chapter 1 through 10

Economics of International Trade

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Midterm Examination Review

What’s on the Midterm Exam?

• Content From Chapters 1 through 9 and Possibly 10

• Analysis of Midterm Exams from 2005 to 2009 Shows the Following Topics (see

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2009 Shows the Following Topics (see next slide):

Topics in Previous Midterm Exams:Absolute Advantage Nontariff Barriers

Comparative AdvantageAcceptable and Unacceptable Arguments for Trade Barriers

Ricardian Model New and Advanced Trade Theories

Heckscher-Ohlin Model Small Country Vs Large Country

General Equilibrium

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General Equilibrium Framework Nominal Rate of Protection

Standard Trade Model Effective Rate of Protection

Partial Equilibrium Analysis Different Kinds of Trade Blocs

General Equilibrium Analysis Customs Union

Tariffs; Seven effects of a Tariff Import Substitution

What is the Exam Format?

• 3 Hours Long, 3 Sections –A, B and C• Section A – Short Answer, Choose One Question from 4 or 5; 10% 0f the Grade

• Section B – Two Questions, You Must

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• Section B – Two Questions, You Must Answer Both of them; 30% of Grade

• Section C – Two Long Essay Questions Two Questions, You Must Answer Both; 60% of Grade

Test Taking Strategy

• Budget Your Time! Many students spend too much time on one question in section A or B and run out of time for Section C.

• Be sure to write some kind of answer for

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• Be sure to write some kind of answer for every question – don’t leave any question blank

• When you first open the exam, quickly look through it for questions in A, B and C that are similar topics.

IELTS Test Skills

The Midterm Exam is also a test of writing ability. If you studied for the IELTS, Remember the writing and time budgeting skills you may have learned. Skills you learned for Writing Task 1 and Writing Task 2 Questions are often useful for Section A

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Task 2 Questions are often useful for Section A and Section B questions on the exam: – Writing Task 1 Problems – 150 Words in 20 Minutes– Writing Task 2 Problems – 250 Words in 40 Minutes

• Section C Questions require longer essay answers

Answering Exam Questions

Follow the Pattern of Explain and Discuss.• First, Explain. Show that you know what the question is about. For example if you are writing about Customs Union, define

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are writing about Customs Union, define what a Customs Union is.

• Use Diagram or Simple Algebra Wherever Possible to Answer Questions.

• It is Possible to get a Passing Mark by explaining well a model or theory.

Answering Exam Questions, Cont’d

Explain and Discuss – Continued:Discuss: After you have explained the basic idea, write about:

• The strengths and weaknesses – the

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• The strengths and weaknesses – the good and bad points. Critical Evaluation.

• Evaluation of the Assumptions.• How Realistic is the theory or model?• Try to Provide at least 3 supporting facts or reasons, especially in Section C.

INTERNATIONAL TRADE

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INTERNATIONAL TRADE THEORY

What makes International Economics different?

• International Economics Consists Of Issues Arise From Problems of Economic Interaction between Sovereign States.

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• It’s Relations Differ from Interregional Economics (Different Parts of the Same Nation) Requiring It to Use Different Tools of Analysis and Justifying Its Existence as a Distinct Branch of Economics.

Concerns of International Economics

• Trade and investment occur between independent nations

• Country’s policies/restrictions disrupt trade and limit imports

• Foreign exchange fluctuations affect the relative prices

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• Foreign exchange fluctuations affect the relative prices of countries imports and exports

• Also, international flows of goods, services and resources give rise to payments and receipts in foreign currencies, which change in value over time.

• International flows may be hampered by differences in languages, customs, and laws

CHAPTER 2: THE LAW OF COMPARATIVE ADVANTAGE

• Why do countries trade?• The Mercantilists Views on Trade – 17th & 18th Centuries

• Adam Smith’s Absolute Advantage Trade

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• Adam Smith’s Absolute Advantage Trade Theory – 18th Century

• Absolute Advantage is the greater efficiency that one nation may have over another in the production of a commodity

• Refer to Transparency – Table 2.1

David Ricardo’s Comparative Advantage Trade Theory

• Comparative Advantage is when a Nation 1 has absolute advantage in both commodities but has comparatively greater advantage in producing good A over than good B. As long as Nation 2 comparative advantage is in the good B for which

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comparative advantage is in the good B for which Nation 1 has comparative disadvantage, but nations can still gain from specialisation and trade.

• The concept of Absolute Advantage is concerned with differences between actual efficiency of production.

• The concept of Comparative Advantage is about the relative efficiency of production.

Ricardo’s Assumptions:1. Two Nations and Two Commodities2. Free trade3. Perfect mobility of labour within each nation

but immobility between nations4. Constant Costs of Production

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4. Constant Costs of Production5. No transport costs6. No technical change, and7. The labour theory of value

• See Table 2.2, Table 2.3

Comparative Advantage: Opportunity Costs

• Law of Comparative Cost• 1939 by Haberler • Opportunity Costs• (Constant Cost) and Relative Prices –

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• (Constant Cost) and Relative Prices –

Comparative Advantage: Opportunity Costs -Cont’d

• Assumptions one to six can be easily relaxed but assumption #7 (Labor Theory of Value) is not valid and should not be used to explain comparative advantage.

• Production Possibility Frontier (PPF)

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• Production Possibility Frontier (PPF) demonstrates the alternative combinations of the two commodities that a nation can produce by fully utilising all of its resources with the best available technology.

Comparative Advantage: Opportunity Costs -Cont’d

MRT Opp cost for Wheat

Relative price for Wheat

OppCost for Cloth

Relative price for Cloth

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Wheat Wheat Cloth Cloth

USA 120/180 =2/3

6/4 = 1.5

Pw/Pc = 2/3

4/6 = 2/3

Pc/Pw = 1.5

UK 120/60 = 2

1/2 Pw/Pc = 2/1=2

2/1 = 2 Pc/Pw = 1/2

Comparative Advantage: Opportunity Costs CONT’D

• The difference in relative commodity prices between two nations is a reflection of their comparative advantage and provides the basis for mutually beneficial trade.

• The equilibrium-relative commodity price with trade is the common relative price in both nations at which trade is balanced: Nation 1 Price = Nation 2 Price

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balanced: Nation 1 Price = Nation 2 Price

• Figure 2.2: Trade Under Constant Cost

• Figure 2.3: Equilibrium-Relative Commodity Prices with Demand and Supply

• Small-Country Case with Constant Costs

Empirical Tests of the Ricardian Model

• Empirical Tests of the Ricardian Model by MacDougall in 1951

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Figure 2.4 – Relative Labor Productivities and Comparative Advantage

CHAPTER 3: THE STANDARD THEORY OF INTERNATIONAL

TRADE

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TRADE

The Production Frontier with Increasing Costs

• Increasing opportunity costs mean that the nation must give up more and more of one commodity to release just enough resources to produce each additional unit of another commodity.

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• The marginal rate of transformation (MRT) of X for Y refers to the amount of Y that a nation must give up to produce each additional unit of X. since the PPF is concave, it represents increase opportunity cost as one more down the PPF.

Community Indifference Curves (3.3A)

• The Indifference Curve represents all combinations of market baskets that provide a consumer with the same level of satisfaction.

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• Equilibrium in Isolation (Autarky) and with Trade

• Figure 3.3: Equilibrium in Isolation

Salvatore: International Economics, 8th Edition © 2004 John Wiley & Sons, Inc.

FIGURE 3-3 Equilibrium in Isolation.

Revealed (Real World) Comparative Advantage (3.4B)

• Case Study 3-1 shows the revealed comparative advantage

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Gains from Trade with Increasing Costs (3.5)

• Figure 3.4: The Gain from Trade with Increasing Costs

• Differences between Constant Costs and

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• Differences between Constant Costs and Increasing Costs

• Small-Country Case with Increasing Costs(3.5D)


FIGURE 3-4 The Gains from Trade with Increasing Costs.

Gains from Exchange and from Specialization

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FIGURE 3-5 The Gains from Exchange and from Specialization.

Trade Based on the Differences in Tastes (3.6A)

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FIGURE 3-6 Trade Based on Differences in Tastes.

CHAPTER 4: DEMAND AND SUPPLY, OFFER CURVES, AND

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SUPPLY, OFFER CURVES, AND THE TERMS OF TRADE

DEMAND AND SUPPLY, OFFER CURVES, AND THE TERMS OF

TRADE

The Equilibrium-Relative Commodity Price with Trade – Partial Equilibrium Analysis

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with Trade – Partial Equilibrium Analysis• Figure 4.1: The Equilibrium-Relative Commodity Price with Trade with Partial Equilibrium Analysis


FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade with Partial Equilibrium Analysis.

The Offer Curve (4.3)• Offer Curve (reciprocal demand curve) shows how much of its import commodity the nation demands for it to be willing to supply various amounts of its export commodity.

• The Offer curve shows a nations’s willingness

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• The Offer curve shows a nations’s willingness to import and export at different commodity prices.

• The Offer Curve can also be derived from a Nation’s PPF, its indifference maps, and the various hypothetical commodity prices where trade could take place.

Derivation of Offer Curves

• Figures 4.3 & 4.4: Derivation of the Offer Curves of Nations 1 & 2

• The Equilibrium-Relative Commodity Price with Trade – General Equilibrium Analysis

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with Trade – General Equilibrium Analysis• Figure 4.5: Equilibrium-Relative Commodity Price with Trade

• Figure 4.6: Equilibrium-Relative Commodity Price with Partial Equilibrium Analysis



FIGURE 4-3 Derivation of the Offer Curve of Nation 1.



FIGURE 4-4 Derivation of the Offer Curve of Nation 2.

Equilibrium-Relative Commodity Price with Trade


FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade.

Equilibrium-Relative Commodity Price with Partial Equilibrium Analysis


FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial Equilibrium Analysis.

The Terms of Trade (4.6)• In a world with two-nations and two commodities situation, the Terms of Trade of a nation is defined as the ratio of the price of its export commodity to the price of its import commodity – the relative trading prices.

• Generally with many nations and commodities, the

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• Generally with many nations and commodities, the terms of trade of a nation (commodity or net barter terms of trade) are given by the ratio of the price index of its exports to the price index of its imports multiplied by 100 to express it as a percentage.

• Case Study 4-3 – Terms of Trade of the G-7 Nations• Case Study4-4 – Terms of Trade of Industrial and Developing Countries for selected years: 1972 0 2001.

CHAPTER 5: FACTOR ENDOWMENTS AND THE

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ENDOWMENTS AND THE HECKSCHER-OHLIN THEORY

Assumptions

We will extend the trade model in two directions:

• To identify the basis for – what determines- comparative advantage

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• To examine the effect of international trade has on the earnings of factors of production in two trading nations – earnings of labour and cause for the international differences in earnings.

• 11 Assumptions, (5.2A)

Factor Intensity, Factor Abundance, and the Shape of the Production Frontier (5.3)

• Factor Intensity (5.3A): commodity Y is capital intensive if the capital-labour ratio K/L used in the production of Y is greater the K/L used in the production of X.

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the K/L used in the production of X.• For Examples:• To produce 1Y requires 2K & 2L (2/2 = 1)• To produce 1X requires 1K & 4L (1/4 = ¼ ) • To produce 1X require 3K & 12L (3/12 = ¼ )

Factor Intensity

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• Figure 5.1: Factor Intensity for Commodity X and Y in Nations 1 2

FIGURE 5-1 Factor Intensities for Commodities X and Yin Nations 1 and 2.

Factor Intensity

Nation 1 Nation 2Commodity

Y (K/L)1 4

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Y (K/L)

Commodity X (K/L)

¼ 1

Labour Intensive

Capital Intensive

What happen if the relative price of capital falls?

• K-Intensity refers to the ratio in terms of the technology K/L used in the production process.

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Factor Abundance (5.3B)

Two ways to define factor abundance• In terms of physical units – overall amount of capital and labour available in the nation. This definition considers only

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nation. This definition considers only the supply of factors.

• Physical K-Abundance refers to the physical amount of capital/labour ratio used in the production process.

Factor Abundance (5.3B) Cont’d

In terms of relative factor prices– rental price of capital & price of labour time in each nation.

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• This definition considers both the supply and the demand of factors under perfect competition. Also, the demand for a factor of production is a derived demand from the final commodity that requires it in the production process.

Factor Abundance (5.3B) Cont’d

• K-Abundance in terms of relative prices refers to the ratio of capital/labour in terms of costs (r/w) used in the production process.

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process.

Factor Endowments and the Shape of the PPF (5.3C)

• Figure 5.2: The Shape of the Production Frontier of Nation 1 & 2 (same as Fig 3.1)

• Case Study 5-1: Relative Resource Endowments of Various Countries and

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Endowments of Various Countries and Regions

• Case Study 5-2: Capital-Labour Ratios of Selected Countries


FIGURE 5-2 The Shape of the Production Frontiers of Nation 1 and Nation 2.

Factor Endowments and the Heckscher-Ohlin Theory (5.4)

The Heckscher-Ohlin Theory can be presented in the form of two theorems:

• The Heckscher-Ohlin Theorem – deals with and predicts the pattern of trade

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with and predicts the pattern of trade• Factor-Price Equalization Theorem – deals with the effect of international trade on factor prices.

• In addition, Theorem 2 holds only if 1 holds.

The Heckscher-Ohlin Theorem (5.4A)

• Figure 5.3: The General Equilibrium Framework of the Heckscher-Ohlin Theory

• Figure 5.4: The Heckscher-Ohlin Model

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• Figure 5.4: The Heckscher-Ohlin Model

• Now compare Fig. 5.4 with Fig. 3.4

Figures 5-4 and 3-4


FIGURE 5-4 The Heckscher-Ohlin Model.

FIGURE 3-4 The Gains from Trade with Increasing Costs.


FIGURE 5-3 General Equilibrium Framework of theHeckscher-Ohlin Theory.


FIGURE 5-4 The Heckscher-Ohlin Model.

Principle of H-O theorem:

• It requires that if tastes differ, they do not differ sufficiently to neutralize the tendency of different factor endowments and production possibility in the two nations.

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• Case Study 5-3: examines the Pattern of revealed Comparative Advantage and disadvantage of Various Countries or Regions.

Factor-Price Equilization and Income Distribution (5.5)

• Heckscher-Ohlin-Samuelson (H-O-S)• Proven by Paul Samuelson

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The H-O-S Theorem

• “International trade will bring about equalization in the relative and absolute returns to homogeneous factors across nations.”

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nations.” • Thus, international trade is a substitute for international mobility of factors.

• Figure 5.5: The Relative Factor-Price Equalization


FIGURE 5-5 Relative Factor–Price Equalization.

Absolute Factor-Prices Equalization

• Means that free international trade also equalizes the real wages for the same type of Labour and the real rate of interest for same type of Capital in the two nations.

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for same type of Capital in the two nations.

Absolute Factor-Prices Equalization, Cont’d

• Trade operates on the demand for factors• Factor mobility operates on the supply of factors

• International trade causes real

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• International trade causes real wages/income of labour to fall in a capital-abundant and labour-scarce nation (USA),

If So, Shouldn’t U.S., the EU, and Japan Restrict Trade?

• If international trade causes real wages/income of labour to fall in a capital-abundant and labour-scarce nation (USA), shouldn’t they have trade restrictions?

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• No, because the loss that trade causes in those countries is less than the gain received by owners of capital. Appropriate taxes on owners of capital and subsidies for labor can bring benefit to both factors from international trade.

The Specific-Factors model (5.5D)

Says that trade will:• Have an ambiguous effect on the nation’s mobile factors.

• Benefit the immobile factors specific to the

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• Benefit the immobile factors specific to the nation’s export commodities or sectors.

• Harm the immobile specific factors to the nation’s import-competing commodities or sectors.

Empirical Relevance of Factor-Price Equilibrium

Theorem- H-O-S

• Has international trade equalized the returns to homogeneous factors in different nations in the real world?

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different nations in the real world? • If it has not, why?• Because the many simplifying assumptions of the model are true, do not hold in the real world…. Identical technology, no transportation costs, etc.

Empirical Test of the Heckscher-Ohlin Model - Leontief (1951)

Assumption: USA most K-abundant nation in the world↓

Expect to find that USA K/L estimates↓

Exported - K-intensive goods and

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Exported - K-intensive goods andImported - L-intensive good

Data used: Input-Output table for 1947↨

RESULT↓

Exports less K-intensive than Imports by 30%LEONTIEF PARADOX

LEONTIEF PARADOX

Leontief Rationalization• Leontief attempted to explain the Paradox by Saying that in 1947 USA was really an L-Intensive country

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L-Intensive country• This Explanation was Not Acceptable and Leontief withdrew it

Factor-Intensity ReversalFactor-intensive reversal (5.6C) • An exception to the H-O and Factor-Price

Equalization Theorem• is when a given commodity is L-intensive in the L-abundant nation AND K-intensive in the K-abundant nation.

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abundant nation AND K-intensive in the K-abundant nation.

• This causes factor-price equalization theorem to fail

• Empirical evidence is that Factor-Intensity Reversal does Happen But is Rare, Unusual.

• Because it is a rare exception, the H-O theory can is Not Invalidated.

CHAPTER 6: ECONOMIES OF SCALE, IMPERFECT COMPETITION, AND

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COMPETITION, AND INTERNATIONAL TRADE

The Heckscher-Ohlin Model and New Trade Theories (6.2)

Relaxing Most of the Assumptions of the H-O models does not affect its validity.

However 3 assumptions require more

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However 3 assumptions require more attention:

• Constant economies of Scale • Perfect Competition • Technological change.

The Heckscher-Ohlin Model and New Trade Theories - Cont’d

Complementary Theories for Constant Economies of Scale and Perfect Competition

• New trade models which take into account

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• New trade models which take into account Economies of Scale and Imperfect Competition can be seen as complementary to, or extensions of, the H-O theory as they explain something about international trade that is not covered by the basic H-O theory.

The Heckscher-Ohlin Model and New Trade Theories - Cont’d

Differences in Technology Between Nations can be Accommodated by the H-O theory.

• However, technological change – not just

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• However, technological change – not just differences in technology requires new theories such as the technological gap and the product cycle models, and these are covered in section 6.5

Economies of Scale and International Trade (6.3)

• Figure 6.1: Trade Based on Economies of Scale

• International economies of scale refer to the reduction in the average costs of production as the firm’s output expands –

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production as the firm’s output expands –remaining internal to the firm.

• External economies refer to the reduction in each firm’s average costs of production as the entire industry output expands –for reasons external to the firm.


FIGURE 6-1 Trade Based on Economies of Scale.

Imperfect Competition and International Trade (6.4)

• Trade Based on Product Differentiation (6.4A) – Intra-Industry Trade Models by Helpman, Krugman, Lancaster and others in 1979

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in 1979

• Case Study 6-2: U.S. Intra-Industry Trade in Automotive Products

Formal Model of Intra-Industry trade (6.4C)

• Figure 6.2: Production and Pricing Under Monopolistic Competition - Firm Analysis

• Monopolistic Competition

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FIGURE 6-2 Production and Pricing Under Monopolistic Competition.

Relationship of the inter-industry and intra-industry trade

• Figure 6.3: Monopolistic Competition and Intra-Industry Trade – Industry Analysis

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FIGURE 6-3 Monopolistic Competition and Intra-Industry Trade.

Trade Based on Dynamic Technological Differences (6.5)

Note that Trade based on Differences in Technology Can Be Seen to Fall within the H-O Model. The basic H-O model can accommodate them. Changes in Technology Require new Models:

Technological Gap and Product Cycle Models• According to the Technological Gap Model, trade among industrialized nations is based on the introduction of new

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industrialized nations is based on the introduction of new products and new production processes – emphasizing time lag in the imitation process.

• The Product Cycle Model is when a new product is introduced which requires skilled labour to produce, as the product matures and standardized, it can be produced by mass production technique and less skilled labour – emphasizing the standardization process.

Illustration of the Product Cycle Model (6.5B)

• Figure 6.4: The Product Cycle Model• Technological diffusion, Standardization, and Lower costs abroad bring an end to the product life cycle. Diffusion lags of new

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product life cycle. Diffusion lags of new technologies in recent years are decreasing –compressing the product life cycle.

• Solution: introduction of new innovative products by the advanced nation.

Product Cycle Model (6.5B)


FIGURE 6-4 The Product Cycle Model.

Costs of Transportation, Environmental Standards, and

International Trade (6.6)• Non-Trade Goods and Services.• Transport Costs are Much Higher for Developing Countries

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Developing Countries• Industries Classifications:– Resource Oriented– Market Oriented– Footloose Industries

Unit 2 INTERNATIONAL TRADE

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Unit 2 INTERNATIONAL TRADE POLICY

CHAPTER 8: TRADE RESTRICTIONS: TARIFFS

• Restrictions and regulations on the free flow of trade or commerce are known as trade or commercial policies.

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• Nominal Tariff on Imports of a Final Commodity:

Partial Equilibrium Analysis of a Tariff

• Figure 8.1: Partial Equilibrium Effects of a Tariff

• Figure 8.2: Effect of a Tariff on Consumer and Producer Surplus

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and Producer Surplus• Figure 8.3: Partial Equilibrium Costs and Benefits of a Tariff


FIGURE 8-1 Partial Equlibrium Effects of a Tariff.


FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.


FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.

Effects of a Tariff

• Consumption Effect• Production Effect Trade/Import Studies 8-1 and 8-2

• Case Study 8-2: The Welfare Effect of

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• Case Study 8-2: The Welfare Effect of Liberalizing Trade in Some U.S. Products

• Case Study 8-3: The Welfare Effect of Liberalizing Trade in Some E.U. Products


FIGURE 8-1 Partial Equlibrium Effects of a Tariff.


FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.


FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.

The Seven Effects of a Tariff

• Consumer• Production Effect• Trade/Import Effect• Consumer Surplus

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• Consumer Surplus• Producer Surplus• Revenue Effect• Deadweight Loss/Protection Cost

Effects of a TariffConsumptionEffect

ProductionEffect

Trade/ImportEffect

ConsumerSurplus

ProducerSurplus

Revenue Effect

Deadweight loss

PartialEquilibr

Reducefrom AB

Increase from

Reducefrom CB

Reduction

Increase by

Collection of

CJM +BHN

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EquilibriumEffects

from ABto GH

e fromAC toGJ

from CBto JH

ionfromARB toGRH

se byAGJC

on ofMJHN

BHN

Costs &BenefitsEffects

-20X +10X -30X $60 $15 $30 $15

The Rate of Effective Protection (8.3A)

• When a Country Imports a material, which is the input for another some final product with zero tariff or a lower tariff than on the importation of the final product.

• Example: Import Tariff on Wool is zero but importation of Cloth made from Wool has a Tariff ,

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importation of Cloth made from Wool has a Tariff , of perhaps 5 %.

• Cascading Tariffs• Domestic value added equals the price of the

final commodity minus the cost of the imported inputs went into the production of the commodity.


FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff Structure in Industrial Countries.

The Rate of Effective Protection (8.3A)

Rate of effective protection is calculated on the domestic value added or processing, that takes place in the

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processing, that takes place in the nation exceed the nominal tariff rate.

• Nominal Tariff Rate is calculated on the value of the final commodity.

The Rate of Effective Protection (8.3A) - Cont’d

The Rate of Effective Protection formula:g = t – aiti / 1 – ai• Case Study 8-5: U.S. Rising Tariff Rates with Degree of Domestic Processing

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with Degree of Domestic Processing• Case Study 8-6: Structure of Tariffs on Industrial Products in the United State, the European Union, Japan and Canada

General Equilibrium Analysis of a Tariff - Small Country (8.4)

• Stolper-Samuelson Theorem states that the increase in the relative price of a commodity (tariff) raises the return or earnings of the factor used intensively

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earnings of the factor used intensively in the production of the commodity.

General Equilibrium Analysis of a Tariff - Large Country

• Figure 8.6: General Equilibrium Effects of a Tariff in a Large Country

• Metzler Paradox: Cases when Px/Py falls for individual producer and consumers

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for individual producer and consumers after a nation impose a tariff and w will fall.


FIGURE 8-6 General Equilibrium Effects of a Tariffin a Large Country.

The Optimum Tariff and Retaliation

101FIGURE 8-7 The Optimum Tariff and Retaliation

CHAPTER 9: NON-TARIFF TRADE BARRIERS AND THE

NEW PROTECTIONISM

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NEW PROTECTIONISM

NON-TARIFF TRADE BARRIERS AND THE NEW PROTECTIONISM

• Voluntary Export Restraints (VERs):• Technical, Administrative, and Other

Regulations:

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Regulations: • International Cartels• Dumping• Export Subsidies

Comparison of an Import Quota to an Import tariff

• Quota is direct quantitative restrictions on the amount of a commodity allow to be imported or exported.

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• Figure 9.1: Partial Equilibrium Effects of an Import Quota

Comparison of Import Quota to Import Tariff

• With a given import quota, an increase in demand will result in a higher domestic price and greater domestic production than with an equivalent import tariff. However, with a given import tariff, an

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However, with a given import tariff, an increase in demand will leave the domestic price and domestic production unchanged but will result in higher consumption and imports than with an equivalent import quota.

Comparison of Import Quota to Import Tariff – Cont’d

• Quotas involve import licenses, and if the government does not auction these off in a competitive market, the companies that have the licenses will receive monopoly profits.

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• Such choices may be made arbitrarily by officials.

• Companies participate in lobbying, and even bribery to get the licenses, also known as “rent seeking activities”.


• Thus import quotas not only replace market mechanism but also result in waste from the point of view of the economy as a whole and contain the seeds of corruption.

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• An import quota limits imports to the specified level with certainty, while a tariff’s effect is uncertain. The reason is that the elasticity of supply and demand often unknown, making it difficult to estimate the import tariff required to restrict imports to a desired level.


• Furthermore, foreign exporters may absorb all or part of the tariff by increasing their efficiency or accepting lower profits. Exporters cannot do this with an import quota since quantity of imports is clearly

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quota since quantity of imports is clearly specified. For this reason domestic producers prefer quotas to tariffs. However, since quotas more restrictive than tariffs, society should resist these efforts.


FIGURE 9-1 Partial Equilibrium Effects of an Import Quota.

Export Subsidies

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FIGURE 9-2 Partial Equilibrium Effect of an Export Subsidy.

Voluntary Export Restraints (VERs)

• Economic Effects of a Quota–Except Revenue is captured by Foreign Exporters

• Case Study 9-2: Voluntary Export

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• Case Study 9-2: Voluntary Export Restraints on Japanese Automobiles to the United States

Technical Administrative and Other Regulations

• 9.3C International Cartels: OPEC• OPEC had influence on the price of oil in the 1970’s but not so much anymore.

• Cartels are Inherently Unstable and often

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• Cartels are Inherently Unstable and often Collapse and Fail

Cartels

• 9.3C International Cartels: OPEC• Cartels are Inherently Unstable and often Collapse and Fail

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Technical Administrative and Other Regulations

• 9.3C International Cartels: OPEC• Cartels are Inherently Unstable and often Collapse and Fail

• OPEC appeared to be able to control

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• OPEC appeared to be able to control prices in the 1970’s.

• However during 1980’s and 90’s More Countries Started Producing oil and Petroleum Prices dropped.

Dumping

• Export of a Commodity at Below Cost• Figure 9.5: International Price Discrimination

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• Case Study 9-3: Antidumping Measures in Force in 2004


FIGURE 9-5 International Price Discrimination.

Export Subsidies:

• Refer to Figure 9.2: Partial Equilibrium Effect of an Export Subsidy

• Case Studies 9-3 and 9-4: Agriculture

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• Case Studies 9-3 and 9-4: Agriculture Subsidies and Countervailing Duties


FIGURE 9-2 Partial Equilibrium Effect of an Export Subsidy.

The Political Economy of Protectionism: Arguments for

Protection Fallacious: • Needed to Protect Domestic Labor Against Cheap Foreign Labor.

• Scientific Tariff

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• Scientific Tariff• Protection Reduces Domestic Unemployment.

• Protection is a Cure for Balance of Payments Deficit.

• Beggar-thy-Neighbor Arguments

Arguments for Protection – II

Questionable Arguments for Protection: • Infant Industry– To be valid the return when the industry grows up would have to high enough to offset the

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up would have to high enough to offset the higher prices paid by consumers during the infant industry period.

– Protection, Once Given, is Difficult to Remove.

– Difficult to choose which industry– Production Subsidy is a better solution

Arguments for Protection – III

Acceptable Economic Arguments• Optimal Tariff (Discussed in Section 8.6)– If a Nation is Large Enough –However an Optimal Tariff Invites

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–However an Optimal Tariff Invites Retaliation

Arguments for Protection – II

Questionable Arguments for Protection: • Infant Industry• Protection, Once Given, is Difficult to Remove

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Remove

Arguments for Protection – III

Acceptable Economic Arguments• Optimal Tariff (Discussed in Section 8.6)– If a Nation is Large Enough –However an Optimal Tariff Invites

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–However an Optimal Tariff Invites Retaliation

Who Gets Protected?

• The Well Organized and Politically Represented.

• Case Study 9-7: Economic Effects on the U.S. Economy of Removing All Import

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U.S. Economy of Removing All Import Restraints

Strategic Trade and Industrial Policies (9.5A)

Strategic Trade Policy: • A nation can create a comparative advantage – through temporary trade protection, subsidies, tax benefits, and

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protection, subsidies, tax benefits, and cooperative government-industry programs – in fields such as semiconductors, computers, telecommunications and other industries

– similar to infant-industry argument.

Game Theory (9.5B):Airbus

Produce Don’t Produce

Boeing Produce -10, -10(million) *

100 million ***

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Free trade may be sub-optimal In theory but it is optimal in practice.

Don’t Produce 100 million ** 0, 0 ****

The U.S. Response to Foreign Industrial Targeting and

Strategic Trade Policies (9.5c)

Some Examples:• The United States has retaliated again countries that adopted policies that were

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countries that adopted policies that were detrimental to US economics interests:– Sematech

The U.S. Response (9.5c) - II

The US has taken Unilateral Steps to force Foreign Markets to Open to US exports, and has retaliated with restrictions of its own against nations that failed to respond:

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own against nations that failed to respond:• 1991 Semiconductor Agreement with Japan

The U.S. Response (9.5c) - III

• In 1998 and 1999 the US imposed Anti-dumping Duties on Steel Imports from Russia, Brazil, Japan and China – which the WTO ruled as Illegal. The US removed

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the WTO ruled as Illegal. The US removed the them in 2003.

• US has demanded reduction of Subsidies granted to Airbus by the Governments of France, Germany, England and Spain.

The History of U.S. Commercial Policy (9.6):

• Smoot-Hawley Act of 1930 – Increased Average Import Duty (Tariff) to 59%

• Foreign Retaliation by more than 60 Countries

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Countries• Trade Agreement Act of 1934 – Tariffs reduced up to 50%

• Introduced the Most Favored Nation (MFN) Principle

The Uruguay Round and Outstanding Trade Problems

Section 9.7:• Tariffs on Inustrial products to be reduce to and average of 3%

• Share of goods with zero tariff to increase to 40 -45 %

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to 40 -45 %• WTO to Replace GATT ( #10)• Collapse of the Doha Round

CHAPTER 10: ECONOMIC INTEGRATION

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INTEGRATION

CUSTOMS UNIONS AND FREE TRADE AREAS

Trading BlocsLowerTariffsamongMembers

Free TradeamongMembers

CommonExternalTariff

FreeMovement ofFactors ofProduction

Harmonisation ofeconomic,legal andsocial policies

Organisations

PreferenceArea

X PreferenceScheme

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Free TradeArea

X EFTA,NAFTA)

CustomsUnion

X X EU prior to1992Mercosur

CommonMarket

X X X EU (1992)and

EconomicUnion

X X X X Objective ofthe EU

Theory of the Second Best

• Economic Integration refers to the commercial policy of discriminatively reducing or eliminating trade barriers only among the nations joining together.

• Are such trade arrangements preferable to free

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• Are such trade arrangements preferable to free trade, or not?

• The Theory of the Second Best says that if it is not possible to achieve all the conditions for optimality, and then the next best option is not necessarily to achieve just some of them.

Trade Creation & DiversionThe static, partial equilibrium effects of customs

unions are measured in terms of trade creation andtrade diversion.

• Trade Creation – Refer to Figure 10.1: A Trade-Creating Customs

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– Refer to Figure 10.1: A Trade-Creating Customs Union

• Trade Diversion – Refer to Figure 10.2: A Trade-Diverting Customs

Union– Refer to Transparency Figure 10.0: UK Market For

Imported Cars

Why Form a Customs Union ?

• Conditions More Likely to Lead to Increased Welfare with Customs Union (10.4B)

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(10.4B)• Dynamic Benefits & etc (10.50• Some History (10.6)

chapter 1 through 10

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