International Trade

•Patterns and Trends in International Trade

•Gains from trade

•Absolute and comparative advantage revisited

•Tariffs

•Quotas

•Welfare loss from trade restrictions

•Arguments for trade restrictions

Imports and Exports of the U.S., Chained 2000 Dollars

0

200

400

600

800

1000

1200

1400

1600

1800

20001

97

8

19

79

19

81

19

83

19

85

19

86

19

88

19

90

19

92

19

93

19

95

19

97

19

99

20

00

20

02

20

04

Year

Exports

Imports

Source: www.bls.gov

8

10

12

14

16

18

20

1980 1985 1990 1995 2000 2005

Import Share of Gross Domestic Product in the USA (Percent)

Year/Quarter

Source: Bureau of Economic Analysis

Recessions are shaded

-700

-600

-500

-400

-300

-200

-100

0

90 92 94 96 98 00 02 04 06 08

Figure 1: Net Exports of the United StatesBillions of chained 2000 dollars

Year/Quarter

Source: Bureau of Economic Analysis

Composition of U.S. Imports and Exports

• Composition of US merchandise exports and imports in 2006

7

8

U.S. production as a percentage of U.S. consumption for various commodities

If U.S. production is <100% of consumption, imports make up the difference.If U.S. production exceeds U.S. consumption, then the difference is exported.

Percent

Ricardo’s principle of comparative advantage shows how trade between nations can be mutually beneficial

11

Production possibilities for United States and Izodia

(a) United StatesProduction possibilities with 100 million workers

(millions of units per day)

U1 U2 U3 U4 U5 U6

FoodClothing

6000

48060

360120

240180

120240

0300

(b) IzodiaProduction possibilities with 200 million workers

(millions of units per day)

I1 I2 I3 I4 I5 I6

FoodClothing

2000

16080

120160

80240

40320

0400

12

Production possibilities frontiers for the United States and Izodia without trade (millions of units per day)

100

200

300

400

500

600

Food

(a) United States

U1

U2

U3

U5

100 200 300 400 Clothing0

100

200

300

400

500

600

Food

(b) Izodia

I1 I2

I4

I5

100 200 300 400 Clothing0

Slope: opportunity cost of an additional unit of food is ½ unit of clothing

An additional unit of food costs 2 units of clothing.

Food is produced at a lower opportunity cost in the United States.

U4

U6

I3

I6

Measuring opportunity cost:

For the United States•Food: 60 clothing/120 food = ½ clothing per food.•Clothing: 120 food/60 clothing = 2 food per clothing

For Izodia•Food: 80 clothing/40food = 2 clothing per food•Clothing: 40 food/80 clothing = ½ food per clothing

Thus the Unites States has the comparative advantage in food and Izodia has the comparative advantage in clothing.

How much of one good exchanges for a unit of another good.

As long as the Americans can get more than ½ unit of

clothing for each unit of food , and as long as the Izodians can get more than ½ unit of food

for a unit of clothing, both sides benefit from

specialization and trade

These terms work for both sides

16

Production (and consumption) possibility frontiers with trade (millions of units per day)

100

200

300

400

500

600

Food

(a) United States

100 200 300 400 Clothing0

100

200

300

400

500

600

Food

(b) Izodia

100 200 300 400 Clothing0

U

I

Trade: 1 unit of clothing for 1 unit of food. Both countries are better off as a result of international trade.

I3

U4

United States IzodiaClothing(units)

Food(units)

Clothing(units)

Food(units)

No Trade 180 240 160 120Trade 200 400 200 200Gain 20 160 40 80

•Trade embargos: Prohibitions on the importation (or exportation) of goods and services. Examples: 1973 Oil embargo, trade embargo with Iraq, embargo on imported sugar from Cuba.

•Tariffs: Taxes imposed on imported goods.

•Quotas: Limits on the quantity or value of goods or services that can be imported or exported. Examples: The textile quota, the sugar quota, export quota on raw timber.

•Subsidies: payments by government to exporters. These stimulate trade by allowing the exporter to charge a lower price.

The Japanese trade ministry (MITI) decided that snow skis

made in the U.S. were not safe enough for Japanese ski

enthusiasts

•Health and safety standards—such as European ban on genetically-modified soybeans and hormone-treated beef.•Product design standards•Licensing requirements•Bureaucratic red tape

20

Consumer and producer surplus from market exchange

$0.50

0.25Pric

e pe

r pou

nd

0 60 Chicken(pounds per day)

S = marginal cost

D = marginal benefit

Consumer surplus

Producer surplus

21

Effect of a tariff

$0.15

0.10

Pric

e p

er p

ound S

D

0 30 Sugar millions of pounds per month)

20 60 70

a b c d

f

At a world P=$0.10 per pound, US consumers demand 70 mill. pounds of sugar per month, and US producers supply 20 mill. pounds per month; the difference is imported.

Tariff= $0.05 per pound; P=$0.15 per pound. US producers increase production to 30 mill. pounds; US consumers cut back to 60 mill. pounds. Imports fall to 30 mill. pounds.

Consumers are worse off. Loss of consumer surplus: areas a, b, c, and d.

a = increase in producer surplus

b = higher marginal cost of domestically producing sugar that could have been produced more cheaply abroad.

c = government revenue from the tariff

d = loss of consumer surplus from the drop in consumption

b+d = Net welfare loss to the US economy

S’

22

Effect of a quota

$0.15

0.10

Pric

e p

er p

ound S

D

0 Sugar (millions of pounds per month)20 50 70

$0.15

0.10

Pric

e p

er p

ound S

D

0 30 Sugar (millions of pounds per month)

20 60 70

a b c d

S’

e

Quota=30 mill., world price=$0.10. S’=supply curve (imports and US production; new price $0.15: intersection of D and S’. Loss of consumer surplus: a+b+c+d; a = transfer from US consumers to US producers; b+d = net loss; c = gain for sellers of foreign-grown sugar

Given the preceding analysis , why are trade restrictions so pervasive?

•National security•Save domestic jobs•Anti-dumping•Infant industry