Chapter 8


Welcome to the chapter 8 lecture about International
Trade. This chapter will introduce several new models, as well as the impact of trade
on consumer and producer surplus. The chapter finishes with a discussion about current trade
policy in the United States. Let’s start with a few definitions. Goods
and services purchased from other countries are imports; goods and services sold to other
countries are exports. Globalization is the phenomenon of growing economic linkages among
countries. To understand why international trade occurs and why economists believe it
is beneficial to the economy, we will first review the concept of comparative advantage. A country has a comparative advantage in producing
a good or service if the opportunity cost of producing the good or service is lower
for that country than for other countries. The Ricardian model of international trade
analyzes international trade under the assumption that opportunity costs are constant. Autarky
is a situation in which a country cannot trade with other countries. The next slide shows
hypothetical production possibility frontiers for the United States and Mexico. We assume
that: (1) there are only two goods (auto parts and airplanes) and (2) the production possibility
frontiers are straight lines. Since the PPF is a straight line, opportunity cost is constant. The U.S. opportunity cost of each bundle of
auto parts in terms of airplanes is 2: 2 airplanes must be forgone for every additional bundle
of auto parts produced. The Mexican opportunity cost of each bundle of auto parts in terms
of airplanes is 0.5: only 0.5 of an airplane must be forgone for every additional bundle
of auto parts produced. So Mexico has a comparative advantage in auto parts and the United States
has a comparative advantage in airplanes. In autarky, CUS is the U.S. production and
consumption bundle and CM is the Mexican production and consumption bundle. We can also set up an opportunity cost table
showing the same information from the production possibility frontiers. The U.S. opportunity
cost for 1 bundle of auto parts in 2 airplanes and the opportunity cost for 1 airplane is
½ bundle of auto parts. The Mexican opportunity cost of 1 bundle of auto parts is ½ airplane
and the opportunity cost of 1 airplane is 2 bundles of auto parts. The Ricardian model of international trade
shows that trade between two countries makes both countries better off than they would
be in autarky—that is, there are gains from trade. The following tables and figures illustrate
that specialization has the effect of increasing total world production of both goods and that
each country can consume more of both goods than it did under autarky. When the United States and Mexico do not trade
with one another, production and consumption will be the same for both countries. Take
a minute to pause the lecture and review the table. When the United States and Mexico specialize
in the production of the good in which they have the comparative advantage, total production
increases. Again, take a minute to pause the lecture and review the table. Trade increases world production of both goods,
allowing both countries to consume more. Here, each country specializes its production as
a result of trade: the United States produces at QUS and Mexico produces at QM. Total world
production of airplanes has risen from 1,500 to 2,000 and of auto parts from 1,500 bundles
to 2,000 bundles. The United States can now consume bundle C′ US, and Mexico can now
consume bundle C′ M—consumption bundles that were unattainable without trade. This table summarizes our findings and confirms
that there are gains from trade. 250 more bundles of auto parts and 250 more airplanes
are produced when the United States and Mexico specialize and trade. Sources of Comparative Advantage. The main
sources of comparative advantage are: international differences in climate. For
example: winter deliveries of Chilean grapes to the United States. We are able to enjoy
many different fruits and vegetables during the Winter due to trade with Chile. Differences
in technology. And, differences in factor endowments. The relationship between comparative
advantage and factor availability is found in an influential model of international trade:
the Heckscher–Ohlin model. Heckscher-Ohlin Model. According to the Heckscher-Ohlin
model, a country has a comparative advantage in a good whose production is intensive in
the factors that are abundantly available in that country. A key concept in the model
is factor intensity. The factor intensity of production of a good
is a measure of which factor is used in relatively greater quantities than other factors in production.
For example, oil refining is capital-intensive compared with clothing manufacture, because
oil refiners use a higher ratio of capital to labor than clothing producers. The Heckscher–Ohlin model shows how comparative
advantage can arise from differences in factory endowments: goods differ in their factor intensity,
and countries tend to export goods that are intensive in the factors they have in abundance.
Trade in manufactured goods amongst developed countries is best explained by increasing
returns to production. Supply, Demand, and International Trade. Let’s
analyze the effects of imports. The domestic demand curve shows how the quantity of a good
demanded by domestic consumers depends on the price of that good. The domestic supply
curve shows how the quantity of a good supplied by domestic producers depends on the price
of that good. The world price of a good is the price at
which that good can be bought or sold abroad. When a market is opened to trade, competition
among importers or exporters drives the domestic price to equality with the world price. If
the world price is lower than the autarky price, trade leads to imports and a fall in
the domestic price compared with the world price. There are overall gains from trade
because consumer gains exceed the producer losses. Consumer Surplus is a measure of welfare gains
to consumers by participating in the market. Producer Surplus is a measure of welfare gains
to producers by participating in the market. In the absence of trade, domestic price is
PA, the autarky price at which the domestic supply curve and the domestic demand curve
intersect. The quantity produced and consumed domestically is QA. Consumer surplus is represented
by the blue-shaded area, and producer surplus is represented by the red-shaded area. Now let’s look at the domestic market with
imports. Here the world price of auto parts, PW, is below the autarky price, PA. When the
economy is opened to international trade, imports enter the domestic market, and the
domestic price falls from the autarky price, PA, to the world price, PW. As the price falls,
the domestic quantity demanded rises from QA to QD and the domestic quantity supplied
falls from QA to QS. The difference between domestic quantity demanded and domestic quantity
supplied at PW, the quantity QD−QS, is filled by imports. When the domestic price falls to PW as a result
of international trade, consumers gain additional surplus (areas X+Z) and producers lose surplus
(area X). Because the gains to consumers outweigh the losses to producers, there is an increase
in the total surplus in the economy as a whole (area Z). The Effects of Exports. If the world price
is higher than the autarky price, trade leads to exports and a rise in the domestic price
compared with the world price. There are overall gains from trade because producer gains exceed
the consumer losses. The graph that follows shows the domestic market with exports. Here the world price, PW, is greater than
the autarky price, PA. When the economy is opened to international trade, some of the
domestic supply is now exported. The domestic price rises from the autarky price, PA, to
the world price, PW. As the price rises, the domestic quantity demanded falls from QA to
QD and the domestic quantity supplied rises from QA to QS. The portion of domestic production
that is not consumed domestically, Q−Q, is exported. When the domestic price rises to PW as a result
of trade, producers gain additional surplus (areas X+Z) but consumers lose surplus (area
X). Because the gains to producers outweigh the losses to consumers, there is an increase
in the total surplus in the economy as a whole (area Z). International Trade and Wages. Exporting industries
produce goods and services that are sold abroad. Import-competing industries produce goods
and services that are also imported. International trade tends to increase the demand for factors
that are abundant in our country compared with other countries, and to decrease the
demand for factors that are scarce in our country compared with other countries. As
a result, the prices of abundant factors tend to rise, and the prices of scarce factors
tend to fall as international trade grows. Effects of Trade Protection. An economy has
free trade when the government does not attempt either to reduce or to increase the levels
of exports and imports that occur naturally as a result of supply and demand. Policies
that limit imports are known as trade protection or simply as protection. Most economists advocate
free trade, although many governments engage in trade protection of import-competing industries.
The two most common protectionist policies are tariffs and import quotas. In rare instances,
governments subsidize export industries. Effects of a Tariff. A tariff is a tax levied
on imports. It raises the domestic price above the world price, leading to a fall in trade
and total consumption and a rise in domestic production. Domestic producers and the government
gain, but consumer losses more than offset this gain, leading to deadweight loss in total
surplus. A tariff raises the domestic price of the
good from PW to PT. The domestic quantity demanded shrinks from QD to QDT, and the domestic
quantity supplied increases from QS to QST. As a result, imports—which had been QD−
QS before the tariff was imposed—shrink to QDT−QST after the tariff is imposed. When the domestic price rises as a result
of a tariff, producers gain additional surplus (area A), the government gains revenue (area
C), and consumers lose surplus (areas A+B+C+D). Because the losses to consumers outweigh the
gains to producers and the government, the economy as a whole loses surplus (areas B+D). Effects of an Import Quota. An import quota
is a legal limit on the quantity of a good that can be imported. Its effect is like that
of a tariff, except that revenues—the quota rents—accrue to the license-holder, not
to the government. The Political Economy of Trade Protection.
Arguments for Trade Protection: Advocates of tariffs and import quotas offer a variety
of arguments. Three common arguments are: national security, job creation, and the infant
industry argument. Despite the deadweight losses, import protections are often imposed
because groups representing import-competing industries are smaller and more cohesive than
groups of consumers.

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