Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-1 Chapter 13 International trade

Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank ank 13-2 Learning objectives 1.In what sense does free trade contribute to the welfare of a country’s citizens? 2.Under what circumstances will a country have a comparative advantage in the production of a commodity? 3.Under what circumstances will an economy be a net importer of a good or service? 4.Under what circumstances will an economy be a net exporter of a good or service? 5.Which groups in society win and which groups lose when an economy moves to free trade? 6.What are the effects of a tariff on (a) consumers, (b) producers and (c) the government? 7.What are the effects of a quota on (a) consumers, (b) producers and (c) the government? 8.In what sense is protectionism inefficient? 9.What are the main arguments in the debate about whether free trade has harmful environmental effects? What does the empirical evidence suggest?

Chapter organisation 13.1Open-economy issues 13.2Production and consumption possibilities and the benefits of trade 13.3A supply and demand perspective on trade 13.4Protectionist policies: Tariffs and quotas Summary Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-3

Issues in globalisation The increasing degree of integration of countries into the global economy has given rise to some key issues: –Why has globalisation come about? –Is it true that the gains from free trade are illusory? –What are the arguments? –What is the evidence? An understanding of the basis for international trade is necessary to address the aforementioned issues. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-4

Chapter organisation 13.1Open-economy issues 13.2Production and consumption possibilities and the benefits of trade 13.3A supply and demand perspective on trade 13.4Protectionist policies: Tariffs and quotas Summary Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-5

Production possibilities curve (PPC) for a one-worker economy Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-6 Figure 13.1 Production possibilities curve (PPC) for a one-worker economy

Production possibilities curve for a two-worker economy Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-7 Figure 13.2 Production possibilities curve for a two-worker economy

Production possibilities curve for a three-worker economy Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-8 Figure 13.3 Production possibilities curve for a three-worker economy

Production possibilities curve for a many-worker economy Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-9 Figure13.4 Production possibilities curve for a many-worker economy

Consumption possibilities without international trade Consumption possibilities refer to the combination of goods and services that can feasibly be consumed. Autarky refers to a country whose economy is closed to the rest of the world. –The country is economically self-sufficient, producing everything its citizens consume. In a closed economy, its PPC is also its consumption possibilities. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-10

Consumption possibilities and the terms of trade Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure 13.5 Brazil’s consumption possibilities with trade

Consumption possibilities in a many- worker economy Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure 13.6 Consumption possibilities in a many-worker economy

Comparative advantage Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure 13.7 Comparative advantage

Production in autarky Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure 13.8 Production in autarky

Production with international trade Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure 13.9 Production and consumption possibilities once trade is opened

Sources of comparative advantage Potential sources of comparative advantage –Climate and resource endowments –Stock of knowledge and experience –Cultural factors Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-16

Chapter organisation 13.1Open-economy issues 13.2Production and consumption possibilities and the benefits of trade 13.3A supply and demand perspective on trade 13.4Protectionist policies: Tariffs and quotas Summary Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-17

Import demand Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure The market for computers in Brazil

Export supply Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure The market for coffee in Brazil

Winners and losers from trade If trade is so wonderful, why do some groups resist free trade and globalisation? In general, domestic consumers of imported goods benefit from free trade, as more goods are available at a lower price, e.g. Brazilian computer buyers. However, in general, domestic producers of imported goods are hurt by free trade, as a smaller quantity of goods is sold at a lower price, e.g. Brazilian computer sellers and workers hurt. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-20

Winners and losers from trade (cont.) The opposite is true for exports. In general, domestic producers of exported goods benefit from free trade, as more goods are sold at higher prices, e.g. Brazilian coffee producers. However, in general, domestic consumers of exported goods are hurt by free trade, as a smaller quantity of goods is bought at a higher price, e.g. Brazilian coffee consumers. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-21

Winners and losers from trade (cont.) Free trade is efficient, in that it increases the size of the pie available to the economy. However, some groups lose from trade, which generates political pressure to block or restrict trade. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-22

Chapter organisation 13.1Open-economy issues 13.2Production and consumption possibilities and the benefits of trade 13.3A supply and demand perspective on trade 13.4Protectionist policies: Tariffs and quotas Summary Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-23

Protectionist policies: Tariffs and quotas Protectionism is the view that free trade is injurious and domestic markets should be protected through legal barriers to imports. The most common barriers are tariffs and quotas. –A tariff is a tax imposed on an imported good. –A quota is a legal limit on the quantity to be imported. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-24

Tariff Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure The market for computers after the imposition of an import tariff

Example: Impacts of a tariff Suppose demand = Q D = 3000 – 0.5 P c and supply = Q S = P c. Then in a closed economy, equilibrium occurs where Q D = Q S : 3000 – 0.5 P c = P c P c = $2000 and Q = 2000 computers. Assume the economy opens to trade and the world price is $1500, then: Q D = 3000 – 0.5(1500) = 2250 and Q S = (1500) = 1750 Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-26

Example: Impacts of a tariff (cont.) Imports = 2250 – 1750 = 500 computers per year A tariff of $300 per computer raises the import prices from $1500 to $1800, so demand will be 3000 – 0.5(1800) = 2100 computers and domestic supply = (1800) = 1900 computers. Imports will then be 2100 – 1900 = 200 per year. Revenue collected by the government = $300/imported computer X 200 computers/year = $60 000/year Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-27

Winners and losers from tariffs Consumers lose from higher prices. Domestic producers gain from selling more computers and getting higher prices for them. Governments gain from tariff revenue. Overall, society is worse off as a result of the tariff. Consumers lose more than producers and government gain. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-28

Quota Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure The market for computers after the imposition of an import quota

Example: Impacts of a quota Suppose the government imposes a quota of 200 imported computers. This adds 200 computers at each level of domestic production, so domestic supply + quota = P c New equilibrium where P c = 3000 – 0.5 P c P c = $1800, total demand = 3000 – 0.5(1800) = 2100, of which 200 will be imported and 1900 domestically produced. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-30

Free trade versus quotas Relative to free trade, the quota: –raises the domestic price above the world price, to p T –reduces domestic purchases from q D to q’ D –increases domestic production of computers, from q S to q’ S –reduces imports to the quota level, q’ D – q’ S. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-31

Tariffs versus quotas A quota or a tariff that restricts imports to the same quantity, which is less than the free trade quantity, will have the same outcomes in the economy, with one exception. Instead of governments receiving the tariff revenue, the revenue goes to the holders of the import licenses, who can buy the computers at the world price and sell them in the domestic market for the higher price. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-32

The inefficiency of protectionism Free trade is efficient because it allows countries to specialise in goods and services in which they have a comparative advantage. This means the total economic pie is bigger for everyone. However, there are some who benefit from trade restrictions, and these people tend to be better organised politically than those who lose from trade restrictions. A better alternative to trade restrictions is to allow free trade and compensate the losers. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-33

The inefficiency of protectionism (cont.) Another complaint is that free trade harms the environment. The efficiency principle suggests that restricting free trade is not the most effective means of achieving environmental goals, as it reduces the level of resources able to deal with the problems. Economists have argued there exists an environmental Kuznets curve: as poor countries develop, their pollution level increases to a point, at which further development reduces pollution. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-34

The environmental Kuznets curve Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank Figure The environmental Kuznets curve

Chapter organisation 13.1Open-economy issues 13.2Production and consumption possibilities and the benefits of trade 13.3A supply and demand perspective on trade 13.4Protectionist policies: Tariffs and quotas Summary Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-36

Summary A nation’s PPC summarises the available points of efficient production by showing, when holding the production of all other commodities fixed, what is the maximum amount of a commodity that can be produced. In autarky, the consumption set comprises only those combinations of goods that can be produced. Under free trade, it is possible that the consumption set is expanded beyond what can be produced locally. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-37

Summary (cont.) There are always winners and losers from free trade. Protectionist measures such as tariffs and quotas can be justified if the winners are willing and able to compensate the losers. Empirical studies suggest that the free trade- environment nexus is complex, though most findings agree that pollution is lower in rich, open countries. Copyright © 2011 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank 13-38