) The current account for the U.S. includes Net exports (value of exports minus imports) net income on investments: received by U.S. residents from investments in other countries minus income paid on investments by residents of other countries owned in the U.S. Financial Account: Records purchases of assets a country has made from the U.S. when a U.S. investor purchases bonds issued by a foreign company or government when a U.S. firm builds a manufacturing plant in another country – there is a capital outflow When a foreign investor buys bonds issued by a U.S. business or by the U.S. government, Or when a foreign firm builds a manufacturing plant in the U.S. – a capital inflow Capital account

U.S. Balance of Payments: Trade and Capital Flows

The debate about trade protections and free trade: the pros and cons Fair trade