International Trade & Trade Policy

Chapter 17

Chapter 17 Learning Objectives. You should be able to:

• Define comparative advantage and explain its relevance for trade debates.

• Explain when the production possibility curve (PPC) for a country would be concave.

• Distinguish between production possibilities and consumption possibilities and show on PPC diagram.

• Show how a exports and imports are represented on a supply and demand diagram.

• Define tariffs and quotas.• Assess arguments in favor of protectionist policies.

Adam Smith (1723-1790)

Critic of mercantilism.

Countries should specialize and trade.

Specialize where there’s an ABSOLUTE ADVANTAGE

ABSOLUTE ADVANTAGE

A region has an absolute advantage if it takes fewer resources to produce a good there than elsewhere.

Coffee in Columbia.

Computer software in Silicon Valley.

David Ricardo (1772-1823)

Theory of comparative advantage.

Even without an absolute advantage a region can trade to the benefit of all parties.

Production Possibilities

• Points on the production possibilities curve.

• Amounts that can be produced when resources are fully employed.

Consumption Possibilities

• Can be to the right of the production possibilities curve.

• Attainable through trade.

Figure 17.2Buying and Selling in World Markets

coffee computers

120 0

100 1

50 2

0 2.4

Coffee price $10

Computer price

$500

Export Industries

If a country has a comparative advantage in a good or service, the world price will be above the domestic (no-trade) price.

Figure 2 International Trade in an Exporting Country

Copyright © 2004 South-Western

Priceof Steel

0Quantityof Steel

Domesticsupply

Priceaftertrade World

price

DomesticdemandExports

Pricebeforetrade

Domesticquantity

demanded

Domesticquantitysupplied

Welfare effects of an export industry

Consumers are worse off—they consume less at higher prices.

Producers are better off—they produce more at higher prices.

Producers’ gains > consumers’ losses.

Net gain from trade.

Imports

If a country does not have a comparative advantage, the world price will be below the domestic (no trade) price.

Figure 4 International Trade in an Importing Country

Copyright © 2004 South-Western

Priceof Steel

0 Quantity

Priceafter

trade

Worldprice

of Steel

Domesticsupply

Domesticdemand

Imports

Domesticquantitysupplied

Domesticquantity

demanded

Pricebeforetrade

Protectionism

• To protect producers.• No protection for consumers.• Example: sugar tariff• http://www.newyorker.com/printables/talk/061127ta_talk_surowiecki

Tariffs

Taxes on imports, used to discourage importing and protect domestic industry.

Quotas

• Importers must have a license.

• Number of licenses is restricted.

• Owners of a license earn an economic rent—like owners of taxi medallions

Arguments for Restricting Trade

1. Jobs

2. National Security

3. Infant Industry

4. Unfair competition

5. Protection as a bargaining chip

The first era, from the late 1800's to World War I, was driven by falling transportation costs, thanks to the steamship and the railroad. That was Globalization 1.0, and it shrank the world from a size large to a size medium. The second big era, Globalization 2.0, lasted from the 1980's to 2000, was based on falling telecom costs and the PC, and shrank the world from a size medium to a size small. Now we've entered Globalization 3.0, and it is shrinking the world from size small to a size tiny. That's what this outsourcing of white-collar jobs is telling us — and it is going to require some wrenching adjustments for workers and political systems.

--Thomas Friedman, NYT 3/4/04

Outsourcing

Features of jobs that won’t be outsourced?

Complex communication.

Physical presence.

Interesting Statistic

135 million American in labor force.

Every three months 7 million lose a job.

Every three months 7 million find a job.