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International TradeInternational Trade
Chapter 9: International Trade Slide 2
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Introduction
Understanding the Economic Issues of International TradeThe benefits of tradeThe costs of tradeThe economic impact of trade restrictions
Chapter 9: International Trade Slide 3
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Comparative Advantageas a Basis for Trade
The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries.
Chapter 9: International Trade Slide 4
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production and Consumption Possibilities and the Benefits of Trade
Closed EconomyAn economy that does not trade with the
rest of the world
Open Economy
An economy that trades with other countries
Chapter 9: International Trade Slide 5
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production Possibilities Curve for a Many-Worker Economy
Computers (number/year)
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
Observations• The OC of producing an
additional unit = the slope of the line that touches the point
• OC will increase as output of on good increases
100,000
40,000
1,000 2,000
Chapter 9: International Trade Slide 6
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A country’s PPC shows the quantities of different goods that its economy can produce.
Consumption PossibilitiesThe combinations of goods and services
that a country’s citizens might feasibly consume
Production and Consumption Possibilities and the Benefits of Trade
Chapter 9: International Trade Slide 7
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
In a closed economy:Society’s production possibilities =
consumption possibilities.If a country is self-sufficient, it is called
autarky.
Production and Consumption Possibilities and the Benefits of Trade
Chapter 9: International Trade Slide 8
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
In an open economy:The society’s consumption possibilities are
typically greater than its production possibilities.
Production and Consumption Possibilities and the Benefits of Trade
Chapter 9: International Trade Slide 9
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buying and Selling in World Markets
Computers/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
Assume:• Producing at D• Closed economy• World price of coffee = $10/lb and
computer = $500120,000
100,000
1,000
50,000
2,000 2,400
150,000
3,000
Chapter 9: International Trade Slide 10
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buying and Selling in World Markets
Computers/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
F
Observation:• Sell 2,000 computers @ $500• Take the $1million and buy 100,000
pounds of coffee• Consumption possibilities of 150,000 is
greater than PPC without trade
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
Chapter 9: International Trade Slide 11
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buying and Selling in World Markets
Computers/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
F
Observation:• Start at D• Sell 50,000 lbs of coffee• Buy 1,000 computers with the $500,000• Pt F is possible with trade but not on the PPC
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
Chapter 9: International Trade Slide 12
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy
Computers/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
F
• 50 lbs of coffee trades for 1 computer• LM = consumption possibilities• G is the optimal combination for Costa Rica• Costa Rica can use trade to locate anywhere
along LM
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
160,000
3,200
G
M
L
Chapter 9: International Trade Slide 13
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Production Possibilities, Consumption Possibilities, and the Optimal Production Mix for an Open Economy
Computers/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
F
Why produce at G?• Slope of the PPC = LM• Domestic and international opportunity costs
of acquiring an extra computer (in terms of forgone coffee) are equal
E150,000
120,000
100,000
1,000
50,000
2,000 2,400 3,000
Consumptionpossibilities
Productionpossibilities
160,000
3,200
G
M
L
Chapter 9: International Trade Slide 14
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Straight-Line Production Possibilities Curve
Tea (pounds/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D
Observation• The tradeoff between
coffee and tea is constant at any point on the PPC
200
200
600
800
600 800
Chapter 9: International Trade Slide 15
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Two Consumption Possibilities Curves
Tea (pounds/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
D’
600
200
600
800
800 1,600
D
200
• Islandia produces at A• Islandia can use the money
earned from selling 800 lbs of coffee to choose any combination on AD’
Consumption possibilities curve when the world price of coffee is twice the world price of tea
Chapter 9: International Trade Slide 16
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Two Consumption Possibilities Curves
Tea (pounds/year
Co
ffee
(p
ou
nd
s/ye
ar)
B
C
A
600
200
600
800
800
1,600
D
200
• Islandia produces at D• Islandia can choose any
combination on A’D
Consumption possibilities curve when the world price of tea is twice the world price of coffee
A’
Chapter 9: International Trade Slide 17
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
What Do You Think?Where should Islandia produce if the price
of coffee and tea were the same?
Consumption Possibilities Withand Without International Trade
Chapter 9: International Trade Slide 18
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
ObservationsWith a bow-shaped PPC consumption
possibilities is typically maximized by producing where the PPC is tangent to the consumption possibilities line.
With a straight-line PPC production is completely specialized.
Consumption Possibilities Withand Without International Trade
Chapter 9: International Trade Slide 19
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Economic NaturalistDoes “cheap” foreign labor pose a danger
to high-wage economies?
Production and Consumption Possibilities and the Benefits of Trade
Chapter 9: International Trade Slide 20
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Economic NaturalistScenario
U.S. and Fredonia produce software and beef.Real wages in Fredonia are lower than in the
U.S.Fredonia is half as productive as the U.S. in
beef production.Fredonia is one-tenth as productive in software
production.
Production and Consumption Possibilities and the Benefits of Trade
Chapter 9: International Trade Slide 21
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Economic NaturalistOutcome
Fredonia has a comparative advantage in beef.U.S. has a comparative advantage in software.The U.S. will trade software for beef and
increase its consumption of both.Employment in the software industry in the U.S.
increases and employment in the beef industry will decrease.
Production and Consumption Possibilities and the Benefits of Trade
Chapter 9: International Trade Slide 22
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market forComputers in Costa Rica
Computer per yearWithout Trade
Computer per yearWith Trade
Domesticdemand
Domesticsupply
Consumer surpluswith trade = $1.96mil/yr
Producer surpluswith trade = $360K/yr
Worldprice
2,000 4,800
E
F
1,200 2,800
Computer Imports
2,000 4,800
2,400
1,400
400Domesticdemand
Domesticsupply
Consumer surpluswithout trade = $1mil/yr
Producer surpluswithout trade = $1mil/yr
2,400
1,400
400
1,000
E
Chapter 9: International Trade Slide 23
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service.
Chapter 9: International Trade Slide 24
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market forCoffee in Costa Rica
Coffee (pounds/year)Without Trade
100,000 240,000
12
7
4
Domesticdemand
Domesticsupply
Consumer surpluswithout trade = $250K/yr
Producer surpluswithout trade = $150K/yr
E
Coffee (pounds/year)With Trade
100,000
12
7
4
Domesticdemand
Consumer surpluswith trade = $40K/yr
Producer surpluswith trade = $600K/yr
E
Domesticsupply
Worldprice
F
40,000 200,000 240,000
Coffee exports
10
Chapter 9: International Trade Slide 25
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service.
Chapter 9: International Trade Slide 26
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
Observations of the Mutually Beneficial Gains from TradeCountries will profit by exporting the goods
and services for which they have a comparative advantage.
The revenue from the exports are used to import goods and services for which they do not have a comparative advantage.
Chapter 9: International Trade Slide 27
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
Observations of the Mutually Beneficial Gains from TradeThe markets will ensure that goods will be
produced where opportunity cost is lowest.The consumption possibilities will be
maximized.
Chapter 9: International Trade Slide 28
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Exercise 9.4
Computers per year
Pri
ce o
f co
mp
ute
rs (
$/co
mp
ute
r)
200
Domesticsupply
Worldprice
Domesticdemand
500 800 1,200
600
1,200
2,100
2,400
Question•Given the graph shown, what impact would trade have on producer and consumer surplus?
Chapter 9: International Trade Slide 29
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
Winners and Losers from TradeWinners
Consumers of imported goodsProducers of exported goods
LosersConsumers of exported goodsProducers of imported goods
Chapter 9: International Trade Slide 30
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
ProtectionismThe view that free trade is injurious and
should be restricted
TariffA tax imposed on an imported good
QuotaA legal limit on the quantity of a good that
may be imported
Chapter 9: International Trade Slide 31
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Tariff
Computers per year
Pri
ce o
f co
mp
ute
rs (
$/co
mp
ute
r)
1,200World price + tariff
1,600 2,400
1,000
1,200
Domesticsupply
World price
Domesticdemand
4,800
400
2,400
E
2,800
Importswithouttariff
Chapter 9: International Trade Slide 32
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Tariff
Computers per year
Pri
ce o
f co
mp
ute
rs (
$/co
mp
ute
r)
1,200
Domesticsupply
World price
Domesticdemand
4,800
400
1,200
2,400
1,000
World price + tariff
E
1,600 2,400 2,800
Importswithtariff
Consumer surpluswith tariff = 1.44K/yr
Producer surpluswith tariff = 640K/yr
Tariff revenue =$160K/yr
Chapter 9: International Trade Slide 33
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Exercise 9.5
Computers per year
Pri
ce o
f co
mp
ute
rs (
$/co
mp
ute
r)
200
Domesticsupply
Worldprice
Domesticdemand
500 800 1,200
600
1,200
2,100
3,600
Question•Given the graph shown, how will a tariff of $300 per computer affect total economic surplus?
1,500
300 700
Chapter 9: International Trade Slide 34
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Protectionist Policies: Tariffs and Quotas
What do you think?Why did President George W. Bush support
the imposition of tariffs on steel imported into the United States?
Chapter 9: International Trade Slide 35
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Protectionist Policies: Tariffs and Quotas
QuotasLegal limit on the number or value of foreign
goods that can be importedCan be enforced by issuing permits
Chapter 9: International Trade Slide 36
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
1,200
1,600 2,400
Domestic supply + quota
F
The Market for Computers after the Imposition of an Import Quota
Computers per year
Pri
ce o
f co
mp
ute
rs (
$/co
mp
ute
r)
1,200 2,800
Imports with free trade = 1,600 computers/yr
1,000
Domestic supply
World price
Domesticdemand
4,800
2,400
E1,400
2,000
400
Chapter 9: International Trade Slide 37
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Market for Computers after the Imposition of an Import Quota
1,200
1,600 2,400
Domestic supply + quota
F
Computers per year
Pri
ce o
f co
mp
ute
rs (
$/co
mp
ute
r)
1,200 2,800
Imports = 800 computers/year
1,000
Domestic supply
World price
Domesticdemand
4,800
2,400
E1,400
2,000
400
Economic rent to holders of import licenses = $80K/year
Producer surplus with quota = $640K/yr
Consumer surpluswith quota = $1,440K/yr
Chapter 9: International Trade Slide 38
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
Quotas & TariffsMarket effects of tariffs are the same.Tariffs generate tax revenue.Quotas generate revenue for the firms that
hold an import license.
Chapter 9: International Trade Slide 39
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
QuestionWhy would the government ever impose a
quota rather than a tariff?
Chapter 9: International Trade Slide 40
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
Economic NaturalistWho benefited from and who was hurt by
voluntary export restraints on Japanese automobiles in the 1980s?
Chapter 9: International Trade Slide 41
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
Other Barriers to TradeRed-tape barriersRegulations
Chapter 9: International Trade Slide 42
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
A Supply and Demand Perspective on Trade
The Inefficiency of ProtectionismTrade barriers are inefficient and reduce the
size of the economic pie.Because trade barriers benefit certain
groups, and these groups may be well organized, they may be successful in lobbying for trade barriers.
The gains from trade could be used to assist groups that have been hurt by trade.
Chapter 9: International Trade Slide 43
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
OutsourcingA term increasingly used to connote having
services performed by low-wage workers overseas
Chapter 9: International Trade Slide 44
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
OutsourcingOutsourcing of services to low-wage foreign
workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers.
Chapter 9: International Trade Slide 45
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Economic NaturalistPaul Solman and his associate Lee
Koromvokis produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program, The NewsHour with Jim Lehrer.
Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderbad?
Outsourcing
Chapter 9: International Trade Slide 46
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
Characteristics of Jobs that are Less Susceptible to OutsourcingLess rules-based jobs“Face-to-Face” complex communication jobsJobs that require the worker to be physically
present
Chapter 9: International Trade Slide 47
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Outsourcing
Responding to changing economic conditions requires the ability to adapt quickly to new circumstances.
Education provides the means to develop a comparative advantage that is not rules-based and does require complex face-to-face communication.
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