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Chapter 15International Trade

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Chapter Outline

• WHAT WE TRADE AND WITH WHOM• WHY TRADE IS GOOD• WHY TRADE IS NOT ALWAYS GOOD FOR EVERYONE• BARRIERS TO TRADE• TRADE AS A DIPLOMATIC WEAPON

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You Are Here

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Exports and ImportsAs a percentage of GDP

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What We Trade: Exports (2007)

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GoodBillions of Dollars of Exports

Industrial Eq 198.5

Elec. Mach. Aud & Video 148.4

Motor Vehicles 107.0

Aerospace 76.0

Optics 66.3

Services 497.2

1,645.7

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What We Trade: Imports (2007)

GoodBillions of Dollars of Imports

Petroleum 361.0

Industrial Eq 250.2

Elec. Mach. Aud & Video 248.9

Motor Vehicles 214.5

Optics 53.8

Services 378.1

Total 2,346.06

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With Whom We Trade

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Why trade is good

• To understand why trade is good lets go back to an example we studied in Chapter 1

• We had our little tribe (unfortunately since chapter 1 Jane got sick and died) but lets make it be hamburgers and buns to make the point extreme and clear

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Person Hamburgers Buns

Donna 5 1

Bill 3 2

Sally 2 3

Carl 1 5

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If this is all one tribe we get the following Production Possibility Frontier

Buns

Burgers

We like this point, 8 burgers and 8 buns

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However now suppose that these are two different tribes that don’t interact and that Donna and Bill are in the same tribe

Now the production possibilities:

Now these are the two points

We only have 2 actual hamburgersfor each tribe

Buns

Burgers

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Gains from Trade

•Now there are serious gains from trade•Without trade:•Donna and Bill have 5 burgers and 2 buns•Sally and Carl have 2 burgers and 5 buns•This suggests the following scenario:•Donna and Bill only make burgers: 8 burgers•Sally and Carl only make buns: 8 buns•They trade 4 burgers for 4 buns•Everybody can have 2 burgers•Essentially the production possibilities frontier has expanded•This is why economists think trade is good

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Coffee Apples

United States 1 2

Brazil 2 1

Suppose there are two countries, the United States and Brazil, and two goods, Apples and Coffee, and the production per unit of labor is shown in the table below.

Clearly, there are benefits from trade. If the Americans focus on apples and the Brazilians focus on coffee and they trade with one another, more apples and more coffee is available to both countries. 1

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Countries

Lets think about this with countries now

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Comparative and Absolute Advantage

So Far I have been abstracting from something. The U.S. was better at apples and worse at coffee

More generally you could be better at both things

•Absolute Advantage: the ability to produce a good better, faster, or more quickly than a competitor

•Comparative Advantage: the ability to produce a good at a lower opportunity cost of the resources used

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The Benefits of Trade: When Comparative and Absolute Advantage are Not the same

Coffee Apples

United States 3 2

Brazil 2 1

Now suppose the Americans are better at producing both goods. The Americans have an absolute advantage in both but a comparative advantage in only Apples.

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There are still benefits from trade. If the Americans focus on apple production and the Brazilians focus on coffee production and they trade with one another more apples and coffee is available to both countries.

•The Brazilians would be willing to trade 2 coffees for one apple, Americans would do that.

•Americans would give 2 apples for 3 coffees, Brazilians would do that

•Exactly where we end up depends on specific demand within the countries

•This is called the Terms of Trade: The amount of a good one country must give up in order to obtain another good from the other country, usually expressed as a ratio.

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Per capita Consumption Possibilities Frontier

Apples

Coffee

Consumption Possibilities Frontier

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To set this up correctly assume that •Brazil and the U.S. are the same size population

•Everyone within the countries are the same

•Terms of trade will be such that all Brazilians and Americans consume exactly the same amount of coffee and apples

•I want to figure out what that level could be with and without trade

Brazilian Frontier without trade

U.S. Possibilities without trade

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Trade not good for everyone

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I have been acting if everyone is identical, but of course that is not true

Opening up trade markets in example above will not generally be good for Brazilian Apple tree owners and workers or American coffee growers and workers

Lets see this in a supply and demand framework

Think of a small country in a global economy so we just take the price of the good as given

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Domestic Supply

Domestic Demand

Exports

International Price

DomesticConsumption

DomesticProduction

Consumers are worse off, but producersare much better off

Gains from trade:

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Domestic Supply

Domestic DemandImports

International Price

DomesticConsumption

DomesticProduction

Producers are worse off, but consumersare much better off

Gains from trade:

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Low Skill and High Skill Workers

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•Do we care about producers? It is not just owners but also workers in these sectors•In the U.S. we often worry about trading with less developed countries•The problem is •We have comparative advantage in high skill workers•They have a comparative advantage in low skill workers•Thus generally when we trade with poorer countries•Good for all consumers•Good for high skill workers•Probably bad for low skill workers in U.S.•Probably good for low skill workers in other countries

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•Really two kinds of problems:•More permanent: for workers who are not great at school, its not clear what they should be doing in the long run•More temporary: for trained workers (say a welder) in industries that are moving overseas, not easy to find another job•This is probably inevitable•We can cushion the blow•We can try to increase skills of these workers•A lot of movement from manufacturing to services

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Other Reasons For Limiting Trade

• National Security• National Identity

• Both of the above can be overstated easily.

• Environmental Concerns• Child-Labor Concerns• Protect Industries from competition

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Methods of Limiting Trade

• Tariffs: a tax on imports• Quotas: a legal restriction on the amount of a good

coming into the country• Non-tariff barriers: barriers to trade that result from

regulatory actions

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Domestic Supply

Domestic Demand

International Price

DomesticConsumption

DomesticProduction

Tariff

Government Revenue

Deadweight Loss

Tariffs

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Domestic Supply

Domestic Demand

International Price

DomesticConsumption

DomesticProduction

Quota

Quota rents

Deadweight Loss

Quotas

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Trade as a Diplomatic Weapon

• Trade sanctions have failed• To get Castro out of Cuba• To get Iran to release our hostages in 1979-1980.• To get the Soviet Union out of Afghanistan.• To get Iraq out of Kuwait in 1990.

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