Principles of Economics CH. 9: Application: International Trade

Examples of bilateral trade agreements

--General Agreement on Tariffs and Trade (GATT), 1947 turned into the World Trade Organization in 1995 --European Community (E), 1958 --North American Free Trade Agreement (NAFTA), 1994

A country that produces soybeans has a Pd of $4 and a Q of 500 when there is no trade. The Pw of soybeans is $6. Under free trade, how would the quantity supplied/demanded for domestic producers and consumers be affected, and will the country export or import soybeans?

--The country will be an exporter of soybeans, because the Pd is lower than the Pw. --when P rises from Pd (4) to Pw (6), domestic consumers demand 300 instead of 500. --When P rises from Pd (4) to Pw (6), domestic producers supply 750 instead of 500. --the amount of exports, based on the numbers above, would be 450. 750 supply minus 300 demanded equals 450.

Why should we care about outsourcing?

--blurred boundaries between exporters and importers --magnification effect on trade barriers --macro-spillover across countries --a new motorway for development: join a GVC, rather than build one from scratch

Why do so many trade barriers exist?

--tariffs are easy to collect --infant industry argument --politics: "size of pie" vs. "distribution of pie" --when a country is large, term of trade gain

A country that produces plasma TVs has a Pd of $3000 and Q of 400 with no trade. The Pw for plasma TVs is $1500. Under free trade, how might the quantity demanded/supplied from consumers and producers change? Will the country export or import plasma TVs?

--the country will import plasma TVs because Pw (1500) is lower than the Pd (3000). --When P falls from Pd (3000) to Pw (1500), domestic consumers' demand rises from 400 to 600. --when P falls from Pd (3000) to Pw (1500) domestic producers' supply drops from 400 to 200. --the amount of imports, based on the numbers above, would be 400. 600 demand minus 200 supply equals 400.

"size of pie" vs. "distribution of pie"

--trade creates losers, even as it makes a country as a whole better off. --the losses are often highly concentrated among a small group of people, who feel them acutely --the gains are often spread thinly over many people, who may not see how trade benefits them.

How can a country liberalize trade?

--unilateral reductions in trade restrictions --multilateral agreements with many other nations --bilateral agreements with several other nations

common conversion rations for US dollars

1 US dollar = 0.8 Euro; e= 0.8 1 US dollar = 8 Chinese Yuan; e= 8 1 US dollar = 120 Japanese Yen; e= 120

two effects of imposing a tariff on imports:

1) when the tariff raises the domestic price of a good above the world price, it encourages domestic producers to increase production quantity. 2) When the tariff raises the price that the domestic consumers of a good have to pay, it encourages them to reduce their consumption of the good.

The Small Economy Assumption

A small economy is a price taker in world markets, meaning its actions have no effect on Pw. When a small economy engages in free trade, Pw is the only relevant price: --no seller would accept less than Pw, since she could sell the good for Pw in world markets. --no buyer would pay more that Pw, since he could buy the good for Pw in world markets.

Should tariffs always be a part of trade policies?

A tariff has an impact only if a nation becomes an importer of a good. in this case, the tariff moves the economy closer to an equilibrium without trade and causes dead-weight losses. A tariff improves the welfare of domestic producers and raises revenue for the government, but these gains are more than offset by the losses suffered by consumers. the best policy from the standpoint of economic efficiency is to allow trade without a tariff.

Tariff

A tax on goods produced abroad and sold domestically.

Heckscher-Ohlin Theorem

A theory that explains the existence of a country's comparative advantage by its factor endowments.

Ricardo model

A theory that explains the existence of a country's comparative advantage by its productivity.

If the Pw for a cotton shirt is $20, and the tariff is determined to be $10 per shirt, how will this affect consumers and producers? If, under free trade, buyers demand 80 and sellers supply 25, what will happen when the $10 tariff is introduced?

Consumers must pay $30 for an imported shirt, so domestic producers can then charge $30 per shirt. with the new tariff, prices rise to $30, buyers demand falls to 70, sellers supply falls to 40, and imports will equal 30 (70-40)

New trade theory

Monopolistic Competition Model (people love variety) cannot be explained by CA

IF the government allows a nation to import and export goods, what will happen to the price of the good and the quantity of the good sold in the domestic market for that good?

Once trade is allowed, the nation's domestic price of textiles will be driven to equal the world price. if the world price is higher than the domestic price, the domestic price will rise and the new higher price will reduce the amount of the good the nation consumes and raise the amount of the good the nation produces. This will lead to the nation becoming an exporter of the good because they have a comparative advantage. if the world price is lower than the domestic price, the domestic price will fall. The lower price will raise the amount of the good domestically consumed and lower the amount of textile that are domestically produced. This will lead to the nation becoming an importer of the good because other countries have a comparative advantage.

Overall, individuals and nations rely on specialization and trade as away to address problems of ___________.

Scarcity

Who will gain from free trade and who will lose, and will the gains exceed the losses?

The answer depends on whether the price rises or falls when trade is allowed. If the price rises, producers will gain and domestic consumers will lose. If the price falls, consumers gain and producers lose. In both cases, however, the gains outweigh losses and thus free trade raises the total welfare of the nation.

Why has outsourcing become a phenomenon?

The costs of transportation and communication have fallen so much that it is now economical to combine resources from many countries to produce a good or service.

If Pd > Pw,

The country does not have a comparative advantage of the good and under free trade, the country would import the good.

If Pd < Pw,

The country has a comparative advantage in the good and under free trade, the country would be an exporter of the good.

Domestic Price (Pd)

The domestic price without trade

The triangular area on the equilibrium curve above the equilibrium point when free trade is occurring, often referred to as "area D" represents what?

The nation's gains from trade.

World Price (Pw)

The price of a good that prevails in the world market for that good.

foreign outsourcing (outsourcing)

The provision of services or the production of various parts of a good in different countries that are then used or assembled into a final good in another location.

Trade surplus

The situation when a country exports more than it imports

Trade deficit

The situation when a country imports more than it exports

True or False: trade agreements can help members avoid trade wars.

True; a large country may gain from a tariff, but only if other larger trading partners don't retaliate.

increased competition (benefits of international trade)

a company shielded from foreign competitors is more likely to have market power, which in turn gives it the ability to raise prices above competitive levels. Opening up trade fosters competition and gives the invisible hand a better chance to work its magic.

lower costs through economies of scale (benefit of international trade)

a firm in a small country cannot take full advantage of economies of scale if it can sell only in a small domestic market. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully.

How do we determine the total welfare effects of a tariff?

add the change in consumer surplus (which is negative), the change in producer surplus (positive), and the change in government revenue (positive).

What is the "protection-as-a-bargaining-chip" argument? What are is counterarguments?

argument: Many policymakers claim to support free trade but, at the same time, argue that trade restrictions can be useful when we bargain with our trading partners. They claim that the threat of a trade restriction can help remove a trade restriction already imposed by a foreign government. (ex: nation 1 imposes a tariff on textiles imported from nation 2, unless nation 2 removes an already existing tariff on wheat imported from nation 1) counterargument: The problem with this strategy mainly lies in the fact that it may not work. If it doesn't, the nation using the argument is forced to make one of two negative decisions: either they carry out the threat and implement a trade restriction that would reduce its own economic welfare, or they back down from the threat and thus lose prestige in future international affairs.

What is the "jobs" argument against free trade? What are the counterarguments?

argument: Some think that if free trade is allowed, prices will drop and makers of the good will become unemployed. counterargument: However, the gains in trade are based on comparative advantage, therefore each country can gain from trading with the other. If one industry fails due to free trade, employees can switch to a new industry in which the nation has the comparative advantage.

What is the "unfair-competition" argument against free trade? What are the counterarguments?

argument: free trade is desirable only if all countries play by the same rules. If firms in different countries are subject to different laws/regulations, then it is unfair to expect firms to compete in the international marketplace. counterargument: Oftentimes even though a nation's economic policy (such as, for example, offering subsidies through tax breaks for a particular industry) may hurt foreign producers of an industry, it would almost certainly be beneficial for the consumers of the good who are purchasing at a lower price. This relates back to the main case for free trade: the gains of the consumers from buying at the lower price would exceed losses of producers.

What is the "infant-industry" argument against free trade? What are its counterarguments?

argument: new industries need temporary trade restrictions to help them get started. Once this period of protection is over, the industry will be strong enough to compete with foreign firms. Older firms also argue that temporary restrictions will help them adjust to new conditions. counterargument: economists believe that this particular idea is difficult to implement in practice. To apply these benefits the government would have to decide which industries will become the most profitable after which is extremely difficult to predict, especially when certain industries are often awarded more protection if it promotes political power. In addition, the political process makes removing these protections from politically powerful industries harder. Economists are also skeptical of the argument on principle alone. History shows that young start-up firms often incur temporary losses and succeed in the long run even without protection from competition.

What is the "national-security" argument against free trade? What are its counterarguments?

argument: the industry that is being threatened with competition from other countries is vital to national security. (ex: steel industry being traded freely could weaken national defense in wartime) counterargument: one should be wary of the national-security argument when it is made by company reps instead of the defense establishment because companies will exaggerate their usefulness to a nation's defense to obtain protection from foreign competition.

what does a tariff cause a dead-weight loss?

because a tariff is a type of tax, and DWLs are caused by taxes.

When a country allows trade and becomes an EXPORTER of a good, domestic producers of the goods are _________, and domestic consumers of the good are _________.

better off; worse off

When a country allows trade and becomes an IMPORTER of a good, domestic consumers of the good are __________, and domestic producers of the good are ____________.

better off; worse off

What factors are considered when looking at the gains and losses from a tariff?

consumer surplus, producer surplus, and government revenue.

Effects on Import (M) and Export (X) with exchange rates and trade

e (stronger dollar, appreciation) -- X ↓ , M >>> (X-M)↓ e↓ (weaker dollar, depreciation) --X, M↓ >>>> (X-M)

A tariff reduces the quantity of imports and moves the domestic market closer to its ____________

equilibrium before trade

Trade raises the economic well-being of a nation in the sense that the gains of the winners _________ the losses of the losers.

exceed

Balance of Trade (BOT)

exports- imports --BOT < 0= trade deficit --BOT > 0= trade surplus --BOT = 0= balanced trade position

Increased variety of goods (benefit of international trade)

goods produced in different countries are not exactly the same. Free trade gives consumers in all countries greater variety to choose from. (ex: german beer vs american beer)

A tariff matters only if a country is __________ a good.

importing

How can we tackle a large US trade deficit?

increase productivity and export competitiveness; spend less and save more; exchange rate policy

Outsourcing was originally mostly done for ________ activities, but today the focus is on the outsourcing of __________.

manufacturing; services

Agricultural subsidies

primary reason: political, due to strong influence of agriculture sectors, specially large agriculture businesses costs: raises domestic producer surplus, reduces consumer surplus due to higher food prices in the exporting country, causes a net loss for an exporting country, especially for a large country due to reduced international prices

With the outsourcing of services to places such as India, in what ways can Europe and the US retain their comparative advantage?

product differentiation, non-tradable nature of some goods and services, innovation and protection of IPRs, and shared prosperity (a changing mindset)

Quotas

quantity restrictions on imports. The effect is similar to tariffs if quota rents are obtained by home firms or governments. examples: Multifibre Arrangment (MFA)>>>Agreement on Textiles and Clothing (ATC) Voluntary export restraint (VER)

economies of scale

some goods can be produced at low cost only if they are produced in large quantities.

total dead-weight loss of a tartaric is the sum of ____________

the DWL from the overproduction of goods AND the DWL from the under-consumption of goods.

Exchange Rate (e)

the amount of foreign currency needed to exchange for one US $. A negative change in e is called devaluation or depreciation. A positive change in e is called revaluation or appreciation.

What happens to the world price when the government imposes a tariff?

the domestic price exceeds the world price by the amount of the tariff.

dead-weight loss

the fall in total surplus, caused by a tariff.

enhanced flow of ideas (benefits of international trade)

the transfer of technological advances around the world is often thought to be linked to the trading of the goods that embody those advances. (ex: the best way for a poor agricultural nation to learn about computers is to buy some computers from abroad rather than trying to make them domestically.

True or False: most economists agree that free trade is beneficial to the welfare of US citizens.

true; most economists overwhelmingly support free trade among nations and believes it is a way of allocating production efficiently and raising living standards both at home and abroad.