Slides by Debbie Evercloud

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1 Slides by Debbie EvercloudTatiana Nikolaevna Kalashnikova/Getty Images CHAPTER 15 (26): INTERNATIONAL TRADE COREECONOMICS, 3RD EDITION BY ERIC CHIANG Slides by Debbie Evercloud © 2013 Worth Publishers CoreEconomics ▪ Chiang/Stone 1

3 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneLEARNING OBJECTIVES At the end of this chapter, the student will be able to: Describe the benefits of free trade Distinguish between absolute and comparative advantage Describe the economic impacts of trade Define the terms of trade © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

4 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneLEARNING OBJECTIVES At the end of this chapter, the student will be able to: List the ways in which trade is restricted Discuss the various arguments against free trade Debate the issues surrounding increasing global economic integration © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

5 EXAMPLE: IMPORTS AND EXPORTSTake a quick look at your closet, and count how many countries contributed to your wardrobe—shirts tailored in Hong Kong, shoes made in Italy, sweaters made in Norway, jackets made in China, and so on. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

6 EXAMPLE: IMPORTS AND EXPORTSWhat do American firms export to the rest of the world? Goods: commercial airplanes, cars and trucks, tractors, high-tech machinery, pharmaceuticals, agricultural goods, and raw materials, such as soybeans and copper Services: medical services, tourist services, higher education, and entertainment, including movies, software, and music © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

8 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneGAINS FROM TRADE A country that does not trade at all is called an autarky. Those countries that trade the least are called closed economies. Most countries are open economies that willingly and actively engage in trade with other nations. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

9 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneGAINS FROM TRADE Trade consists of imports, goods and services purchased from other countries, and exports, goods and services sold abroad. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

10 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneVOLUNTARY TRADE Many people assume that trade between nations is a zero sum game: a game in which, for one party to gain, the other party must lose. But voluntary exchange is in fact a positive sum game, meaning that both parties to a transaction can gain. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

11 ABSOLUTE AND COMPARATIVE ADVANTAGEAn absolute advantage exists when one country can produce more of a good than another country. One country enjoys a comparative advantage in producing a particular good if it can do so at the lowest opportunity cost. If each country specializes according to its comparative advantage, both nations can be made better off through trade. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

12 COMPARATIVE ADVANTAGEAssume the following numbers for our example of comparative advantage: In the U.S., the opportunity cost of producing one cow is one guitar. In Canada, the opportunity cost of producing one cow is 4/10 of a guitar. In this example, Canada has the comparative advantage in cattle, because the opportunity cost is lower. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

13 COMPARATIVE ADVANTAGEBoth countries can be made better off by specializing according to their comparative advantage. Canada will produce beef. The United States will produce some beef and some guitars. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

14 PRACTICAL CONSTRAINTS ON TRADESome practical constraints on trade: Every transaction involves costs, including transportation, communications, and the general costs of doing business. Over the last several decades, however, transportation and communication costs have declined. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

15 PRACTICAL CONSTRAINTS ON TRADESome practical constraints on trade: The production possibilities curves for nations are not linear; they are governed by increasing costs and diminishing returns. Specializing in one product is risky since the market for any one product can always decline, new technology might replace it, or production can be disrupted by changing weather patterns. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

16 EFFECTS OF VOLUNTARY TRADEAlthough it is true that trading partners will benefit from trade, some individuals and groups within each country may lose. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

17 CHECKPOINT: THE GAINS FROM TRADEA comparative advantage exists when one country can produce a good at a lower opportunity cost than another country. Both countries gain from trade when each specializes in producing goods in which they have a comparative advantage. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

18 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneTHE TERMS OF TRADE When countries trade many commodities, the terms of trade are defined as the average price of exports divided by the average price of imports. As a country devotes more resources to producing one particular item, it will encounter increasing opportunity costs. As each product settles into an equilibrium price, the terms of trade are established. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

19 WINNERS AND LOSERS IN FREE TRADEWith free trade, some sectors of the economy win and others lose. American consumers have been happy to purchase Korean televisions, such as Samsung and LG. American television manufacturers have not been so pleased. These firms have had to adapt to overseas competition. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

20 WINNERS AND LOSERS IN FREE TRADEAs textile production has been relocated to low-wage countries, American consumers have enjoyed a substantial drop in the price of clothing. Still, being able to purchase inexpensive imported clothes is small consolation for the unemployed textile workers in North Carolina. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

21 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneTRADE RESTRICTIONS The most common forms of trade restrictions are tariffs and quotas. A tariff is a tax collected on imports. A quota restricts the volume of imports. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

22 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneTARIFFS Tariffs are often ad valorem taxes. This means the product is taxed by a certain percentage of its price as it crosses the border. Other tariffs are unit taxes, in which a fixed tax per unit of the product is assessed at the border. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

23 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneEFFECT OF A UNIT TARIFF S Price in $ With a tariff, domestic consumers pay more than otherwise. Some of this added expense is collected by domestic producers. The shaded area represents the amount of government revenue collected. 600 500 400 D 2 3 4 Quantity in thousands © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

24 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneQUOTAS Under a quota system, the government limits imports to a specified quantity. No revenue is collected for the government, but prices are higher because of the restricted quantity. This translates into more profit for the manufacturer. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

25 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneQUOTAS The United States imposed quotas on Japanese automobiles in the 1980s. The primary effect of these quotas was to dramatically raise the minimum standard equipment and price for some Japanese cars. If a firm is limited in the number of vehicles it can sell, why not sell higher-priced ones where the profit margins are higher? © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

26 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneEFFECT OF A QUOTA S A quota is a restriction on the quantity of imports. The domestic price will rise to the market-clearing level, but no revenue is collected for the government. Price in $ 600 500 400 D Quota 2 3 4 Quantity in thousands © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

27 ISSUE: FOREIGN TRADE ZONESA foreign trade zone is a designated area in a country in which foreign companies can import inputs, without tariffs, to be used for product assembly by local workers. The workers are often paid a fraction of what equivalent workers would be paid in the company’s home country. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

28 ISSUE: FOREIGN TRADE ZONESWhat may be surprising, however, is that foreign trade zones are not limited to developing countries with low labor costs. The United States has many foreign trade zones established for the same purpose: to attract foreign companies to invest in manufacturing plants. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

29 CHECKPOINT: TERMS OF TRADEThe terms of trade are determined by the ratio of the price of exported goods to the price of imported goods. Tariffs are taxes on imports that protect domestic producers and generate revenue for the government. Quotas restrict the volume of particular imports that can come into a country. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

31 TRADITIONAL ECONOMIC ARGUMENTSThe Infant Industry Argument An infant industry is one so underdeveloped as to not be able to survive in the global environment. Unless the industry’s government provides it with some protection through tariffs, quotas, or subsidies, it might not survive in the face of foreign competition. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

32 TRADITIONAL ECONOMIC ARGUMENTSDrawbacks of the Infant Industry Argument: First, protecting an industry must be done in a way that makes the industry internationally competitive. With tariff protection, an industry may never mature. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

33 TRADITIONAL ECONOMIC ARGUMENTSDrawbacks of the Infant Industry Argument: Second, infant industry protection tends to focus on capital manufacturing. Third, many industries seem to be able to develop without protections, so countries may be wasting their resources and reducing their incomes by imposing protection measures. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

34 TRADITIONAL ECONOMIC ARGUMENTSAntidumping Argument: Dumping means that goods are sold at lower prices (perhaps below cost) abroad than in their home market. This often is a result of government subsidies. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

35 TRADITIONAL ECONOMIC ARGUMENTSFirms can use dumping as a form of predatory pricing. They charge higher prices in domestic markets to support unrealistically low prices in foreign markets. If the federal government determines that a foreign firm is dumping products onto the American market, it can impose antidumping tariffs on the offending products. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

36 TRADITIONAL ECONOMIC ARGUMENTSLow Foreign Wages: Some advocates of trade barriers maintain that domestic firms and workers need to be protected from cheap foreign labor. On balance, however, the benefits of lower-priced goods considerably exceed the costs of lost employment. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

37 TRADITIONAL ECONOMIC ARGUMENTSNational Defense: In times of national crisis, the United States must rely on key domestic industries, such as oil, steel, and the defense industry. Some argue that these industries may require protection even during peacetime to ensure that they are already well established if a crisis prevents importing key products. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

38 GLOBALIZATION CONCERNSTrade and Domestic Employment Some firms, unable to compete with imports, will be forced to lay off workers. Even so, increased trade usually allows firms that are exporters to expand their operations and hire new workers. For workers who lose their jobs, switching industries can be difficult and time consuming. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

39 GLOBALIZATION CONCERNSTrade and the Environment: Concerns that expanded trade will lead to increased environmental degradation as companies take advantage of lax environmental laws in the developing world Fears that environmental laws will be viewed as disguised protectionism © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

40 GLOBALIZATION CONCERNSTrade and the Environment: Will free trade come at the expense of the environment? Every action involves a tradeoff. However, trade policies can also be complementary to good environmental policies. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

41 GLOBALIZATION CONCERNSTrade and the Environment: As professors Bhagwati and Hudec argue, there has been no systematic “race to the bottom.” Many corporations often have the highest environmental and labor standards in the developing world. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

42 GLOBALIZATION CONCERNSTrade and the Environment: As incomes rise over time, environmental protection takes on added importance everywhere. The demand for environmental quality is income elastic. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

43 GLOBALIZATION CONCERNSWorking Conditions in Developing Nations: Some anti-globalization activists argue that trade with developing countries simply exploits workers where wages are low. But it is not clear that workers would be helped if the United States were to cut off its trade with low-wage countries. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

44 CHECKPOINT: ARGUMENTS AGAINST FREE TRADEThe infant industries argument claims that some industries need protection to survive in a global competitive environment. Dumping involves selling products at lower prices in foreign markets, often with the help of subsidies from the government. Some argue that domestic workers need protection from low wages overseas. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

45 CHECKPOINT: ARGUMENTS AGAINST FREE TRADEGlobalization has meant that some U.S. workers have lost jobs to foreign competition. The overall effect of international trade has been to increase overall employment. Concern about the environment is often a factor in trade negotiations. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

46 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneCHAPTER SUMMARY Voluntary exchange is a positive sum game, meaning that both parties to a transaction can benefit. International trade is based on the principle of comparative advantage. The terms of trade are defined as the average price of exports divided by the average price of imports. © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

47 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneCHAPTER SUMMARY The most common forms of trade restrictions are tariffs and quotas. The traditional economic arguments against free trade include the following: Infant industries Antidumping Key industries Environmental degradation Protection against cheap labor © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

48 © 2013 Worth Publishers CoreEconomics ▪ Chiang and StoneDISCUSSION QUESTIONS Take a look at the items in your backpack. How many of them were made in other countries? What about the backpack itself? Explain the way in which a country can benefit from trading with other countries that are less productive overall. Does an increase in international trade threaten the national security of the United States? © 2013 Worth Publishers CoreEconomics ▪ Chiang and Stone

Slides by Debbie Evercloud

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