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Introduction
The benefits of trade
The costs of trade
Chapter 16: International Trade and Trade Policy
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Copyright c 2007 by The McGraw-Hill Companies, Inc. All
rights reserved.
Comparative Advantage
as a Basis for Trade
The principle of comparative advantage tells us that we can all
enjoy more goods and services when each country produces according
to its comparative advantage, and then trades with other
countries.
Chapter 16: International Trade and Trade Policy
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Production and Consumption Possibilities and the Benefits of
Trade
Closed Economy
An economy that does not trade with the rest of the world
Open Economy
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Production Possibilities
Computers (number/year)
Coffee (pounds/year)
B
C
A
D
Observations
The OC of producing an additional unit = the slope of the line that
touches the point
OC will increase as output of on good increases
100,000
40,000
1,000
2,000
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Production and Consumption Possibilities and the Benefits of
Trade
A country’s PPC shows the quantities of different goods that its
economy can produce.
Consumption Possibilities
The combinations of goods and services that a country’s citizens
might feasibly consume
Chapter 16: International Trade and Trade Policy
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Production and Consumption Possibilities and the Benefits of
Trade
In a closed economy:
If a country is self-sufficient, it is called autarky.
Chapter 16: International Trade and Trade Policy
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Production and Consumption Possibilities and the Benefits of
Trade
In an open economy:
The society’s consumption possibilities are typically greater than
its production possibilities.
Chapter 16: International Trade and Trade Policy
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Buying and Selling in World Markets
Computers/year
120,000
100,000
1,000
50,000
2,000
2,400
150,000
3,000
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Buying and Selling in World Markets
Consumption
possibilities
Production
possibilities
Computers/year
Consumption possibilities of 150,000 is greater than PPC without
trade
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
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Buying and Selling in World Markets
Consumption
possibilities
Production
possibilities
Computers/year
Buy 1,000 computers with the $500,000
Pt F is possible with trade but not on the PPC
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
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Production Possibilities, Consumption Possibilities, and the
Optimal Production Mix for an Open Economy
Computers/year
LM = consumption possibilities
Costa Rica can use trade to locate anywhere along LM
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
Consumption
possibilities
Production
possibilities
160,000
3,200
G
M
L
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Production Possibilities, Consumption Possibilities, and the
Optimal Production Mix for an Open Economy
Computers/year
Slope of the PPC = LM
Domestic and international opportunity costs of acquiring an extra
computer (in terms of forgone coffee) are equal
E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
Consumption
possibilities
Production
possibilities
160,000
3,200
G
M
L
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A Straight-Line Production Possibilities Curve
Tea (pounds/year
Coffee (pounds/year)
B
C
A
D
Observation
The tradeoff between coffee and tea is constant at any point on the
PPC
200
200
600
800
600
800
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Two Consumption Possibilities Curves
Islandia produces at A
Islandia can use the money earned from selling 800 lbs of coffee to
choose any combination on AD’
Consumption possibilities curve when the world price of coffee is
twice the world price of tea
Chapter 16: International Trade and Trade Policy
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Two Consumption Possibilities Curves
Islandia can choose any combination on A’D
Consumption possibilities curve when the world price of tea is
twice the world price of coffee
A’
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Consumption Possibilities With
and Without International Trade
What Do You Think?
Where should Islandia produce if the price of coffee and tea were
the same?
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Consumption Possibilities With
With a bow-shaped PPC consumption possibilities is typically
maximized by producing where the PPC is tangent to the consumption
possibilities line.
With a straight-line PPC production is completely
specialized.
Chapter 16: International Trade and Trade Policy
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Production and Consumption Possibilities and the Benefits of
Trade
Economic Naturalist
Does “cheap” foreign labor pose a danger to high-wage
economies?
Chapter 16: International Trade and Trade Policy
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Production and Consumption Possibilities and the Benefits of
Trade
Economic Naturalist
Real wages in Fredonia are lower than in the U.S.
Fredonia is half as productive as the U.S. in beef
production.
Fredonia is one-tenth as productive in software production.
Chapter 16: International Trade and Trade Policy
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Production and Consumption Possibilities and the Benefits of
Trade
Economic Naturalist
Fredonia has a comparative advantage in beef.
U.S. has a comparative advantage in software.
The U.S. will trade software for beef and increase its consumption
of both.
Employment in the software industry in the U.S. increases and
employment in the beef industry will decrease.
Chapter 16: International Trade and Trade Policy
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The Market for
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A Supply and Demand Perspective on Trade
If the price of a good or service in a closed economy is greater
than the world price, and that economy opens itself to trade, the
economy will tend to become a net importer of that good or
service.
Chapter 16: International Trade and Trade Policy
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The Market for
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A Supply and Demand Perspective on Trade
If the price of a good or service in a closed economy is lower than
the world price, and that economy opens itself for trade, the
economy will tend to become a net exporter of that good or
service.
Chapter 16: International Trade and Trade Policy
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A Supply and Demand Perspective on Trade
Observations of the Mutually Beneficial Gains from Trade
Countries will profit by exporting the goods and services for which
they have a comparative advantage.
The revenue from the exports are used to import goods and services
for which they do not have a comparative advantage.
Chapter 16: International Trade and Trade Policy
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A Supply and Demand Perspective on Trade
Observations of the Mutually Beneficial Gains from Trade
The markets will ensure that goods will be produced where
opportunity cost is lowest.
The consumption possibilities will be maximized.
Chapter 16: International Trade and Trade Policy
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Exercise 9.4
200
Domestic
supply
World
price
Domestic
demand
500
800
1,200
600
1,200
2,100
2,400
Question
Given the graph shown, what impact would trade have on producer and
consumer surplus?
Chapter 16: International Trade and Trade Policy
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A Supply and Demand Perspective on Trade
Winners and Losers from Trade
Winners
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A Supply and Demand Perspective on Trade
Protectionism
The view that free trade is injurious and should be
restricted
Tariff
Quota
A legal limit on the quantity of a good that may be imported
Chapter 16: International Trade and Trade Policy
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The Market for Computers after the Imposition of an Import
Tariff
Computers per year
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The Market for Computers after the Imposition of an Import
Tariff
Computers per year
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Exercise 9.5
200
Domestic
supply
World
price
Domestic
demand
500
800
1,200
600
1,200
2,100
3,600
Question
Given the graph shown, how will a tariff of $300 per computer
affect total economic surplus?
1,500
300
700
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Protectionist Policies: Tariffs and Quotas
What do you think?
Why did President George W. Bush support the imposition of tariffs
on steel imported into the United States?
Chapter 16: International Trade and Trade Policy
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Protectionist Policies: Tariffs and Quotas
Quotas
Legal limit on the number or value of foreign goods that can be
imported
Can be enforced by issuing permits
Chapter 16: International Trade and Trade Policy
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The Market for Computers after the Imposition of an Import
Quota
Computers per year
1,000
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The Market for Computers after the Imposition of an Import
Quota
Computers per year
Producer surplus with quota = $640K/yr
Consumer surplus
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A Supply and Demand Perspective on Trade
Quotas & Tariffs
Tariffs generate tax revenue.
Quotas generate revenue for the firms that hold an import
license.
Chapter 16: International Trade and Trade Policy
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A Supply and Demand Perspective on Trade
Question
Why would the government ever impose a quota rather than a
tariff?
Chapter 16: International Trade and Trade Policy
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A Supply and Demand Perspective on Trade
Economic Naturalist
Who benefited from and who was hurt by voluntary export restraints
on Japanese automobiles in the 1980s?
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A Supply and Demand Perspective on Trade
Other Barriers to Trade
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A Supply and Demand Perspective on Trade
The Inefficiency of Protectionism
Trade barriers are inefficient and reduce the size of the economic
pie.
Because trade barriers benefit certain groups, and these groups may
be well organized, they may be successful in lobbying for trade
barriers.
The gains from trade could be used to assist groups that have been
hurt by trade.
Chapter 16: International Trade and Trade Policy
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Outsourcing
Outsourcing
A term increasingly used to connote having services performed by
low-wage workers overseas
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Outsourcing
Outsourcing
Outsourcing of services to low-wage foreign workers is exactly
analogous to the importation of goods manufactured by low-wage
foreign workers.
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Outsourcing
Economic Naturalist
Paul Solman and his associate Lee Koromvokis produce video segments
that provide in-depth analysis of current economic issues for the
PBS evening news program, The NewsHour with Jim Lehrer.
Is it likely that his job will someday be outsourced to a low-wage
reporter from Hyderbad?
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Outsourcing
Less rules-based jobs
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Outsourcing
Responding to changing economic conditions requires the ability to
adapt quickly to new circumstances.
Education provides the means to develop a comparative advantage
that is not rules-based and does require complex face-to-face
communication.
Chapter 16: International Trade and Trade Policy
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