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Welcome to Econ 414 International Economics

Study Guide

Week Ten

Ending: Friday November 2

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Assignment 4 (10 points)Key

• The statement “American car producers will prefer a new tariff on imported cars to an equivalent amount of quota if the U.S economy is predicted to be in recession in the near future.” is true.

• See the next two slides

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Suppose initially quota has the same effect as tariff

S

D

Price of Cloth

Quantity of Cloth60 703020

10

12

S + Q

Tariff

•Tariff = $2 per unit

•Quota = 30

•Gain in producer surplus = a

a

4

Now domestic demand grows to D’

S

D

Price of Cloth

Quantity of Cloth603020

10

12

S + Q

D’

Under tariff, P is still 12, imports go down to to 10 and the gain in producer surplus remains the same ( a= b + c)

Under quota, at p =12 there is a surplus P↓ to 11, domestic production goes down to 25 and producer surplus goes down to c

40

b

Quota is more

restrictive

11

2555

c

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Here is a couple of questions the answers to which is not in your book

1. What is Fair Trade?

2. Is it a distortion to free trade?

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• Fair trade is an organized social movement that promotes the payment of a fair price as well as social and environmental standards in areas related to the production of a variety of goods.

• The movement focuses on exports from developing countries to developed countries, most notably handicrafts, coffee, cocoa, tea, bananas, honey, cotton, wine, fresh fruit etc.

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• Fair trade's strategic intent is to deliberately work with marginalized producers and workers in order to help them move from a position of vulnerability to security and economic self-sufficiency.

• It also aims at empowering them to become stakeholders in their own organizations and actively play a wider role in the global arena to achieve greater equity in international trade.

• Fair trade proponents include international religious, development aid, social and environmental organizations such as Oxfam, Amnesty International, and Caritas International.

• The next slide shows a photo of a Oxfam store in Galway

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Controversy

• Some economists see fair trade as a type of subsidy that distorts free trade.

• Segments of the left criticize fair trade for not doing enough.

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Chapter 8

• Suppose there is a proposal to impose a new tariff on imported widgets

• There are 10,000 consumers of widgets in the US • Demand for widgets is perfectly inelastic

– Each American buys a widget no matter what the price

• If the tariff becomes effective, the price of widgets goes up by $1• That is each consumer loses $1• All consumers together lose $10,000• If the tariff becomes effective each of the 3 domestic producers

of widget gain $1000.

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Case 1: Direct democracy

• Everyone has one vote

• All consumers vote against tariff

• The 3 producers vote for tariff

• Majority wins

• Tariff does not go into effect

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Case 2: Representative Democracy

• In order to make your representative aware of your wish you need to hire a lobbyist who charges $500

• Who is more likely to hire the lobbyist?– None of the consumers

• since they each will only lose $1 if the proposed tariff become law.

• and it takes time and effort to get organized. – But each of the producers has an incentive to hire the

lobbyist since he will gain $1000 if the tariff goes into effect.

 

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So under Representative Democracy

• Tariff is likely to be imposed

• This is called rent –seeking behavior– Occurs when government approves a

program that benefits only a small group within society, but the society as a whole pays the cost.

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Average Tariff Rate(Source: World Bank)

2002 2003 2004 2005

EU 1.7 1.7 2.5 2.5

US 3.7 3.3 3.1 3.0

Japan 2.8 2.7 2.7 2.7

China 12.3 10.5 9.6 9.0

India 28.3 28.3 28.3 16.0

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Total trade barriers (tariff and non tariff) in comparison Source: World Bank

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• Facts:1. Imports and exports have conflicting effects.2. Free trade benefits consumers but firms and

workers in importing industry can be harmed.3. Regulation can favor one segment of society.4. Domestic industries and firms have a demand

for government regulation.5. Special interest groups lobby for changes

that benefit them.

The Political Economy of Protectionism

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• It is the economic analysis of the political process and government decision-making.

• Assumptions1. Politicians attempt to maximize utility2. Utility comes in the form of votes

• Question– Since trade benefits the country as a whole

and there are more consumers (voters) than firms, shouldn’t we expect politicians to favor free trade?

What is the public choice theory?

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Answer• Not necessarily;

– The loss in one consumer’s surplus due to trade restriction may not even be noticeable to him.

– Consumers cannot easily form groups, get organized and let politicians hear them but firms can.

– Given group support, votes to politician may increase.– Politicians favor programs having immediate and

clear-cut benefits with vague or deferred costs.– Detailed tariff schedule allows politician to pick up

votes for protecting specific good without protests from average consumer.

• Tariffs on very similar goods may be very different.

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– Firms with comparative advantage lobby foreign governments for free trade of exports.– Firms that compete with imports would lobby for protection from imports.

Who does what?

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1. Industries that are more important to a country are more likely to receive protection.2. More concentrated an industry, more likely to have protection.

– Easier for firms to organize and lobby

3. Intermediate products easier to gain protection– Voters unlikely to notice

4. Industries with a larger number of employees are more likely to get protection.5. Regionally concentrated or unionized industry are more likely protected.6. Industries with comparative disadvantage are more likely protected.

Who gets more protection and why?

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• Two definitions:1. Cost-based dumping

• A firm sells a product at a price below its cost of production in a foreign market.

2. Price-based• A firm sells a product in a foreign market at a price lower than the price charged in its home

market.

What is dumping?

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1. Sporadic dumping– occasional dumping

2. Persistent dumping– Because there is more competition in the foreign market than at home.

3. Predatory dumping– Temporary– To drive competing firms out of business.

Types of Dumping

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• A law that does not allow an international firm to sell its product in an export market for less than it is sold for in its home market.• Most countries have it

Antidumping law

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• A tariff imposed by a country that is designed to increase the price of the imported good by an amount equal to any export subsidies.• Most nations have this too

Countervailing Duty

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Attention my dear students

You must know You must know everything in this Chapter on GATT and WTO everything in this Chapter on GATT and WTO

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The General Agreement on Tariffs and Trade (GATT)

Table 8.3: GATT and WTO Multilateral Trade Negotiations

See text for details1422001-Doha Round

Aborted1999Millennium Round

Tariffs, services, agriculture12538.01987-1994Uruguay Round

Tariffs and NTBs9929.61974-1979Tokyo Round

Tariffs, ag, and dumping6236.01964-1967Kennedy Round

Tariffs262.41961-1962Dillion Round

Tariffs263.51955-1956Fourth Round

Tariffs383.01950-1951Third Round

Tariffs131.91949Second Round

Tariffs2321.11947First Round

Tariffs2333.2%1931-1947Pre-GATT

Major Negotiation# of CountriesTariff CutsDatesMultilateral Trade Round

Source: Data adapted from R.P. Lavergne

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Asst 5(20 points)Due: Friday, November 2 before 10 PM

1. Visit the WTO’s web page at wto.org to answer the following questions:

a) Is Iran a member of WTO? How about Iraq?b) Which country is the newest member of WTO?c) Is the following statement true or false? Explain. “WTO

is for free trade at any cost.”d) Is the following statement true or false? Explain. “The

voting power of a nation that is a member of WTO depends on its GDP.”

e) What was the size of the WTO’s budget last year?

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Asst 5

2. Search the web (or elsewhere) for at least two examples of countervailing and/or antidumping duties imposed by the U.S. in the recent years. Name the products and their exporting countries and the nature of the imposed duties. Clearly list your sources.