ECO 1003
Handouts for
Chapters 28-29-30
Chapter 28
Globalization and the Wealth of America
• Globalization
• The integration of national economies into
an international economy as a result of lower
trade barriers and reduced transportation
and communication costs
• North American Free Trade Agreement
(NAFTA)
• An agreement signed by Canada, Mexico,
and the United States, creating a trilateral
trade bloc in North America
• The agreement came into force on January
1, 1994
Chapter 28
Globalization and the Wealth of America
• General Agreement on Tariffs and Trade (GATT)
• A multilateral agreement regulating international
trade
• According to its preamble, its purpose was the
“substantial reduction of tariffs and other trade
barriers and the elimination of preferences, on a
reciprocal and mutually advantageous basis”
• It was negotiated during the United Nations
Conference on Trade and Employment and was the
outcome of the failure of negotiating governments
to create the International Trade Organization (ITO)
• GATT was signed in 1947 and lasted until 1994,
when it was replaced by the World Trade
Organization in 1995
Chapter 28
Globalization and the Wealth of America
• World Trade Organization (WTO)
• An association of more than 145 nations that
helps reduce trade barriers among its members
and settles international trade disputes among
them
• Trade barriers
• Any rules having the effect of reducing the
amount of international exchange; tariffs and
quotas are trade barriers
• Tariff
• A tax levied on imports
Chapter 28
Globalization and the Wealth of America
• Quotas
• An import quota is a limit on the quantity of a good
that can be produced abroad and sold domestically.
• It is a type of protectionist trade restriction that sets
a physical limit on the quantity of a good that can
be imported into a country in a given period of time
• Quotas, like other trade restrictions, are used to
benefit the producers of a good in a domestic
economy at the expense of all consumers of the
good in that economy
Chapter 28
Globalization and the Wealth of America
• Subsidies
• Government payments for the production of
specific goods, generally designed to raise the
profits of the firms receiving the subsidies and
often intended to increase the output of the
subsidized goods
• Luxury good
• A good for which the income elasticity of
demand is greater than 1, meaning that people
spend an increasing proportion of their income
on the good as they get richer
Chapter 28
Globalization and the Wealth of America
• The Effects of An Import Tariff
Chapter 28
Globalization and the Wealth of America
• There are two sources of potential supply,
domestic firms with supply curve Sd, and foreign
firms with supply curve Sf
• Absent government intervention, the market
supply curve would be St, which is the
horizontal summation of Sc and Sf
• Market price and quantity would thus be P and
Qt in the domestic market
Chapter 28
Globalization and the Wealth of America
• Suppose the domestic firms convince the government to
impose a per-unit tariff on imports, causing the foreign
supply curve to shift up vertically by the amount of the
per-unit tariff to Sf’ and result in a new market supply of St’
• This causes the domestic price to rise to P′ (making
domestic consumers worse off), and reduces the total
amount of the good consumed domestically to Qt’
• The rise in price is far less than the higher costs
suffered by the foreign firms, so they too are made
worse off
• The big winners are the domestic firms, for they enjoy
higher prices and greater market share, both
contributing to higher profits for them
Chapter 28
Globalization and the Wealth of America
• The greater the tariff that the government imposes, the greater are
the benefits to the domestic firms and the greater are the losses to
both the foreign firms and to domestic consumers
• The greater the initial importance of imports in supplying domestic
consumers, the greater are the benefits to the domestic industry
and the greater the losses to domestic consumers
• Although a tariff definitely reduces world welfare, because it
reduces the extent of mutually beneficial exchange, it may actually
yield net benefits to the citizens of the nation that imposes it
• This can occur if the domestic economy is large enough relative
to the world market that the domestic tariff affects world prices
• In this case, the domestic government can use an import tariff to
redistribute wealth from foreigners to domestic citizens
Chapter 29
The $750,000 Steelworker
• Gains from trade
• Productivity
• Output produced per unit of input
• Comparative advantage
• The ability to produce a good at a lower opportunity cost than
others; the principle of comparative advantage implies that
individuals, firms and nations will specialize in producing
goods for which they have the lowest opportunity cost
compared to other entities
• Protectionism
• The imposition of rules designed to protect certain individuals
or firms from competition, usually competition from imported
goods
• Imports and exports
Chapter 29
The $750,000 Steelworker
• The Effects of a Quota System
Chapter 29
The $750,000 Steelworker
• Quotas are restrictions imposed by one nation on the
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quantity of a specific foreign good that can be imported
and sold in its domestic market.
Absent any quotas, the price of autos is denoted as P0,
and U.S. consumers buy QUS at that price
The panel on the left shows the foreign-produced supply
of autos to the U.S. market
At price P0, Qf autos will be supplied by foreign firms
The middle panel shows the domestic supply of autos in
the U.S. market, with Qd being supplied at price P0
In the right panel, SUS is the horizontal summation of the
supply curves Sf and Sd
Thus at price P0, the quantity QUS = Qf + Qd
Chapter 29
The $750,000 Steelworker
• If the U.S. government imposes a quota limiting imports to Qf’
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the new supply curve of imported autos is ABSf’
With the decrease in the supply of foreign autos (shown in the
U.S. market as a shift from SUS to SUS’ the price in the U.S.
market rises to P1 and the quantity demanded falls to QUS’
The resulting loss in consumer surplus to U.S. auto consumers
is shown by the shaded area in the right panel
As shown in the middle panel, however, the increase in the
price of autos causes an increase in the quantity of
domestically supplied autos from Qd to QUS’ which increases
the producer surplus of domestic manufacturers by an amount
shown by the shaded area in the middle panel
At least in the short run, a quota system can be shown to
increase the profits of import-competing domestic firms, but
there is also a loss in consumer surplus due to the increase in
price—a loss that must exceed the gains to producers
Chapter 30
The Lion, the Dragon, and the Future
• Direct foreign investment (FDI)
• Resources provided to individuals and firms in a
nation by individuals or firms located in other
countries, often taking the form of foreign
subsidiary or branch operations of a parent
company
• Economic growth
• Sustained increases over time in real per capita
income
• Per capita income
• Average income per person
Chapter 30
The Lion, the Dragon, and the Future
• Purchasing power
• The amount of goods or services that can be
purchased with a unit of currency
• Outsourcing
• The practice of having workers located in foreign
lands perform tasks typically services that have
traditionally been performed by domestic workers
• Intellectual property
• Creative ideas and expressions of the human mind
that have commercial value and receive the legal
protection of a property right, as through the
issuance of a patent, copyright or trademark