Econ789 chapter038

International Trade

Chapter 38

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38-2

Global Economy

• Households and firms in the U.S. economy interact with households and firms in other economies in two main ways:

• International Trade: They buy and sell goods and services.

• International Finance: They borrow and lend.

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Global Economy

• Households and firms in the U.S. economy interact with those in the rest of the world in goods markets and financial markets.

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• The red flow shows the expenditure by Americans on imports of goods and services.

• The blue flow shows the expenditure by the rest of the world on U.S. exports (other countries’ imports).

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Global Economy

• The green flow shows U.S. lending to the rest of the world.

• The orange flow shows U.S. borrowing from the rest of the world

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• These international trade and international finance flows tie nations together.

• Global booms and slumps are transmitted through these flows.

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U.S. Trade Facts

• U.S. exports and imports as shares of gross domestic product have been on a long-term upward trend.

• International trade has roughly tripled in importance compared to the economy as a whole in the past 50 years.

• Both imports and exports fell in 2009 due to the recession.

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U.S. Trade Facts

• Exports and Imports as a Percentage of U.S. GDP

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U.S. Trade Facts

• Compared to the United States, other countries are even more tied to international trade.

• Their imports and exports as a share of GDP are substantially higher.

• The United States, due to its size and diversity of resources, relies less on international trade than almost any other country.

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U.S. Trade Facts

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U.S. Trade Facts

• In 2013, the world as a whole produced goods and services worth about $74 trillion at current price.

• World trade in goods and services exceeded $23 trillion in 2013.

• More than 30% of world output is sold across national borders.

• So, who trades with whom? In particular, whom does the U.S. trade with?

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U.S. Trade Facts

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U.S. Trade Facts

• The 5 largest trading partners with the U.S. in 2012 were Canada, China, Mexico, Japan, and Germany.

• The largest 15 trading partners with the U.S. accounted for 69% of the value of U.S. trade in 2012.

• 3 of the top 10 trading partners with the U.S. in 2012 were also the 3 largest European economies: Germany, the United Kingdom, and France.

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U.S. Trade Facts

• Total U.S. Trade with Major Partners, 2012

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U.S. Trade Facts

• Principal U.S. exports include:• Chemicals• Agricultural products• Consumer durables• Semiconductors• Aircraft

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• Principal U.S. imports include:• Petroleum• Automobiles• Metals• Household appliances• Computers

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U.S. Trade Facts

• Trade surplus when exports exceed imports• Trade deficits when imports exceeds exports• U.S. trade deficit in goods • $735 billion in 2012

• U.S. trade surplus in services • $196 billion in 2012

• Trade deficit with China• $315 billion in 2012

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Specialization and Trade

• Specialization: People concentrate on what they are good at.

• Division of Labor: Breaking up a task into a number of smaller, more specialized tasks.

• Specialization through division of labor leads to greater production of goods and services without increasing inputs.

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• Mutual Gains from Voluntary Exchange: A voluntary exchange between two parties must make both parties better off.

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Before Exchange

After Exchange

Exchange

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• Nations have different resource endowments

• Land, Labor, Capital, and Entrepreneur

• Goods and services are produced with different combinations of resources

• Land-intensive goods: Agricultural & mining goods

• Labor-intensive goods: Manufacturing & services

• Capital-intensive goods: Manufacturing & services

• Some economies are good at producing land-intensive goods, while others are good at Labor-intensive or Capital-intensive goods.

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• Each person or economy can produce identical goods and services.

• Each person and economy has different skill/technology and resources. Their production possibilities frontiers differ, and so as their opportunity costs.

• With limited resources each person and economy should specialize in producing goods and services that they are good at, to achieve greater production, then trade each others. ⇒ More efficient!

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• Assume U.S. and Mexico have the same amount of labor resources, and they can produce vegetables or beef using own labor

• U.S. can produce maximum of 30 tons of vegetables or 30 tons of beef, but currently producing 12 tons of vegetable or 18 tons of beef

• Mexico can produce maximum of 20 tons of vegetables or 10 tons of beef, but currently producing 4 tons of vegetable or 8 tons of beef

Absolute Advantage

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Absolute Advantage

(a) United States (b) Mexico

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• Absolute advantage: one nation is more productive than another—needs fewer inputs or takes less time to produce a good or perform a production task.

• U.S. has an absolute advantage in production of both vegetables and beef over Mexico

• With same number of labor the U.S. can produce more vegetables than Mexico (30 > 20)

• With same number of labor the U.S. can produce more beef than Mexico (30 > 10)

• Should the U.S. trade with Mexico?

Absolute Advantage

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• Comparative advantage: the ability of a nation to produce a good or service at a lower opportunity cost than someone else.

• When one nation has a comparative advantage in producing one good, the other nation has a comparative advantage in producing the other goods.

• Opportunity cost: Opportunity cost of producing one good is the decrease in the quantity of the other good as it moves along the PPF.• The slope of PPF measures the opportunity cost of

producing goods measured along X-axis.

Comparative Advantage

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• Opportunity cost of producing 1 ton of beef:• 1 pound of vegetables in U.S.• 2 pounds of vegetables in Mexico• The U.S. has a comparative advantage of

producing beef over Mexico

• Opportunity cost of producing 1 ton of vegetable:• 1 pound of beef in U.S.• 1/2 pounds of beef in Mexico• The Mexico has a comparative advantage of

producing vegetables over the U.S.


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• Law of comparative advantage: A nation should specialize in producing goods and services on which the nation has a comparative advantage.• Nations can gain from specializing in production of

the goods in which they have a comparative advantage and then trading.

• The U.S. should specialize in production of beef and produce 30 tons.

• Mexico should specialize in production of vegetables and produce 20 tons.

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• Trade: the U.S. trades 10 tons of beef for 15 tons of vegetable.• The U.S. exports 10 tons of beef and imports 15

tons of vegetables.

• After trade• The U.S. can consume 20 tons of beef (= 30 – 10)

and 15 tons of vegetables (= 0 + 15)• Mexico can consume 10 tons of beef (= 0 + 10)

and 5 tons of vegetables (= 20 – 15)

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• Gains from Trade: After specialization and trade each nation can consume than before trading.• The U.S. can consume 2 extra-tons of beef (= 20 – 18)

and 3 extra-tons of vegetables (= 15 – 12)• Mexico can consume 2 extra-tons of beef (= 10 – 8)

and 1 extra-ton of vegetables (= 5 – 4)

• Two nations mutually benefit from trade.• Both nations achieve consumption combinations

beyond own PPF.

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Gains from Trade


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TradingPossibilities Line

TradingPossibilities Line

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• Summary

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• Terms of trade: Rate of exchange of two goods• 2 tons of beef = 3 tons of vegetables

• Trading possibilities line: a line starting from the production combination point under specialization with its slope equals terms of trade• Both nation can choose any combination of two

goods along the trade possibilities line under the terms of trade as own consumption point

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• Why do they trade?• Before trade, an opportunity cost of 1 ton of

vegetables was 1 ton of beef in the U.S. and ½ tons of beef in Mexico.

• It is cheaper to buy vegetables from Mexico than producing by itself even at terms of trade of 2/3 tons of beef.

• How about beef for Mexico?

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Increasing Cost and Trade

• Under constant costs• PPF is a straight line• Complete specialization

• Under increasing costs• Concave PPF• Resources not perfectly substitutable • Incomplete specialization: both nations still

produce both goods

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Supply and Demand Analysis of International Trade

• Without international trade, the market must be at equilibrium in each country

• If foreign price is different from domestic price• Firms want to sell products at higher price, so firms

exports to the country where the market price is higher

• Households want to buy products at lower price, so households imports from the country where the market price is lower

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• If foreign price > domestic price• Domestic firms make more profits by selling to

foreigners• Export to foreign country• Domestic price rises• Surplus will be exported• Export supply curve

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• If foreign price < domestic price• Domestic consumers can buy cheaply from foreign

firms• Import from foreign country• Domestic price falls• Shortage will be imported• Import demand curve

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• At equilibrium• Exporting country has surplus, while importing

country has shortage• Trade must be balanced: Export must be equal to

import• Surplus in the exporting country must be equal to

shortage in the importing country• Trade ends when the price in tow countries are

the same.

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1.50

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Quantity of Aluminum(Millions of Pounds)

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(a) U.S. Domestic Aluminum Market

(b) U.S. Export Supplyand Import Demand

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Surplus = 100

Shortage = 50

Shortage = 100

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(a) Canada’s Domestic Aluminum Market

(b) Canada’s Export Supplyand Import Demand

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Surplus = 50

Surplus = 100

Shortage = 50


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International Trade Equil ibrium

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Import demand = Export supply

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Equilibrium

CanadianImport Demand

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Case for Free Trade

• All countries participating trade benefit from specialization and trade• Promote efficiency• Promote competition• Variety of goods and services• Higher standard of living (more

consumption possible)

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Trade Barriers

• Trade Barriers: The government-imposed restraint on the international trade of goods or services• Tariffs: Excise taxes on imported goods• Import quota: A limit on the quantity of goods

imported• Nontariff barrier (NTB): licensing, product standard,

inspection, and other government measures intended to restrict imports

• Voluntary export restriction (VER): Exporting country voluntarily limits the amount of exports

• Export subsidy: Subsidies on export goodsLO4

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Economic Impact of Trade Barriers

• Direct effects• Increase in domestic price• Decline in consumption (Loss of consumer surplus)• Increase in domestic production and profits of domestic firms• Decline in imports• Tariff revenue

• Indirect effects• Loss of efficiency (Producing at higher cost)• Decline in exports (Trade is an exchange of goods produced)• Decline in standard of living and welfare

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The Case for Protection

• Military self-sufficiency• Diversification for stability• Infant industry • Protection against dumping• Increased domestic employment• Cheap foreign labor

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Multi lateral Trade Agreements

• World Trade Organization (WTO)• European Union (EU)• North American Free Trade Agreement

(NAFTA)• Trans-Pacific Partnership (TPP)

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WTO

• Established by Uruguay Round of GATT • 153 member nations in 2010• Oversees trade agreements and rules on

disputes• Critics argue that it may allow nations to

circumvent environmental and worker-protection laws

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European Union

• Initiated in 1958 as Common Market• Abolished tariffs and import quotas between

member nations• Established common tariff with nations

outside the EU• Created Euro Zone with one currency

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NAFTA

• Agreement between U.S., Canada, and Mexico• Established a free trade zone between the

countries• Trade has increased in all countries• Enhanced standard of living

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Trade Adjustment and Offshoring

• Trade Adjustment Assistance Act• Designed to help individuals hurt by

international trade• Offshoring of jobs• Shifting of work previously done by

American workers to workers abroad

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Econ789 chapter038

Economy & Finance

Transcript of Econ789 chapter038