© 2005 thomson c hapter 31 international trade. © 2005 thomson 2 gottheil - principles of...

© 2005 Thomson

CChapter 31hapter 31

International TradeInternational Trade

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Gottheil - Principles of Economics, 4e

Economic PrinciplesEconomic Principles

Absolute advantage

Comparative advantage

Free trade

Tariffs

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Economic PrinciplesEconomic Principles

Quotas

Customs unions

Free trade areas

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EXHIBIT 1 ILLINOIS PRODUCTION POSSIBILITIES CURVE

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Exhibit 1: Illinois Exhibit 1: Illinois Production Production

Possibilities CurvePossibilities Curve1. What is the opportunity cost of producing an additional barrel of oil in Illinois?• The opportunity cost of producing an additional barrel of oil is one bushel of corn.

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Possibilities CurvePossibilities Curve1. What is the opportunity cost of producing an additional barrel of oil in Illinois?• The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 1.

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Possibilities CurvePossibilities Curve2. What is the opportunity cost of producing an additional bushel of corn in Illinois?• The opportunity cost of producing an additional bushel of corn is one barrel of oil.

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Intrastate TradeIntrastate Trade

1. If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Illinois?

• We know that one barrel of oil must be given up to get one bushel of corn in Illinois. As a result one bushel of corn will trade for one barrel of oil in Illinois.

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EXHIBIT 2 OKLAHOMA PRODUCTION POSSIBILITIES CURVE

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Exhibit 2: Oklahoma Exhibit 2: Oklahoma Production Possibilities Production Possibilities

CurveCurve1. What is the opportunity cost of producing an additional barrel of oil in Oklahoma?• The opportunity cost of producing an additional barrel of oil is 0.0833 bushels of corn.

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CurveCurve1. What is the opportunity cost of producing an additional barrel of oil in Oklahoma?• The opportunity cost of an additional barrel of oil is given by the slope of the production possibilities curve in Exhibit 2.

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CurveCurve2. What is the opportunity cost of producing an additional bushel of corn in Oklahoma?• The opportunity cost of producing an additional bushel of corn is 12 barrels of oil.

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Intrastate TradeIntrastate Trade

2. If corn and oil exchange according to their relative opportunity costs, what will one bushel of corn trade for in terms of barrels of oil in Oklahoma?• We know that 12 barrels of oil must be given up to get one bushel of corn in Oklahoma. As a result one bushel of corn will trade for 12 barrels of oil in Oklahoma.

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Interstate TradeInterstate Trade

• Since oil producers must give 12 barrels of oil for a bushel of corn in Oklahoma, but need only give one barrel of oil for a bushel of corn in Illinois, Oklahoma oil producers would seek out buyers in Illinois.

1. If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil?

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1. If Illinois and Oklahoma engage in free trade, which state would export corn and which state would export oil?• Likewise, since a bushel of corn trades for one barrel of oil in Illinois, but trades for 12 barrels of oil in Oklahoma, Illinois corn farmers would seek out buyers in Oklahoma.

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Free trade

• International trade that is not encumbered by protectionist government policies such as tariffs and quotas.

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EXHIBIT 3 PRODUCTION OF CORN AND OIL IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

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Exhibit 3: Production of Corn Exhibit 3: Production of Corn and Oil in Illinois and and Oil in Illinois and

Oklahoma, Before and After Oklahoma, Before and After Free Trade (bushels and Free Trade (bushels and

barrels)barrels)What are the total gains from free trade between Oklahoma and Illinois?• By having Illinois specialize in producing corn, and Oklahoma specialize in producing oil, an additional 75 bushels of corn and an extra 200 barrels of oil are produced.

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EXHIBIT 4 CORN AND OIL CONSUMPTION IN ILLINOIS AND OKLAHOMA, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

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Exhibit 4: Corn and Oil Exhibit 4: Corn and Oil Consumption in Illinois and Consumption in Illinois and Oklahoma, Before and After Oklahoma, Before and After

Free Trade (bushels and Free Trade (bushels and barrels)barrels)What relative price leads to

Oklahoma and Illinois consuming the same quantity of oil after trade?• A relative price of three barrels of oil for one bushel of corn will result in both states consuming 300 barrels of oil.

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2. If Illinois and Oklahoma engage in free trade, and if there are aggregate gains from trade, then is it true that nobody loses?• No. Oil producers in Illinois are priced out by cheap imports of Oklahoma oil. Likewise corn growers in Oklahoma are priced out by cheap imports of Illinois corn.

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International TradeInternational Trade

International specialization

• The use of a country’s resources to produce specific goods and services, allowing other countries to focus on the production of other goods and services.

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EXHIBIT 5 PRODUCTION OF CORN AND OIL IN THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

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Exhibit 5: Production of Corn Exhibit 5: Production of Corn and Oil in the United States and Oil in the United States

and Mexico, Before and After and Mexico, Before and After Free Trade (Bushels and Free Trade (Bushels and

Barrels)Barrels)What does Mexico specialize in producing in Exhibit 5?

• Mexico specializes in producing oil.

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EXHIBIT 6 CORN AND OIL CONSUMPTION THE THE UNITED STATES AND MEXICO, BEFORE AND AFTER FREE TRADE (BUSHELS AND BARRELS)

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Exhibit 6: Corn and Oil Exhibit 6: Corn and Oil Consumption in the United Consumption in the United

States and Mexico, Before and States and Mexico, Before and After Free Trade (bushels and After Free Trade (bushels and

barrels)barrels)What relative price leads to Mexico and the United States consuming the same quantity of corn after trade in Exhibit 6?

• Four barrels of oil for one bushel of corn.

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Absolute and Absolute and Comparative Comparative AdvantageAdvantage

Absolute advantage

• A country’s ability to produce a good using fewer resources than the country it trades with.

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Comparative advantage

• A country’s ability to produce a good at a lower opportunity cost than the country with which it trades.

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1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage?• The opportunity cost of producing one bushel of corn in the United States is three barrels of oil.

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1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage?• The opportunity cost of producing one bushel of corn in Mexico is 12 barrels of oil.

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1. In the example of corn and oil trade between the United States and Mexico, what was the United States’ comparative advantage?• The U.S. has a comparative advantage in growing corn because it can do so at a lower opportunity cost than Mexico.

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2. In the example of corn and oil trade between the United States and Mexico, what was Mexico’s comparative advantage?• Using the same process as that used for the U.S., we find that Mexico has a lower opportunity cost for producing oil.

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3. What determines how much each country gains from free trade?• The relative price of the goods being traded.

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EXHIBIT 7 CORN AND OIL CONSUMPTION IN THE UNITED STATES AND MEXICO, UNDER CONDITIONS OF NO TRADE AND FREE TRADE

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Exhibit 7: Corn and Oil Exhibit 7: Corn and Oil Consumption in the United Consumption in the United States and Mexico, Under States and Mexico, Under

Conditions of No Trade and Conditions of No Trade and Free TradeFree Trade1. If a bushel of corn trades for four

barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.?• Mexico must trade 800 barrels of oil with the United States in order to get 200 bushels of corn.

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Conditions of No Trade and Conditions of No Trade and Free TradeFree Trade2. If a bushel of corn now trades for five

barrels of oil, how much of its oil must Mexico keep for itself, and how much must it trade for corn, in order to get 200 bushels of corn from the U.S.?• Mexico must trade 1000 barrels of oil with the United States in order to get 200 bushels of corn.

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Conditions of No Trade and Conditions of No Trade and Free TradeFree Trade

• Mexico is worse off because it must trade an extra 200 barrels of oil just to keep getting 200 bushels of corn from the United States.

3. When the relative price of a bushel of corn rises from four to five barrels of oil, which country is better off and which country is worse off?

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Conditions of No Trade and Conditions of No Trade and Free TradeFree Trade3. When the relative price of a bushel

of corn rises from four to five barrels of oil, which country is better off and which country is worse off? • The United States is better off because it gets an extra 200 barrels of oil for the same 200 bushels of corn it exports to Mexico.

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During the colonial period, European colonial powers used their political power to manipulate trade prices so that most all of the gains from trade were shifted to them.

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Calculating Terms of Calculating Terms of TradeTrade

Imports

• Good and services bought by people in one country that are produced in other countries.

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Exports

• Good and services produced by people in one country that are sold in other countries.

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Terms of trade

• The amount of a good or service (export) that must be given up to buy a unit of another good or service (import). A country’s terms of trade is measured by the ratio of the country’s export prices to its import prices.

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EXHIBIT 8 JAPANESE MOTORCYCLE AND BOLIVIAN TIN EXPORTS

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Exhibit 8: Japanese Exhibit 8: Japanese Motorcycle and Bolivian Motorcycle and Bolivian

Tin ExportsTin Exports

• The price of Japanese motorcycles rises in panel a, while the price of Bolivian tin falls in panel b.

What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?

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Tin ExportsTin Exports

• As a result, Bolivia’s terms of trade equation goes from (6,000/6000) × 100 = 100 in 1987, to (5,000/7,500) × 100 = 66.7 in 1995.

What happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?

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Tin ExportsTin ExportsWhat happens to Bolivia’s terms of trade as a result of the changes shown in panels a and b in Exhibit 8?• Bolivia’s terms of trade have deteriorated. Bolivia’s exports end up with only 67 percent of their former purchasing power.

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EXHIBIT 9 LDC TERMS OF TRADE FOR 2000 (1980 = 100)

Source: Human Development Report, Oxford University Press, 2003.

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Exhibit 9: LDC Terms Exhibit 9: LDC Terms of Trade for 2000 of Trade for 2000

(1980 = 100)(1980 = 100)Which of the countries shown in Exhibit 9 have experienced the smallest deterioration in its terms of trade between 1980 and 2000?• Colombia’s terms of trade declined the least during that time period.

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EXHIBIT 10 TERMS OF TRADE VOLATILITY FOR LDCS: 1990–98 (1995 = 100)

Source: World Development Indicators, 2000, The World Bank.

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Exhibit 10: Terms of Exhibit 10: Terms of Trade Volatilities for Trade Volatilities for

LDCsLDCsWhich of the countries shown in Exhibit 10 experienced the largest gain in their terms of trade during the 1990s?• Guatemala’s terms of trade increased by 20 percent between 1990 and 1998.

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EXHIBIT 11 PERCENTAGE DISTRIBUTION OF EXPORTS TO DEVELOPED, LDCs, AND OTHER ECONOMIES: 2001

Source: Direction of Trade Statistics, Yearbook 2002 (Washington, D.C.: International Monetary Fund, 2002).

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Exhibit 11: Percentage Exhibit 11: Percentage Distribution of Exports to Distribution of Exports to

Developed, LDCs, and Developed, LDCs, and Other Economies: 2001Other Economies: 2001What percentage of exports from

LDCs actually went to other LDCs?a. 26.6 percent

b. 41.5 percent

c. 33 percent

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Exhibit 11: Percentage Exhibit 11: Percentage Distribution of Exports to Distribution of Exports to

Developed, LDCs, and Developed, LDCs, and Other Economies: 1999Other Economies: 1999What percentage of exports from

LDCs actually went to other LDCs?a. 26.6 percent

b. 41.5 percent

c. 33 percent

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Exhibit 12: 2001 Exports Exhibit 12: 2001 Exports and Imports of the Major and Imports of the Major Developed Economies ($ Developed Economies ($

billions)billions)True or false: Japan was the world’s leading exporter among the developed countries in 2001 (measured in $).• False. The United States was the world’s leading exporter.

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Exhibit 13: 2001 U.S. Trade Exhibit 13: 2001 U.S. Trade with Its Major Trading with Its Major Trading Partners ($ billions)Partners ($ billions)

Complete the sentence:

_____ was the United States’ largest trading partner in 2001 (measured in $).

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Exhibit 13: 1996 U.S. Trade Exhibit 13: 1996 U.S. Trade with Its Major Trading with Its Major Trading Partners ($ billions)Partners ($ billions)

Complete the sentence:

Canada was the United States’ largest trading partner in 2001 (measured in $).

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Do We Need Do We Need Protection Against Protection Against

Free Trade?Free Trade?1. What is the national security argument for against free trade?

• Key domestic industries need to be protected so that if war breaks out with our trading partners, we are still able to produce during a time of crisis.

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Free Trade?Free Trade?2. What is the infant-industries argument against free trade?• It takes time for new (“infant”) industries to gain expertise, and during that time it is fair and reasonable to protect those industries from international competition.

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Free Trade?Free Trade?3. How long should infant-industries be protected from free trade?• There is no clear answer, certainly not from the industries being protected. Infant industry protection is easily abused.

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Free Trade?Free Trade?4. If domestic industry is not protected from imports from low-wage countries, who gains and who loses?• Domestic producers and workers in this industry lose, while domestic consumers gain from lower prices.

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Free Trade?Free Trade?Dumping

• Exporting a good or service at a price below its cost of production.

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The Economics of The Economics of Trade Protection?Trade Protection?

Tariff

• A tax on an imported good.

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Exhibit 14: Tariff-Exhibit 14: Tariff-Restricted TradeRestricted Trade

Which of the following occur as a result of a tariff?a. Domestic prices rise.

b. The quantity imported falls.

c. Domestic production increases.

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Exhibit 14: Tariff-Exhibit 14: Tariff-Restricted TradeRestricted Trade

Which of the following occur as a result of a tariff?a. Domestic prices rise.

b. The quantity imported falls.

c. Domestic production increases.

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The Economics of Trade The Economics of Trade Protection?Protection?

Quota

• A limit on the quantity of a specific good that can be imported.

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Exhibit 15: Quota-Exhibit 15: Quota-Restricted TradeRestricted Trade

True or false: Quota protection causes domestic prices to fall and increases the quantity of imported goods.• False. Quota protection increases domestic prices and limits the quantity of imports.

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Negotiating Tariff Negotiating Tariff StructuresStructures

GATT (General Agreement on Tariffs and Trade)• A trade agreement to negotiate reduction in tariffs and other trade barriers and to provide equal and nondiscriminating treatment among members of the agreement.

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World Trade Organization (WTO)

• The successor to GATT. The WTO is the only global international organization dealing with the rules of trade between nations. WTO agreements are ratified by member nations’ parliaments.

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Customs union

• A set of countries that agree to free trade among themselves and a common trade policy with all other countries.

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Free trade area

• A set of countries that agree to free trade among themselves but are free to pursue independent trade policies with other countries.

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EXHIBIT 16 AVERAGE U.S. TARIFF RATES ON IMPORTS

Source: Economic Report of the President, January 1989 (Washington, D.C.: U.S. Government Printing Office, 1989), p. 152.

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Exhibit 16: Average Exhibit 16: Average U.S. Tariff Rates on U.S. Tariff Rates on

ImportsImportsWhat was the average U.S. tariff rate in 1990-93?a. 45.9 percent

b. 25.3 percent

c. 5.9 percent

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Exhibit 16: Average Exhibit 16: Average U.S. Tariff Rates on U.S. Tariff Rates on

ImportsImportsWhat was the average U.S. tariff rate in 1990-93?a. 45.9 percent

b. 25.3 percent

c. 5.9 percent

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