Trade Between Alpha and Omega What would happen if Alpha and Omega started to trade? What would happen if Alpha and Omega started to trade? Under what circumstances will these two countries trade bread for milk? Under what circumstances will these two countries trade bread for milk? Determine the limits within which the terms of trade must fall for the two countries to trade Determine the limits within which the terms of trade must fall for the two countries to trade Show what trade will do for each country Show what trade will do for each country

Terms of Trade Alpha would not import milk if its cost per 1 gallon exceeds 0.5 loaves of bread Alpha would not import milk if its cost per 1 gallon exceeds 0.5 loaves of bread Omega would not engage in trade if terms of trade exceed 2 loaves of bread per 1 gallon of milk (or equivalently 0.5 gallon of milk per 1 loaf of bread) Omega would not engage in trade if terms of trade exceed 2 loaves of bread per 1 gallon of milk (or equivalently 0.5 gallon of milk per 1 loaf of bread) Both would trade if the terms of trade are one gallon of milk per one loaf of bread Both would trade if the terms of trade are one gallon of milk per one loaf of bread The result of trade is: The result of trade is: Unchanged production possibilities frontiers Unchanged production possibilities frontiers Upward shift of consumption possibilities frontiers Upward shift of consumption possibilities frontiers Trade allows for more consumption with the same production resources Trade allows for more consumption with the same production resources

Specialization in Trade and Production If Alpha produces only milk and trades milk for bread, it can consume more bread for each amount of milk consumption compared to no- trade situation If Alpha produces only milk and trades milk for bread, it can consume more bread for each amount of milk consumption compared to no- trade situation If Omega produces only bread and trades bread for milk, it can consume more milk for each amount of bread consumption compared to no- trade situation If Omega produces only bread and trades bread for milk, it can consume more milk for each amount of bread consumption compared to no- trade situation Alpha will concentrate on the production of milk Omega will concentrate on the production of bread

Comparative Advantage Comparative advantage: the ability of a country to produce a good at a lower opportunity cost of producing the good than any other country Comparative advantage: the ability of a country to produce a good at a lower opportunity cost of producing the good than any other country We’re not talking about the absolute costs here We’re not talking about the absolute costs here In terms of labor, Alpha may use three times as much labor and capital for the production of one gallon of milk compared to Omega, yet it would still have comparative advantage in the production of milk In terms of labor, Alpha may use three times as much labor and capital for the production of one gallon of milk compared to Omega, yet it would still have comparative advantage in the production of milk Comparative disadvantage: the inability of a country to produce a good except at a higher opportunity cost of producing the good than another country Comparative disadvantage: the inability of a country to produce a good except at a higher opportunity cost of producing the good than another country A country typically has comparative advantage in some goods and comparative disadvantage in some other goods A country typically has comparative advantage in some goods and comparative disadvantage in some other goods Different resource endowments and states of technology account for a great deal of differences in comparative advantages and in comparative disadvantages Different resource endowments and states of technology account for a great deal of differences in comparative advantages and in comparative disadvantages

Financing the International Trade Exchange rate is the price of one currency in terms of the monetary units of another country Exchange rate is the price of one currency in terms of the monetary units of another country Exchange rates (in the absence of the government intervention) are determined in exchange markets that arise from millions of import-export transactions between the countries Exchange rates (in the absence of the government intervention) are determined in exchange markets that arise from millions of import-export transactions between the countries

World Exchange Rates

Sources of Foreign Currency

Tariffs A tax placed on internationally traded goods, usually imports A tax placed on internationally traded goods, usually imports Tariffs are an important source of (federal) government revenue Tariffs are an important source of (federal) government revenue Tariffs are used mainly to protect domestic jobs and production Tariffs are used mainly to protect domestic jobs and production Infant industry protection argument Infant industry protection argument Tariff burden normally gets shared between producers and consumers, but rarely in equal proportion Tariff burden normally gets shared between producers and consumers, but rarely in equal proportion Tariffs increase demand for domestically produced products making domestically produced goods more expensive Tariffs increase demand for domestically produced products making domestically produced goods more expensive

Quotas Quota is a regulation that limits by law the quantity of specific foreign goods or services that may be imported during a period of time Quota is a regulation that limits by law the quantity of specific foreign goods or services that may be imported during a period of time Quotas are used less often than tariffs Quotas are used less often than tariffs The new supply curve is vertical since only that much of Brazilian sugar can be sold in the US The new supply curve is vertical since only that much of Brazilian sugar can be sold in the US Price the US consumers pay for Brazilian sugar exceeds the price received by Brazilian sugar producers Price the US consumers pay for Brazilian sugar exceeds the price received by Brazilian sugar producers This difference in consumer and producer prices is the profit of import license holders This difference in consumer and producer prices is the profit of import license holders Quotas also increase prices of domestically produced goods Quotas also increase prices of domestically produced goods

Voluntary Export Restrictions and Embargoes Voluntary restraint agreement is an international treaty whereby one nation “volunteers” to restrict its exports of a product that it sells to another nation Voluntary restraint agreement is an international treaty whereby one nation “volunteers” to restrict its exports of a product that it sells to another nation A voluntary restraint agreement is in essence a quota without the effect of law A voluntary restraint agreement is in essence a quota without the effect of law Voluntary but not really voluntary Voluntary but not really voluntary Embargo is a government action aimed at eliminating international trade between the two countries Can be thought of as import and export quotas set to zero Most embargoes result from political disputes (OPEC in the 1970s, N. Korea these days, Cuba) Embargoes impose costs not only on the foreign nation, but on the domestic economy as well

Foreign Trade Controversy Protection from cheap foreign goods Protection from cheap foreign goods A country’s population will lose from import restrictions A country’s population will lose from import restrictions Foreign goods cannot possibly displaced all domestic production since imports have to be paid for with foreign currency which can only be obtained as a result of exports Foreign goods cannot possibly displaced all domestic production since imports have to be paid for with foreign currency which can only be obtained as a result of exports Free trade may indeed injure segments of national economy (e.g. less demand for domestically produced goods, more unemployment) Free trade may indeed injure segments of national economy (e.g. less demand for domestically produced goods, more unemployment) Effects of the early 1980s “voluntary” exports restrictions for Japanese cars in the US Effects of the early 1980s “voluntary” exports restrictions for Japanese cars in the US Jobs in domestic car production saved Jobs in domestic car production saved Jobs lost in the exporting sector Jobs lost in the exporting sector A job paying $30000-$40000 imposed a cost of $ as a result of increased domestic prices A job paying $30000-$40000 imposed a cost of $ as a result of increased domestic prices