L3 Free Trade & The Real World Sloman Chapter 23, p664- 668 Swann Chapter 1 L3 Free Trade & The Real World Sloman Chapter 23, p664- 668 Swann Chapter 1.

L3 Free Trade & The Real World

Sloman Chapter 23, p664-668

Swann Chapter 1

L3 Free Trade & The Real World

Sloman Chapter 23, p664-668

Swann Chapter 1

Free Trade & the Real WorldFree Trade & the Real World

There are a number of key influences affecting world trade today

1. Historical Protectionism, exacerbated by the great

recession between the world wars, led to very low levels

of international trade.

2. Post WWII, 23 nations formed the GATT with the object of

reducing tariffs and, more recently, other trade barriers.

- Slow progress, and some continuing, and highly contentious,

stumbling bocks, e.g. Agriculture and Textiles

3. These problems have led some regions (most notably

the EU) to go down the path of Preferential Trading

Arrangement as a sort-of Free Trade ‘half-way house’

• Preferential Trading Arrangement as a form

of Free Trade:– free trade areasfree trade areas– customs unionscustoms unions– common marketscommon markets

PREFERENTIAL TRADINGPREFERENTIAL TRADING

• Preferential Trading Arrangement as a form

of Free Trade:

• Free Trade Areas

– Each country maintains its pre-existing tariffs

against third countries (NAFTA, ASEAN).

– Need to prevent back-door trades.

• Customs Union

– Adopt a common EXTERNAL tariff.



– A common system of regulations governing

production, employment and trade

– Free movement of labour & capital markets and a

common market for services and government

procurement

– Other issues are possibly law, macroeconomic

policy and a common currency/fixed exchange rate.

– A common system of regulations governing

production, employment and trade



procurement

– Other issues are possibly law, macroeconomic

policy and a common currency/fixed exchange rate.

•Common Market•Common Market

Reminder - Why we tradeReminder - Why we trade

• 1. Different tastes 1. Different tastes – (same Technology & Factors)(same Technology & Factors)

• 2. Different technology or physical capabilities2. Different technology or physical capabilities– (Patented R&D, Land/Minerals)(Patented R&D, Land/Minerals)

• 3. Differences in Factor Endowments3. Differences in Factor Endowments– Labour/CapitalLabour/Capital

• 4. Differences in Taxes 4. Differences in Taxes - e.g. Corporation tax, alcohol, - e.g. Corporation tax, alcohol,

• 5. (Differences in, or restrictions on) Competition5. (Differences in, or restrictions on) Competition– (Monopoly pushes prices up)(Monopoly pushes prices up)

• 6. One Special case: Can trade even if we are 6. One Special case: Can trade even if we are identicalidentical– Increasing Returns to ScaleIncreasing Returns to Scale

Applying Free Trade Analysis to the EUApplying Free Trade Analysis to the EU

• Trade due to differences in tastes Trade due to differences in tastes – clearly an element but hard to measure. But clearly an element but hard to measure. But

when combined with other factors clearly when combined with other factors clearly welfare enhancing welfare enhancing

• Trade due to differences in technologyTrade due to differences in technology– Would clearly have been an issues in the early Would clearly have been an issues in the early

stages of EU (1960’s & 70’s). Liberalisation of stages of EU (1960’s & 70’s). Liberalisation of capital flows, the ability of firms to locate and capital flows, the ability of firms to locate and reverse engineer traded goods has reduced reverse engineer traded goods has reduced this issue. Patents and IP still an issue. Clearly this issue. Patents and IP still an issue. Clearly still an issue for emerging economies.still an issue for emerging economies.

Trade due to differences in endowmentsTrade due to differences in endowments– Originally regarded as the key motive for trade, and Originally regarded as the key motive for trade, and

even with original 6 : Germany, France, Italy, Belgium, even with original 6 : Germany, France, Italy, Belgium, Luxembourg & Netherlands seen as a factor. When Luxembourg & Netherlands seen as a factor. When UK, Ireland & Denmark join, followed by Spain UK, Ireland & Denmark join, followed by Spain Portugal & Greece trade still seen as shake out of Portugal & Greece trade still seen as shake out of comparative advantage due to vague factor comparative advantage due to vague factor endowment reasonsendowment reasons

• But factor endowments are also endogenous and But factor endowments are also endogenous and improved financial capital flows makes endowment of improved financial capital flows makes endowment of physical capital less crucial. physical capital less crucial.

– Now endowment of skilled capital versus unskilled Now endowment of skilled capital versus unskilled capital seen to be more crucial.capital seen to be more crucial.

• Hence Lisbon Agenda Hence Lisbon Agenda

– But no longer sure how important But no longer sure how important differences are differences are Estimated to be about 2% of GNP in ‘1992’ exercise.Estimated to be about 2% of GNP in ‘1992’ exercise.

Trade due differences in taxesTrade due differences in taxes

• – – this is a mildly important issue in the EU.this is a mildly important issue in the EU.– Technically this sort of trade is a distortion. Technically this sort of trade is a distortion. – In a true single market the ‘cheapest’, most In a true single market the ‘cheapest’, most

efficient producer should win out but if exercise efficient producer should win out but if exercise taxes, local rates, or low corporate tax rates or taxes, local rates, or low corporate tax rates or financial taxes and/or regulatory regimes affects financial taxes and/or regulatory regimes affects production (firm location) and consumption production (firm location) and consumption patterns (alcohol, cigs & petrol) then this might patterns (alcohol, cigs & petrol) then this might be a problem.be a problem.

• But US, Canada, Australia or even UK & But US, Canada, Australia or even UK & German regions no different. German regions no different.

Appling Free Trade Analysis to the EUAppling Free Trade Analysis to the EU

• Trade due to increasing returns to scaleTrade due to increasing returns to scale• This was seen as the major advantage of the This was seen as the major advantage of the

‘1992’ single market exercise.‘1992’ single market exercise.– Abolitions of non-tariff barriers to trade crucial. Abolitions of non-tariff barriers to trade crucial.

Common technical specifications and Common technical specifications and requirementsrequirements

– Estimates 6-12% of GNP. Big bang!!Estimates 6-12% of GNP. Big bang!!– Larger Market allows greater specialisation AND Larger Market allows greater specialisation AND

improves our competitive position v.v. the rest improves our competitive position v.v. the rest of the world.of the world.

• But again skills, patents & IP crucial for But again skills, patents & IP crucial for Increasing Returns to scale– Lisbon AgendaIncreasing Returns to scale– Lisbon Agenda

Single market versus Fortress Europe Single market versus Fortress Europe

• But our arguments above were for freer trade. But our arguments above were for freer trade. • PTA is not free trade, just a sub-set of countries PTA is not free trade, just a sub-set of countries

with free trade towards themselves and trade with free trade towards themselves and trade restrictions on everyone elserestrictions on everyone else

• In addition, in the case of the EU some very In addition, in the case of the EU some very special types of distortions/restrictions e.g. special types of distortions/restrictions e.g. Agriculture (CAP) and Textiles (Multi-Fibre Agriculture (CAP) and Textiles (Multi-Fibre Agreement).Agreement).

• So is a PTA a move towards Free Trade?So is a PTA a move towards Free Trade?• Or have we created Fortress Europe?Or have we created Fortress Europe?• And does that matter?And does that matter?

Consumer and Producer Surplus

Chapter 4 Slomanp94 &95

Chapter 11 p292 & 299

Consumer and Producer Surplus

Chapter 4 Slomanp94 &95

Chapter 11 p292 & 299

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Demand

A

B

C

D

E

Demand Curve with market Price of £8Demand Curve with market Price of £8P

rice

(£

pe

r kg

)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E

However, some consumers were prepared to pay £20 for the However, some consumers were prepared to pay £20 for the goodgood

Pri

ce (

£ p

er

kg)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E

However, some consumers were prepared to pay £20 for the However, some consumers were prepared to pay £20 for the goodgood

Pri

ce (

£ p

er

kg)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Pri

ce (

£ p

er

kg)

Demand

A

B

C

D

E

So all these people have essentially saved £12So all these people have essentially saved £12

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E

Similarly, some people were prepared to pay £16Similarly, some people were prepared to pay £16P

rice

(£

pe

r kg

)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E


rice

(£

pe

r kg

)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E

Similarly, some people were prepared to pay £16Similarly, some people were prepared to pay £16

So they have all saved £8

Pri

ce (

£ p

er

kg)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E


rice

(£

pe

r kg

)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E


rice

(£

pe

r kg

)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

A

B

C

D

E In general, everyone along the In general, everyone along the demand curve who was willing to demand curve who was willing to

pay more than £8 is gainingpay more than £8 is gaining

Pri

ce (

£ p

er

kg)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800


Demand

B

In general, everyone along the In general, everyone along the demand curve who was willing to demand curve who was willing to

pay more than £8 is gainingpay more than £8 is gaining

Pri

ce (

£ p

er

kg)

0

4

8

12

16

20

0 100 200 300 400 600 700 800X*

Demand

B

This area represents the gain of the This area represents the gain of the Consumer ORConsumer OR

Consumer Surplus Consumer Surplus

Pmax

Px*

0

4

8

12

16

20

0 100 200 300 400 600 700 800

X*

Demand

B

This area represents the gain of the This area represents the gain of the Consumer ORConsumer OR

Consumer Surplus Consumer Surplus

CS =

½ X(Pmax-Px*)

Pmax

Px*

X*

The cost of protectionThe cost of protection

O

P

Q

Sdom (=MC)

Ddom

Pw

Similarly, firms also gain from selling at

market price compared with the

price they were prepared to supply at


O

P

Q

Sdom (=MC)

Ddom

Pw

Similarly, firms also gain from selling at

market price compared with the

price they were prepared to supply at

• Market Consumer Surplus

http://www.winecon.com/winecon71/topics/05740.winecon


O

P

Q

Sdom (=MC)

Ddom

O

P

Q

Sdom (=MC)

S worldPW

Ddom


O

P

Q

Sdom (=MC)

S world

Q1 Q2

PW

Ddom


O

P

Q

Sdom (=MC)

S world

a

c b

Q1 Q2

PW

Ddom


O

P

Q

Sdom (=MC)

S world

a

c b

Q1 Q2

PW

Ddom


Consumer Surplus

Producer Surplus

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

c b

Q1 Q2

TariffPW + t

PW

Ddom


•New Diagram•New Diagram

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

c b

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


O

P

Q

Sdom (=MC)

S world + tariff

S world

a

de

c b

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


Consumer Surplus

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

de

c bf

1 2 3 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


Loss of CS=1+2+3+4

Gain of PS =1

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

de

c bf

1 2 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


Tariff Revenue =3

3

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

de

c bf

1 2 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


Welfare Loss = 2+ 4

3

O

P

Q

S world + tariff

S world

a

de

c bf

1 2 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


Overall Loss of CS=1+2+3+4

Gain in PS=1

Tariff Revenue=3

Welfare Loss = 2+ 4

3

O

P

Q

S world + tariff

S world

a

de

c bf

2 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom


3

Overall Loss of CS=1+2+3+4

Gain in PS=1

Tariff Revenue=3

Welfare Loss = 2+ 4

Preferential Trading: Trade creationPreferential Trading: Trade creation

O

P

Q

SUK

DUK

PEU + tariffP1

O

P

Q

SUK

Q2 Q1

DUK

P1 PEU + tariff

Trade creationTrade creation

O

P

Q

SUK

Q2 Q1

DUK

PEU

P1

P2

PEU + tariff


O

P

Q

SUK

Q4 Q3Q2 Q1

DUK

PEU

P1

P2

PEU + tariff


O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEU

P1

P2

PEU + tariff


O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEU

P1

P2

Gains

PEU + tariff


Trade diversionTrade diversion

O

P

Q

SUK

QSUK QDUK

DUK

PNZ + tariffP1

P3 PNZ

PEC+ tariff

PEC

O

P

Q

SUK

Q*DUK

DUK

PEC

P1

P2

P3 PNZ

PNZ + tariff


PEC+ tariff

QSUK QDUKQ*SUK

O

P

Q

SUK

1 2 3 4

Q*SUK

DUK

PEC

P1

P2

P3 PNZ

PNZ + tariff


QSUK QDUK Q*DUK

O

P

Q

SUK

1 2 3 4

DUK

PEC

P1

P2

P3 PNZ

5

Gains

Losses

PNZ + tariff


QSUK QDUKQ*SUK Q*DUK

O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEC

P1

P2

P3 PNZ5

Gains

Losses

PNZ + tariff


THE EUROPEAN UNIONTHE EUROPEAN UNION

• Non-tariff barriers pre 1993

– quotas and other quantitative restrictionsAirline restrictions

Government procurement

– cost-increasing barriersTaxing foreign products more

Subsidies to domestic firms

– barriers to entryTechnical regulations

Non-recognition of qualifications


– quotas and other quantitative restrictionsAirline restrictions

Government procurement

– cost-increasing barriersTaxing foreign products more

Subsidies to domestic firms

– barriers to entryTechnical regulations

Non-recognition of qualifications



– quotas and other quantitative restrictions

– cost-increasing barriers

– barriers to entry





•The single market

•the Single European Act

•(1987) 300 measures - implementation in

‘1992’

•The single market

•the Single European Act

•(1987) 300 measures - implementation in

‘1992’


– A common system of regulations governing production,

employment and trade



procurement

– Other issues are possibly law, macroeconomic policy

and a common currency/fixed exchange rate.

– A common system of regulations governing production,

employment and trade



procurement

– Other issues are possibly law, macroeconomic policy

and a common currency/fixed exchange rate.

•free trade areas

•customs unions

•common markets

•free trade areas

•customs unions

•common markets






• The single market

– the Single European Act

– (1987) 300 measures - implementation in ‘1992’





• The single market

– the Single European Act

– (1987) 300 measures - implementation in ‘1992’

•Mutual recognition,

•race to the bottom & Majority Voting (but not taxes)

•Mutual recognition,

•race to the bottom & Majority Voting (but not taxes)


• The benefits of the single market– trade creation– reduction in the direct costs of barriers– economies of scale– greater competition: short run– greater competition: long run

• Criticisms of the single market– radical economic change is costly– adverse regional multiplier effects– development of monopoly / oligopoly power– trade diversion

• The future of the EU?

• The benefits of the single market– trade creation– reduction in the direct costs of barriers– economies of scale– greater competition: short run– greater competition: long run

• Criticisms of the single market– radical economic change is costly– adverse regional multiplier effects– development of monopoly / oligopoly power– trade diversion

• The future of the EU?

WinEcon LinksWinEcon Links

• WinEcon does not have many links relevant to the material in these lectures but there are a few that may be beneficial.

• A good link is Understanding Consumer Surplus

• 5.4.5 Looks at The Effect of a Tariff on Imports But this largely repeats what is covered in the lecture

• 17.5 17.5. The Direction of International Trade gives a good background on World Trade

patterns.• Remember for these links to work you must have

WinEcon on your machine or be in the Strathcona Labs or insert your WinEcon CD from the Sloman textbook.

• WinEcon does not have many links relevant to the material in these lectures but there are a few that may be beneficial.

• A good link is Understanding Consumer Surplus

• 5.4.5 Looks at The Effect of a Tariff on Imports But this largely repeats what is covered in the lecture

• 17.5 17.5. The Direction of International Trade gives a good background on World Trade

patterns.• Remember for these links to work you must have

WinEcon on your machine or be in the Strathcona Labs or insert your WinEcon CD from the Sloman textbook.









L3 Free Trade & The Real World Sloman Chapter 23, p664- 668 Swann Chapter 1 L3 Free Trade & The Real World Sloman Chapter 23, p664- 668 Swann Chapter 1.

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