chapter application: international trade

© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Seventh Edition

MacroeconomicsPrinciples of

N. Gregory Mankiw

Application: International Trade

CHAPTER

9

Woj

ciec

h Ge

rson

(183

1-19

01)

Presenter

Presentation Notes

This relatively short chapter has a few main objectives: Welfare analysis of free trade in a good that a country exports, relative to no trade. Welfare analysis of free trade in a good that the country imports, relative to no trade. Welfare analysis of a tariff, relative to free trade in a good the country imports. The most common arguments for restricting imports, and the economist’s response to each.

In this chapter, look for the answers to these questions

• What determines how much of a good a country will import or export?

• Who benefits from trade? Who does trade harm? Do the gains outweigh the losses?

• If policymakers restrict imports, who benefits? Who is harmed? Do the gains from restricting imports outweigh the losses?

• What are some common arguments for restricting trade? Do they have merit?


2© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2

Introduction

Recall from Chapter 3: A country has a comparative advantage in a good if it produces the good at lower opportunity cost than other countries. Countries can gain from trade if each exports the goods in which it has a comparative advantage.

Now we apply the tools of welfare economics to see where these gains come from and who gets them.


3

The World Price and Comparative Advantage PW = the world price of a good,

the price that prevails in world markets PD = domestic price without trade If PD < PW, country has comparative advantage in the good under free trade, country exports the good

If PD > PW, country does not have comparative advantage under free trade, country imports the good

Presenter

Presentation Notes

The notation PW and PD introduced here are not in the textbook.


4

The Small Economy Assumption A small economy is a price taker in world markets:

Its actions have no effect on PW.

Not always true—especially for the U.S.—but simplifies the analysis without changing its lessons.

When a small economy engages in free trade,PW is the only relevant price: No seller would accept less than PW, since

she could sell the good for PW in world markets. No buyer would pay more than PW, since

he could buy the good for PW in world markets.


5

A Country That Exports SoybeansWithout trade,

PD = $4Q = 500

PW = $6 Under free trade, domestic

consumers demand 300 domestic producers

supply 750 exports = 450

P

QD

S

$6

$4

500300

Soybeans

exports

750

Presenter

Presentation Notes

Students may not be aware of the economic importance of soybeans. In fact, soybeans are big business in the U.S. In 2012, Soybeans were grown in more than 30 states. Farmers produced 3.0 billion bushels of soybeans, worth $43 billion. The U.S. earned $19 billion from soybean exports. Source: American Soybean Association, http://www.soystats.com/ Before covering this slide, alert your students that, in just a moment, they will be asked to do some analysis very similar to the analysis shown on this and the following slide. In this case, PD < PW, so this country will export soybeans. The quantity of exports is simply the difference between the domestic quantity supplied and the domestic quantity demanded at the world price.


6

A Country That Exports SoybeansWithout trade,CS = A + BPS = CTotal surplus

= A + B + C

With trade, CS = APS = B + C + DTotal surplus

= A + B + C + D

P

QD

S

$6

$4

Soybeans

exportsA

B D

Cgains

from trade

Presenter

Presentation Notes

Trade benefits soybean producers because they can sell at a higher price. Producer surplus rises by the area B + D. Trade makes domestic buyers worse off because they have to pay a higher price. Consumer surplus falls by the area B. The gains to producers are greater than the losses to consumers, so trade increases total welfare: total surplus rises by the amount D.

A C T I V E L E A R N I N G 1Analysis of trade


Without trade,PD = $3000, Q = 400

In world markets, PW = $1500

Under free trade, how many TVs will the country import or export?

Identify CS, PS, and total surplus without trade, and with trade.

P

QD

S

$1500

200

$3000

400 600

Plasma TVs

Presenter

Presentation Notes

The two preceding slides show students the analysis of trade when the country exports. The next step is to cover the analysis of trade when the country imports the good. Instead of lecturing on this material, I suggest you have students work on this exercise, which asks students to do this analysis themselves. It’s an activity that breaks up the lecture and gives students a chance to apply the techniques you’ve just presented. I suggest you have students work on it in pairs. Give them about 5 minutes, then go over the answers on the following two slides. While students are working, circulate around the room and offer to assist any students who ask for help. This will also give you a sense of how well students are understanding the material. If you prefer to lecture on the material instead, replace these slides with the two “hidden” slides that immediately follow the CHAPTER SUMMARY at the end of this file. You will then have to “unhide” those slides by unselecting “Hide Slide” from the “Slide Show” drop-down menu.

A C T I V E L E A R N I N G 1Answers


Under free trade, domestic

consumers demand 600 domestic

producers supply 200 imports = 400

P

QD

S

$1500

200

$3000

600

Plasma TVs

imports

Presenter

Presentation Notes

PD > PW, so this country will import plasma TV sets from abroad. The quantity of imports is simply the difference between the quantity demanded by domestic consumers and the quantity supplied by domestic firms at the world price.

A C T I V E L E A R N I N G 1Answers


Without trade, CS = APS = B + CTotal surplus

= A + B + C

With trade, CS = A + B + DPS = CTotal surplus

= A + B + C + D

P

QD

S

$1500

$3000

Plasma TVs

A

B D

C

gains from trade

imports

Presenter

Presentation Notes

Trade benefits consumers in this case because it allows them to buy plasma TVs at lower prices, so more consumers can afford plasma TVs if imports are allowed. The gains to consumers appear on the graph as the area (B+D), which represents the increase in consumer surplus when the country allows trade. In this example, trade harms domestic producers because they now must sell their plasma TVs at a lower price. As a result, they produce a smaller quantity, earn less revenue, and likely let go of some of their workers. These losses are represented on the graph by the area B , which represents the fall in producer surplus resulting from trade. As the graph shows, the gains to consumers outweigh the losses to producers: total surplus increases by the amount D, which represents the gains from trade in plasma TV sets.


10

total surplus

producer surplus

consumer surplus

direction of trade

rises

falls

rises

imports

PD > PW

rises

rises

falls

exports

PD < PW

Summary: The Welfare Effects of Trade

Whether a good is imported or exported, trade creates winners and losers. But the gains exceed the losses.


Other Benefits of International Trade Consumers enjoy increased variety of goods.

Producers sell to a larger market, may achieve lower costs by producing on a larger scale.

Competition from abroad may reduce market power of domestic firms, which would increase total welfare.

Trade enhances the flow of ideas, facilitates the spread of technology around the world.


12

Then Why All the Opposition to Trade? Recall one of the Ten Principles from Chapter 1:

Trade can make everyone better off. The winners from trade could compensate the losers

and still be better off.

Yet, such compensation rarely occurs.

The losses are often highly concentrated among a small group of people, who feel them acutely. The gains are often spread thinly over many people, who may not see how trade benefits them.

Hence, the losers have more incentive to organize and lobby for restrictions on trade.

Presenter

Presentation Notes

In December 2005, thousands of protestors gathered outside the meeting place of the World Trade Organization talks in Hong Kong. Some protests turned violent, and police made 900 arrests.


Tariff: An Example of a Trade Restriction Tariff: a tax on imports

Example: Cotton shirtsPW = $20Tariff: T = $10/shirtConsumers must pay $30 for an imported shirt. So, domestic producers can charge $30 per shirt.

In general, the price facing domestic buyers & sellers equals (PW + T ).


14

$30

Analysis of a Tariff on Cotton ShirtsPW = $20

Free trade:buyers demand 80sellers supply 25imports = 55

T = $10/shirtprice rises to $30buyers demand 70sellers supply 40imports = 30

P

QD

S

$20

25

Cotton shirts

40 70 80

importsimports


15

$30

Analysis of a Tariff on Cotton ShirtsFree tradeCS = A + B + C

+ D + E + FPS = GTotal surplus = A + B

+ C + D + E + F + G

TariffCS = A + BPS = C + GRevenue = ETotal surplus = A + B

+ C + E + G

P

QD

S

$20

25

Cotton shirts

40

AB

D EG

FC

70 80

deadweight loss = D + F

Presenter

Presentation Notes

The tariff benefits domestic producers by allowing them to sell for a higher price. Producer surplus increases by C. The tariff makes consumers worse off because they have to pay a higher price. Consumer surplus falls by C + D + E + F. The tariff generates revenue for the government equal to E. The losses from the tariff exceed the gains, so total welfare falls. The tariff reduces total surplus by (D + F).


16

$30

Analysis of a Tariff on Cotton ShirtsD = deadweight loss

from the overproduction of shirts

F = deadweight loss from the under-consumption of shirts

P

QD

S

$20

25

Cotton shirts

40

AB

D EG

FC

70 80

deadweight loss = D + F

Presenter

Presentation Notes

A tariff is a tax. Like the taxes we studied in the preceding chapter, the tariff causes a deadweight loss because it distorts incentives. Here, the tariff causes the economy to devote more resources to a good that could be produced at lower opportunity cost in other countries. This causes a deadweight loss, represented on the graph by the area D. Also, the tariff gives consumers an incentive to purchase a smaller quantity. The result is a deadweight loss (area F on graph).


17

Import Quotas: Another Way to Restrict Trade Import quota: a quantitative limit on imports of a

good. Mostly has the same effects as a tariff: Raises price, reduces quantity of imports. Reduces buyers’ welfare. Increases sellers’ welfare.

A tariff creates revenue for the govt. A quota creates profits for the foreign producers of the imported goods, who can sell them at higher price.

Or, govt could auction licenses to import to capture this profit as revenue. Usually it does not.


Arguments for Restricting Trade

1. The jobs argumentTrade destroys jobs in industries that compete with imports.

Economists’ response:Total unemployment does not rise as imports rise, because job losses from imports are offset by job gains in export industries….

U.S. Imports & Unemployment, Decade averages, 1961–2010

0%

2%

4%

6%

8%

10%

12%

14%

16%19

61-

1970

1971

-19

80

1981

-19

90

1991

-20

00

2001

-20

10

Imports (% of GDP)

Unemployment (% of labor force)

Presenter

Presentation Notes

By using decade averages, the short-term noise and fluctuations average out, which makes the long-term trends easier to see. Unemployment hovers around 6%, while imports keep trending up. Indeed, the period from 1981-2000 sees unemployment fall while imports rise. Note: This data does not appear in the textbook. I include it here because I think it is effective. But it is not supported in the Test Bank or Study Guide, so please feel free to omit this and the preceding slide if you wish. Data source: FRED database, St Louis Federal Reserve, http://research.stlouisfed.org/fred2/ and my calculations. (I constructed imports as a percentage of GDP, then computed simple averages of the two series over each of the decades shown in the graph.)


Arguments for Restricting Trade2. The national security argument

An industry vital to national security should be protected from foreign competition, to prevent dependence on imports that could be disrupted during wartime.

Economists’ response:Fine, if trade restrictions based on true security needs. But producers may exaggerate their own importance to national security to obtain protection from foreign competition.


Arguments for Restricting Trade3. The infant-industry argument

A new industry argues for temporary protection until it is mature and can compete with foreign firms.

Economists’ response:Difficult for govt to determine which industries will eventually be able to compete and whether benefits of establishing these industries exceed cost to consumers of restricting imports. Besides, if a firm will be profitable in the long run, it should be willing to incur temporary losses.


Arguments for Restricting Trade4. The unfair-competition argument

Producers argue their competitors in another country have an unfair advantage, e.g. due to govt subsidies.

Economists’ response:We should welcome imports of low-cost products subsidized by the other country’s taxpayers. The gains to our consumers will exceed the losses to our producers.


Arguments for Restricting Trade5. The protection-as-bargaining-chip argument

Example: The U.S. can threaten to limit imports of French wine unless France lifts their quotas on American beef.

Economists’ response:Suppose France refuses. Then the U.S. must choose between two bad options: A) Restrict imports from France, which reduces

welfare in the U.S.B) Don’t restrict imports, which reduces U.S.

credibility.

Presenter

Presentation Notes

Of course, this argument and response are meant to apply more generally than in the specific example described. But most non-economics majors more easily learn a general concept if they start with a specific, graspable example than with the general concept itself.


Trade Agreements A country can liberalize trade with unilateral reductions in trade restrictions multilateral agreements with other nations

Examples of trade agreements: North American Free Trade Agreement

(NAFTA), 1993 General Agreement on Tariffs and Trade

(GATT), ongoing

World Trade Organization (WTO), est. 1995, enforces trade agreements, resolves disputes

Presenter

Presentation Notes

The WTO website (http://www.wto.org) has useful information, especially the section for students: http://wto.org/english/forums_e/students_e/students_e.htm

Summary

• A country will export a good if the world price of the good is higher than the domestic price without trade. Trade raises producer surplus, reduces consumer surplus, and raises total surplus.

• A country will import a good if the world price is lower than the domestic price without trade. Trade lowers producer surplus but raises consumer and total surplus.

• A tariff benefits producers and generates revenue for the govt, but the losses to consumers exceed these gains.


Summary

• Common arguments for restricting trade include: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.

• Some of these arguments have merit in some cases, but economists believe free trade is usually the better policy.


chapter application: international trade

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