Objectives After studying this chapter, you will able to Describe the trends and patterns in international trade Explain comparative advantage and the economic implications of free trade Explain why international trade restrictions reduce the volume of imports and exports, and reduce our consumption possibilities Patterns and Trends in International Trade Trade in Goods Manufactured goods represent 55 percent of U.S. imports and 68 percent of exports. Raw materials and semi-manufactured materials represent 14 percent of U.S. exports and 15 percent of imports. The largest export item from the United States is capital goods and the largest import item is automobiles. Patterns and Trends in International Trade Trade in Services International trade in services such as travel, transportation, and insurance is large and growing. Geographical Patterns of International Trade Trading relation US-Canada is the largest in the world (446 billion dollars per year, and growing) Mexico is the second largest trading partner of the US (Mexico US trade = 266 billion per year, and growing) Patterns and Trends in U.S. international trade Trends in the Volume of Trade In 1960, the United States exported 3.5 percent of its total output and imported 4 percent of the total amount that Americans spent on goods and services. In 2005, the United States exported 10 percent of its total output and imported 16 percent of the total amount that Americans spent on goods and services. International trade is expanding rapidly (each year there are new record numbers for exports and imports) Patterns and Trends in International Trade Net Exports The value of exports minus imports is called net exports. During the third quarter of 2006, imports exceeded exports in the United States, so net exports were negative $810 billion (trade balance) Some people do not like free trade agreements What can you say about the economic impact of trade? The benefits of trade The costs of trade The economic impact of trade restrictions What drives countries to trade? Comparative advantage is the fundamental force that generates trade between nations. The basis for comparative trade is divergent opportunity costs between countries. Nations can increase their consumption of goods and services when they allocate resources to the production of those goods and services for which they have a comparative advantage. Production and Consumption Possibilities and the Benefits of Trade A country’s PPC (Production Possibilities Curve) shows the quantities of different goods that its economy can produce. Consumption Possibilities: combinations of goods and services that a country’s citizens might feasibly consume. Production and Consumption Possibilities Two good economy -- computers and coffee Two workers who work 50 weeks/year – Carlos Can produce 100 pounds or 1 computer per week – Maria Can produce 100 pounds or 2 computers per week How to construct the PPC? 1. Find the extremes (maximum feasible production for each type of good). 2. Start at one of the extremes (assume all productive resources are devoted to producing one type of good – say is the y-axis good) 3. What is the best way of producing some units of the x-axis good? How to construct PPC (2) The agent with the comparative advantage (lowest cost) should produce the x-axis good. Once you exhaust the time available to this individual, find the agent with the second lowest cost. And so on… Production Possibilities Curve for a Two-Worker Economy A 10,000 SlopeAC = Maria’s OCcomputers = Coffee (pounds/year) - 50 pounds coffee/computer 5,000 C SlopeCB = Carlos’ OCcomputers = - 100 pounds coffee/computer B 100 150 Computers (number/year) Production Possibilities Curve for a Three-Worker Economy Maria produces computers A C Coffee (pounds/year) Maria and Pedro produce computers D All three workers produce computers B Computers (number/year) Production and Consumption Possibilities and the Benefits of Trade In a closed economy: – Society’s production possibilities = consumption possibilities. Closed economy: consumption possibilities = production possibilities Without Trade •Brazil’s consumption possibilities = ACB •Assume production is at C •The OC of 50 lbs coffee = 1 computer •The OC of 1 computer = 100 lbs coffee A Coffee (pounds/year) 10,000 Production possibilities Slope = -50 pounds coffee/computer Production possibilities 5,000 C Slope = -100 pounds coffee/computer B 100 150 Computers (number/year) Computers (number/year) Open economy consumption possibilities F Consumption possibilities with trade 13,000 Slope = -80 pounds coffee/computer With Trade Coffee (pounds/year) • World market: 80 lbs coffee for 1 computer • Trade 100 computers for 8,000 lbs coffee + 5,000 lbs from Carlos = 13,000 lbs • Trade 80 lbs coffee for 1 computer or 5,000 lbs of coffee for 62.5 computers + 100 computers from Maria = 162.5 computers • Consumption Possibilities = FCG C 5,000 G 100 162.5 Computers (number/year) Computers (number/year) Implications of opening to trade F Consumption possibilities with trade 13,000 Slope = -80 pounds coffee/computer A Production possibilities Coffee (pounds/year) 10,000 Slope = -50 pounds coffee/computer C 5,000 B G 100 150 162.5 Computers (number/year) Are the gains of one country the losses of another? The consumers of the two countries win as a result of free trade! International Trade Restrictions Governments restrict international trade to protect domestic producers from competition by using two main tools Tariffs Nontariff barriers A tariff is a tax that is imposed by the importing country when an imported good crosses its international boundary. A nontariff barrier is any action other than a tariff that restricts international trade. International Trade Restrictions The History of Tariffs This figure shows the average tariff rate over the last 70 years. Average tariffs reached their peak of 20 percent in 1933. The Case Against Protection Despite the fact that free trade promotes prosperity, trade is restricted. It is often argued that international trade should be restricted to Protect infant industries Punish dumping Save jobs Allow us to compete with cheap foreign labor Prevent rich nations from exploiting poor ones The Case Against Protection The Infant Industry Argument The infant-industry argument is that it is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets. The Case Against Protection The Dumping Argument Dumping occurs when foreign a firm sells its exports at a lower price than its cost of production. Dumping is seen as a justification for a tariff to prevent a foreign firm driving domestic firms out of business and then raising its price. Problem: It is virtually impossible to determine a firm’s costs; The Case Against Protection Saves Jobs The idea that buying foreign goods costs domestic jobs is wrong. It destroys some jobs and creates other better jobs. It also increases foreign incomes and enables foreigners to buy more domestic production. Protection to save particular jobs is very costly. The Case Against Protection Allows us to Compete with Cheap Foreign Labor The idea that a high-wage country cannot compete with a low-wage country is wrong. Low-wage labor is less productive than high-wage labor. The Case Against Protection Prevents Rich Countries from Exploiting Poorer Countries The idea that trade restrictions prevent rich countries from exploiting poorer countries is wrong. Free trade is the best way of raising wages and improving working conditions in poor countries. The Case Against Protection The most compelling argument against protection is that it invites retaliation. We have seen it today as the world reacts to high U.S. tariffs on steel and agriculture. Why Is International Trade Restricted? The two key reasons why international trade is restricted are Tariff revenue Rent seeking Why Is International Trade Restricted? Tariff Revenue It is costly for governments to collect taxes on income and domestic sales. It is cheaper for governments to collect taxes on international transactions because international trade is carefully monitored. This source of revenue is especially attractive to governments in developing nations. Why Is International Trade Restricted? Rent Seeking Rent seeking is lobbying and other political activities that seek to capture the gains from trade. Despite the fact that protection is inefficient, governments respond to the demands of those who gain from protection and ignore the demands of those who gain from free trade because protection brings concentrated gains and diffused losses. Why Is International Trade Restricted? Compensating Losers The gains from free trade exceed the losses, and sometimes free trade agreements address the issue of the distribution of gains from trade by compensating those who lose from free trade. For example, under NAFTA, a $56 million fund was created to support and retrain workers who lot their jobs from foreign competition resulting from the agreement.
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