14–1 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Chapter 14 An Introduction to the Open Economy

14–2 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Chapter 14: An Introduction to the Open Economy Open economy issues Global trends and patterns in international trade A supply and demand perspective on trade Protectionist policies: tariffs and quotas

14–3 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Some Facts World trade grows faster than world production Asia, Europe and US are large traders compared with Africa, Middle East and Latin America Large trade imbalances, with US in deficit and Asia in surplus Reduction of tariff barriers over time Growth of regional trade agreements since 1992

14–4 Global Exports and Production

14–5 Share of World Exports and Imports

14–6 Regional Trade Agreements

14–7 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Import Demand Domestic demand curve for product Domestic supply curve for product For a small country, domestic price is given by the world price Import demand = domestic demand – domestic supply at that world price These products are called ‘importables’

14–8 Illustration: Importables

14–9 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Export Supply Domestic demand curve for product Domestic supply curve for product For a small country, domestic price is given by the world price Export supply = domestic supply – domestic demand at that price These products are called ‘exportables’

14–10 Illustration: Exportables

14–11 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade Pattern Depends on Price As price rises, the quantity demanded falls and the quantity supplied by domestic producers increases, causing import volume to fall If this continues, the country produces a surplus for export Whether a commodity is an importable or an exportable for a country depends on its price

14–12 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Price Impact of Restricting Trade For an importable, the introduction of trade lowers price, and restricting trade would raise price For an exportable, the introduction of trade raises price, and restricting trade would lower price

14–13 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Who Gains (Loses) from Trade? Trade lowers the domestic price of importables, so domestic consumers gain and domestic producers lose Trade raises the domestic price of exportables, so domestic consumers lose and domestic producers gain

14–14 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade Gains Exceed Losses Trade causes the domestic prices of importables to fall For importables, domestic demand always exceeds domestic production So, for a given fall in price, the fall in costs for consumers must be less than the fall in income for producers Consumers gain more than producers lose Consumers could compensate producers and still be better off

14–15 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade Gains Exceed Losses Trade causes the domestic price of exportables to rise For exportables, domestic production exceeds domestic consumption So, for a given rise in price, the increase in income for domestic producers must exceed the rise in costs for consumers Producers gain more than consumers lose Producers could compensate consumers and still be better off

14–16 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Why Losers Oppose Trade With compensation for losers, everyone could be made better off by trade But compensation is rarely made So losers usually oppose trade

14–17 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Restricting Imports – Tariffs Tariffs raise domestic price above world price Quantity demanded falls Quantity supplied rises Volume of imports falls

14–18 The Impact of a Tariff

14–19 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Winners and Losers from Tariffs Consumers lose from higher prices Producers gain from higher prices Government gains from tariff revenue But consumers lose more than producers and government gain

14–20 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Restricting Imports – Quotas Government allows tariff-free entry of goods at world prices But imposes a physical limit on the volume of imports by the issue of licences to import Domestic supply = domestic production + quota on imports Domestic price rises and volume of imports falls to quota level

14–21 Import Quota

14–22 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Tariffs vs Quotas For any given tariff rate, an alternative import quota could be imposed with the same effects on price and quantities Tariff generates revenue for the government Quota generates profits for the lucky recipients of the quotas who import goods at world prices and sell at higher domestic prices Quotas are administratively cumbersome

14–23 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Third Parties May Oppose Trade Sympathy for the uncompensated losers in both poor and rich countries who may already be at the lower end of their income distributions Trade changes cultures Trade introduces new products which consumers may not have the expertise/backup to use wisely: infant milk formula requires access to clean water If rich countries gain more from trade than poor countries, even though all gain, there is a perception that the distribution of world income has worsened Farm/export subsidies hurt poor countries

14–24 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade and the Environment Also a concern for third parties Trade, combined with pollution-emission controls in rich countries, sometimes shifts emissions to poorer countries, who may have deliberately chosen lower environmental standards because of their lower incomes This does not mean that total emissions must have increased

14–25 Income and Environment

14–26 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade and the Environment The ultimate cause of environmental problems is lack of, or inappropriate, emission controls, not trade So these problems should be solved by using the right emission controls, not by restricting trade The income-enhancing effects of trade increase both the desire and the means to improve the environment

14–27 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Free Trade and World Inequality Inequality between rich and poor countries tends to fall, because free trade causes real wages to converge between rich and poor countries Wages earned by low-skilled labour engaged in producing traded goods tend to rise in poor countries and fall in rich countries In its effect on wages, trade in goods is like free immigration of labour

14–28 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank But Trade is Not Free Europe and the US subsidise farm exports This reduces their world price This hurts farmers in poor countries This turns the terms of trade against poor countries and is a factor which tends to increase world inequality

14–29 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Income Distribution at Home The reduction of unskilled wages in rich countries and the increase in the return to human and physical capital raises inequality in rich countries This was illustrated in Chapter 5 The rise in unskilled wages in poor countries and the fall in the return to physical capital reduces inequality in poor countries