1. © 2005 Thomson C hapter 31 International Trade

2. © 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Absolute advantage Comparative advantage Free trade Tariffs

3. © 2005 Thomson 3 Gottheil - Principles of Economics, 4e Economic Principles Quotas Customs unions Free trade areas

4. © 2005 Thomson 4 EXHIBIT 1ILLINOIS PRODUCTION POSSIBILITIES CURVE

5. © 2005 Thomson 5 Gottheil - Principles of Economics, 4e Exhibit 1: Illinois Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Illinois? The opportunity cost of producing an additional barrel of oil is one bushel of corn.

6. © 2005 Thomson 6 Gottheil - Principles of Economics, 4e Exhibit 1: Illinois Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Illinois? The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 1.

7. © 2005 Thomson 7 Gottheil - Principles of Economics, 4e Exhibit 1: Illinois Production Possibilities Curve 2. What is the opportunity cost of producing an additional bushel of corn in Illinois? The opportunity cost of producing an additional bushel of corn is one barrel of oil.

8. © 2005 Thomson 8 Gottheil - Principles of Economics, 4e Intrastate Trade 1. If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Illinois? We know that one barrel of oil must be given up to get one bushel of corn in Illinois. As a result one bushel of corn will trade for one barrel of oil in Illinois.

9. © 2005 Thomson 9 Gottheil - Principles of Economics, 4e EXHIBIT 2OKLAHOMA PRODUCTION POSSIBILITIES CURVE

10. © 2005 Thomson 10 Gottheil - Principles of Economics, 4e Exhibit 2: Oklahoma Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Oklahoma? The opportunity cost of producing an additional barrel of oil is 0.0833 bushels of corn.

11. © 2005 Thomson 11 Gottheil - Principles of Economics, 4e Exhibit 2: Oklahoma Production Possibilities Curve 1. What is the opportunity cost of producing an additional barrel of oil in Oklahoma? The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 2.

12. © 2005 Thomson 12 Gottheil - Principles of Economics, 4e Exhibit 2: Oklahoma Production Possibilities Curve 2. What is the opportunity cost of producing an additional bushel of corn in Oklahoma? The opportunity cost of producing an additional bushel of corn is 12 barrels of oil.

13. © 2005 Thomson 13 Gottheil - Principles of Economics, 4e Intrastate Trade 2. If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Oklahoma? We know that 12 barrels of oil must be given up to get one bushel of corn in Oklahoma. As a result one bushel of corn will trade for 12 barrels of oil in Oklahoma.

14. © 2005 Thomson 14 Gottheil - Principles of Economics, 4e Interstate Trade Since oil producers must give 12 barrels of oil for a bushel of corn in Oklahoma, but need only give one barrel of oil for a bushel of corn in Illinois, Oklahoma oil producers would seek out buyers in Illinois. 1. If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil?

15. © 2005 Thomson 15 Gottheil - Principles of Economics, 4e Interstate Trade 1. If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil? Likewise, since a bushel of corn trades for one barrel of oil in Illinois, but trades for 12 barrels of oil in Oklahoma, Illinois corn farmers would seek out buyers in Oklahoma.

16. © 2005 Thomson 16 Gottheil - Principles of Economics, 4e Interstate Trade Free trade International trade that is not encumbered by protectionist government policies such as tariffs and quotas.

17. © 2005 Thomson 17 Gottheil - Principles of Economics, 4e EXHIBIT 3PRODUCTION OF CORN AND OIL IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

18. © 2005 Thomson 18 Gottheil - Principles of Economics, 4e Exhibit 3: Production of Corn and Oil in Illinois and Oklahoma, Before and After Free Trade (bushels and barrels) What are the total gains from free trade between Oklahoma and Illinois? By having Illinois specialize in producing corn, and Oklahoma specialize in producing oil, an additional 75 bushels of corn and an extra 200 barrels of oil are produced.

19. © 2005 Thomson 19 Gottheil - Principles of Economics, 4e EXHIBIT 4CORN AND OIL CONSUMPTION IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

20. © 2005 Thomson 20 Gottheil - Principles of Economics, 4e Exhibit 4: Corn and Oil Consumption in Illinois and Oklahoma, Before and After Free Trade (bushels and barrels) What relative price leads to Oklahoma and Illinois consuming the same quantity of oil after trade? A relative price of three barrels of oil for one bushel of corn will result in both states consuming 300 barrels of oil.

21. © 2005 Thomson 21 Gottheil - Principles of Economics, 4e Interstate Trade 2. If Illinois and Oklahoma engage in free trade, and if there are aggregate gains from trade, then is it true that nobody loses? No. Oil producers in Illinois are priced out by cheap imports of Oklahoma oil. Likewise corn growers in Oklahoma are priced out by cheap imports of Illinois corn.

22. © 2005 Thomson 22 Gottheil - Principles of Economics, 4e International Trade International specialization The use of a country’s resources to produce specific goods and services, allowing other countries to focus on the production of other goods and services.

23. © 2005 Thomson 23 Gottheil - Principles of Economics, 4e EXHIBIT 5PRODUCTION OF CORN AND OIL IN THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

24. © 2005 Thomson 24 Gottheil - Principles of Economics, 4e Exhibit 5: Production of Corn and Oil in the United States and Mexico, Before and After Free Trade (Bushels and Barrels) What does Mexico specialize in producing in Exhibit 5? Mexico specializes in producing oil.

25. © 2005 Thomson 25 Gottheil - Principles of Economics, 4e EXHIBIT 6CORN AND OIL CONSUMPTION THE THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

26. © 2005 Thomson 26 Gottheil - Principles of Economics, 4e Exhibit 6: Corn and Oil Consumption in the United States and Mexico, Before and After Free Trade (bushels and barrels) What relative price leads to Mexico and the United States consuming the same quantity of corn after trade in Exhibit 6? Four barrels of oil for one bushel of corn.

27. © 2005 Thomson 27 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage Absolute advantage A country’s ability to produce a good using fewer resources than the country it trades with.

28. © 2005 Thomson 28 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage Comparative advantage A country’s ability to produce a good at a lower opportunity cost than the country with which it trades.

29. © 2005 Thomson 29 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage 1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? The opportunity cost of producing one bushel of corn in the United States is three barrels of oil.

30. © 2005 Thomson 30 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage 1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? The opportunity cost of producing one bushel of corn in Mexico is 12 barrels of oil.

31. © 2005 Thomson 31 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage 1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage? The U.S. has a comparative advantage in growing corn because it can do so at a lower opportunity cost than Mexico.

32. © 2005 Thomson 32 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage 2. In the example of corn and oil trade between the United States and Mexico, what was Mexico’s comparative advantage? Using the same process as that used for the U.S., we find that Mexico has a lower opportunity cost for producing oil.

33. © 2005 Thomson 33 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage 3. What determines how much each country gains from free trade? The relative price of the goods being traded.

34. © 2005 Thomson 34 Gottheil - Principles of Economics, 4e EXHIBIT 7CORN AND OIL CONSUMPTION IN THE UNITED STATES AND MEXICO, UNDER CONDITIONS OF NO TRADE AND FREE TRADE

35. © 2005 Thomson 35 Gottheil - Principles of Economics, 4e Exhibit 7: Corn and Oil Consumption in the United States and Mexico, Under Conditions of No Trade and Free Trade 1. If a bushel of corn trades for four barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.? Mexico must trade 800 barrels of oil with the United States in order to get 200 bushels of corn.

36. © 2005 Thomson 36 Gottheil - Principles of Economics, 4e Exhibit 7: Corn and Oil Consumption in the United States and Mexico, Under Conditions of No Trade and Free Trade 2. If a bushel of corn now trades for five barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.? Mexico must trade 1000 barrels of oil with the United States in order to get 200 bushels of corn.

37. © 2005 Thomson 37 Gottheil - Principles of Economics, 4e Exhibit 7: Corn and Oil Consumption in the United States and Mexico, Under Conditions of No Trade and Free Trade Mexico is worse off because it must trade an extra 200 barrels of oil just to keep getting 200 bushels of corn from the United States. 3. When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off?

38. © 2005 Thomson 38 Gottheil - Principles of Economics, 4e Exhibit 7: Corn and Oil Consumption in the United States and Mexico, Under Conditions of No Trade and Free Trade 3. When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off? The United States is better off because it gets an extra 200 barrels of oil for the same 200 bushels of corn it exports to Mexico.

39. © 2005 Thomson 39 Gottheil - Principles of Economics, 4e Absolute and Comparative Advantage During the colonial period, European colonial powers used their political power to manipulate trade prices so that most all of the gains from trade were shifted to them.

40. © 2005 Thomson 40 Gottheil - Principles of Economics, 4e Calculating Terms of Trade Imports Good and services bought by people in one country that are produced in other countries.

41. © 2005 Thomson 41 Gottheil - Principles of Economics, 4e Calculating Terms of Trade Exports Good and services produced by people in one country that are sold in other countries.

42. © 2005 Thomson 42 Gottheil - Principles of Economics, 4e Calculating Terms of Trade Terms of trade The amount of a good or service (export) that must be given up to buy a unit of another good or service (import). A country’s terms of trade is measured by the ratio of the country’s export prices to its import prices.

43. © 2005 Thomson 43 Gottheil - Principles of Economics, 4e EXHIBIT 8JAPANESE MOTORCYCLE AND BOLIVIAN TIN EXPORTS

44. © 2005 Thomson 44 Gottheil - Principles of Economics, 4e Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports The price of Japanese motorcycles rises in panel a, while the price of Bolivian tin falls in panel b. What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?

45. © 2005 Thomson 45 Gottheil - Principles of Economics, 4e Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports As a result, Bolivia’s terms of trade equation goes from (6,000/6000) × 100 = 100 in 1987, to (5,000/7,500) × 100 = 66.7 in 1995. What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?

46. © 2005 Thomson 46 Gottheil - Principles of Economics, 4e Exhibit 8: Japanese Motorcycle and Bolivian Tin Exports What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8? Bolivia’s terms of trade have deteriorated. Bolivia’s exports end up with only 67 percent of their former purchasing power.

47. © 2005 Thomson 47 Gottheil - Principles of Economics, 4e EXHIBIT 9LDC TERMS OF TRADE FOR 2000 (1980 = 100) Source: Human Development Report, Oxford University Press, 2003.

48. © 2005 Thomson 48 Gottheil - Principles of Economics, 4e Exhibit 9: LDC Terms of Trade for 2000 (1980 = 100) Which of the countries shown in Exhibit 9 have experienced the smallest deterioration in its terms of trade between 1980 and 2000? Colombia’s terms of trade declined the least during that time period.

49. © 2005 Thomson 49 Gottheil - Principles of Economics, 4e EXHIBIT 10TERMS OF TRADE VOLATILITY FOR LDCS: 1990–98 (1995 = 100) Source: World Development Indicators, 2000, The World Bank.

50. © 2005 Thomson 50 Gottheil - Principles of Economics, 4e Exhibit 10: Terms of Trade Volatilities for LDCs Which of the countries shown in Exhibit 10 experienced the largest gain in their terms of trade during the 1990s? Guatemala’s terms of trade increased by 20 percent between 1990 and 1998.

51. © 2005 Thomson 51 Gottheil - Principles of Economics, 4e EXHIBIT 11PERCENTAGE DISTRIBUTION OF EXPORTS TO DEVELOPED, LDCs, AND OTHER ECONOMIES: 2001 Source: Direction of Trade Statistics, Yearbook 2002 (Washington, D.C.: International Monetary Fund, 2002).

52. © 2005 Thomson 52 Gottheil - Principles of Economics, 4e Exhibit 11: Percentage Distribution of Exports to Developed, LDCs, and Other Economies: 2001 What percentage of exports from LDCs actually went to other LDCs? a. 26.6 percent b. 41.5 percent c. 33 percent

53. © 2005 Thomson 53 Gottheil - Principles of Economics, 4e Exhibit 11: Percentage Distribution of Exports to Developed, LDCs, and Other Economies: 1999 What percentage of exports from LDCs actually went to other LDCs? a. 26.6 percent b. 41.5 percent c. 33 percent

54. © 2005 Thomson 54 Gottheil - Principles of Economics, 4e EXHIBIT 122001 EXPORTS AND IMPORTS OF THE MAJOR DEVELOPED ECONOMIES ($ BILLIONS) Source: Direction of Trade Statistics, Yearbook 2002 (Washington, D.C.: International Monetary Fund, 2002).

55. © 2005 Thomson 55 Gottheil - Principles of Economics, 4e Exhibit 12: 2001 Exports and Imports of the Major Developed Economies ($ billions) True or false: Japan was the world’s leading exporter among the developed countries in 2001 (measured in $). False. The United States was the world’s leading exporter.

56. © 2005 Thomson 56 Gottheil - Principles of Economics, 4e EXHIBIT 132001 U.S. TRADE WITH ITS MAJOR TRADING PARTNERS ($ BILLIONS) Source: Direction of Trade Statistics, Yearbook 2002 (Washington, D.C.: International Monetary Fund, 2002).

57. © 2005 Thomson 57 Gottheil - Principles of Economics, 4e Exhibit 13: 2001 U.S. Trade with Its Major Trading Partners ($ billions) Complete the sentence: _____ was the United States’ largest trading partner in 2001 (measured in $).

58. © 2005 Thomson 58 Gottheil - Principles of Economics, 4e Exhibit 13: 1996 U.S. Trade with Its Major Trading Partners ($ billions) Complete the sentence: Canada was the United States’ largest trading partner in 2001 (measured in $).

59. © 2005 Thomson 59 Gottheil - Principles of Economics, 4e Do We Need Protection Against Free Trade? 1. What is the national security argument for against free trade? Key domestic industries need to be protected so that if war breaks out with our trading partners, we are still able to produce during a time of crisis.

60. © 2005 Thomson 60 Gottheil - Principles of Economics, 4e Do We Need Protection Against Free Trade? 2. What is the infant-industries argument against free trade? It takes time for new (“infant”) industries to gain expertise, and during that time it is fair and reasonable to protect those industries from international competition.

61. © 2005 Thomson 61 Gottheil - Principles of Economics, 4e Do We Need Protection Against Free Trade? 3. How long should infant- industries be protected from free trade? There is no clear answer, certainly not from the industries being protected. Infant industry protection is easily abused.

62. © 2005 Thomson 62 Gottheil - Principles of Economics, 4e Do We Need Protection Against Free Trade? 4. If domestic industry is not protected from imports from low- wage countries, who gains and who loses? Domestic producers and workers in this industry lose, while domestic consumers gain from lower prices.

63. © 2005 Thomson 63 Gottheil - Principles of Economics, 4e Do We Need Protection Against Free Trade? Dumping Exporting a good or service at a price below its cost of production.

64. © 2005 Thomson 64 Gottheil - Principles of Economics, 4e The Economics of Trade Protection? Tariff A tax on an imported good.

65. © 2005 Thomson 65 Gottheil - Principles of Economics, 4e EXHIBIT 14TARIFF-RESTRICTED TRADE

66. © 2005 Thomson 66 Gottheil - Principles of Economics, 4e Exhibit 14: Tariff-Restricted Trade Which of the following occur as a result of a tariff? a. Domestic prices rise. b. The quantity imported falls. c. Domestic production increases.

67. © 2005 Thomson 67 Gottheil - Principles of Economics, 4e Exhibit 14: Tariff-Restricted Trade Which of the following occur as a result of a tariff? a. Domestic prices rise. b. The quantity imported falls. c. Domestic production increases.

68. © 2005 Thomson 68 Gottheil - Principles of Economics, 4e The Economics of Trade Protection? Quota A limit on the quantity of a specific good that can be imported.

69. © 2005 Thomson 69 Gottheil - Principles of Economics, 4e EXHIBIT 15QUOTA-RESTRICTED TRADE

70. © 2005 Thomson 70 Gottheil - Principles of Economics, 4e Exhibit 15: Quota-Restricted Trade True or false: Quota protection causes domestic prices to fall and increases the quantity of imported goods. False. Quota protection increases domestic prices and limits the quantity of imports.

71. © 2005 Thomson 71 Gottheil - Principles of Economics, 4e Negotiating Tariff Structures GATT (General Agreement on Tariffs and Trade) A trade agreement to negotiate reduction in tariffs and other trade barriers and to provide equal and nondiscriminating treatment among members of the agreement.

72. © 2005 Thomson 72 Gottheil - Principles of Economics, 4e Negotiating Tariff Structures World Trade Organization (WTO) The successor to GATT. The WTO is the only global international organization dealing with the rules of trade between nations. WTO agreements are ratified by member nations’ parliaments.

73. © 2005 Thomson 73 Gottheil - Principles of Economics, 4e Negotiating Tariff Structures Customs union A set of countries that agree to free trade among themselves and a common trade policy with all other countries.

74. © 2005 Thomson 74 Gottheil - Principles of Economics, 4e Negotiating Tariff Structures Free trade area A set of countries that agree to free trade among themselves but are free to pursue independent trade policies with other countries.

75. © 2005 Thomson 75 Gottheil - Principles of Economics, 4e EXHIBIT 16AVERAGE U.S. TARIFF RATES ON IMPORTS Source: Economic Report of the President, January 1989 (Washington, D.C.: U.S. Government Printing Office, 1989), p. 152.

76. © 2005 Thomson 76 Gottheil - Principles of Economics, 4e Exhibit 16: Average U.S. Tariff Rates on Imports What was the average U.S. tariff rate in 1990-93? a. 45.9 percent b. 25.3 percent c. 5.9 percent

77. © 2005 Thomson 77 Gottheil - Principles of Economics, 4e Exhibit 16: Average U.S. Tariff Rates on Imports What was the average U.S. tariff rate in 1990-93? a. 45.9 percent b. 25.3 percent c. 5.9 percent