1
INTERNATIONAL TRADE
• Principles of Microeconomic Theory,
ECO 284
• John Eastwood
• CBA 213
• 523-7353
• John.Eastwood@nau.edu
• www.cba.nau.edu/eastwood-j
2
Learning Objectives
• Describe the trends and patterns in
international trade
• Explain comparative advantage and explain
why all countries can gain from
international trade
• Explain how economies of scale and
diversity of taste lead to gains from trade
3
Learning Objectives (cont.)
• Explain why trade restrictions reduce the
volume of imports and exports and reduce
our consumption possibilities
• Explain the arguments used to justify trade
restrictions and show how they are flawed
• Explain why we have trade restrictions
Patterns and Trends in
International Trade
• Imports are the goods and services we buy
from other countries.
• Exports are the goods and services we sell
to people in other countries.
5
Patterns and Trends in
International Trade
• Trade in Goods
– 50% of our exports and 60% of our imports are
manufactured goods
– Capital goods and autos are the leading export
and import
– Services make up 26% of our exports and 17%
or our imports
6
Patterns and Trends in
International Trade
• Trade in Services
– The spending of a foreigner (students,
vacationers) in a country is the importation of
services.
– Shipping and insurance charges paid to foreign
firms on imported goods is the importation of
services.
7
Patterns and Trends in
International Trade
• Geographical Patterns
– Canada is the Unites States’ leading trading
partner for both imports and exports
– 45% of our imports are from Asian countries
8
Patterns and Trends in
International Trade
9
• Trends in the Volume of Trade
– In 1960, the U.S. exported less than 5% of total
output and imported 4.5% of the goods and
services consumed domestically.
– Since, 1960 the composition of imports have
changed dramatically
• food and raw material imports have fallen
• machinery comprise close to 50% of total imports
Patterns and Trends in
International Trade
• Balance of Trade and International
Borrowing
– The balance of trade is the value of exports
minus the value of imports
– In 1996 the U.S. had a $95 billion deficit
– We must either borrow from foreigners or sell
some of our assets
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Opportunity Cost and
Comparative Advantage
• A comparative advantage exists for a
country if it can perform an activity at a
lower opportunity cost than any other
country.
• Recall Ricardo’s example using England
and Portugal (Chapter 2 & notes).
12
Opportunity Cost and
Comparative Advantage
• Countries can increase consumption if they
produce only those goods in which they
have a comparative advantage.
• Let’s look at Farmland and Mobilia
13
Grain(billions of bushels per year)
Opportunity Cost in Farmland
36
30
24
15
6
0
4
7 8 9
12
Cars (millions per year)
14
Grain(billions of bushels per year)
Opportunity Cost in Farmland
36
30
24
a
15
6
0
Farmland’s PPF
4
7 8
9
12
Cars (millions per year)
15
Grain(billions of bushels per year)
Opportunity Cost in Farmland
36
30
24
Opportunity cost
of 1 car is 9,000
bushels of grain
18 billion
bushels
of grain
a
15
6
0
2 million
cars
4
Farmland’s PPF
7 8
9
12
Cars (millions per year)
16
Grain(billions of bushels per year)
Opportunity Cost in Mobilia
20
18
14
12
6
0
2
4
8
12
Cars (millions per year)
17
Grain(billions of bushels per year)
Opportunity Cost in Mobilia
20
18
a'
14
12
Mobilia’s PPF
6
0
2
4
8
12
Cars (millions per year)
18
Opportunity Cost and
Comparative Advantage
• Mobilia has a comparative advantage in car
production
• Farmland has a comparative advantage in
grain production.
20
21
Gains from Trade
• Let’s see how two groups do business with
each other.
Price (thousands of bushels of grain per car)
International Trade in Cars
9
6
3
0
2
4
6
Quantity (millions of cars per year)
22
Price (thousands of bushels of grain per car)
International Trade in Cars
a
Farmland’s
no-trade point
9
6
Mobilia’s
export supply
of cars
Mobilia’s
no-trade point
3
Farmland’s import
demand for cars
1 a'
0
2
4
6
Quantity (millions of cars per year)
25
26
Gains from Trade
• Balanced Trade
– Farmland pays for its cars by exporting grain
– They must export 12 billion bushels of grain for
4 million cars.
– Mobilia is exporting 4 million cars for 12
billion bushels of grain.
• Trade is balanced
27
Gains from Trade
• Changes in Production and Consumption
– How is it possible for everyone to gain?
– With international trade economies can
consume a different quantity than it produces.
Grain(billions of bushels per year)
Expanding Consumption Possibilities
48
42
Farmland
36
30
24
18
12
6
0
4 5
8 9
12
15 16
Cars (millions per year)
28
Grain(billions of bushels per year)
Expanding Consumption Possibilities
48
42
Farmland
36
No-trade
production
and
consumption
30
24
18
a
12
6
0
4 5
8 9
12
15 16
Cars (millions per year)
29
Grain(billions of bushels per year)
Expanding Consumption Possibilities
48
42
Farmland
Production
with trade
36
No-trade
production
and
consumption
30
24
b
18
a
12
6
0
4 5
8 9
12
15 16
Cars (millions per year)
30
Grain(billions of bushels per year)
Expanding Consumption Possibilities
48
42
Farmland
Production
with trade
36
No-trade
production
and
consumption
30
24
b
c
18
a
Consumption
with trade
12
6
0
4 5
8 9
12
15 16
Cars (millions per year)
31
Grain(billions of bushels per year)
Expanding Consumption Possibilities
Mobilia
36
24
21
9
0
4 5
8 9
12
16
Cars (millions per year)
32
Grain(billions of bushels per year)
Expanding Consumption Possibilities
Mobilia
36
24
21
a'
9
0
No-trade
production
and
consumption
4 5
8 9
12
16
Cars (millions per year)
33
Grain(billions of bushels per year)
Expanding Consumption Possibilities
Mobilia
36
24
21
a'
9
0
No-trade
production
and
consumption
4 5
b'
Production
with trade
8 9
12
16
Cars (millions per year)
34
Grain(billions of bushels per year)
Expanding Consumption Possibilities
Mobilia
36
c'
24
21
Consumption
with trade
a'
9
0
No-trade
production
and
consumption
4 5
b'
Production
with trade
8 9
12
16
Cars (millions per year)
35
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Learning Objectives
• Describe the trends and patterns in
international trade
• Explain comparative advantage and explain
why all countries can gain from
international trade
• Explain how economies of scale and
diversity of taste lead to gains from trade
37
Gains from Trade in Reality
• The U.S. buys TVs and VCRs from Korea,
machinery from Europe, and fashion goods
from Hong Kong.
• We sell machinery, grain, and lumber,
airplanes, computers and financial services.
• Why do we exchange manufactured goods?
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Gains from Trade in Reality
• Diversity of Taste and Economies of Scale
– Due to the large diversity in human tastes,
people value diversity and are willing to pay for
it.
– The production of many manufactured goods
are faced with economies of scale.
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Learning Objectives (cont.)
• Explain why trade restrictions reduce the
volume of imports and exports and reduce
our consumption possibilities
• Explain the arguments used to justify trade
restrictions and show how they are flawed
• Explain why we have trade restrictions
40
Trade Restrictions
• Tariffs are a tax imposed by an importing
country when an imported good crosses its
international boundary.
• Nontariff barriers are actions other than a
tariff that restricts international trade.
– quantity restrictions, licensing requirements
U.S. Tariffs: 1930–1996
•The Smoot-Hawley Act (1930)
•GATT (since 1947)
•Tariffs now as low as ever
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42
Trade Restrictions
• The North American Free Trade Agreement
(NAFTA) became effective January 1, 1994.
– All trade barriers will virtually be eliminated
between the U.S., Mexico, and Canada during a
15 year phasing-in period.
• European Union
– Created the largest unified tariff-free market in
the world
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Trade Restrictions
• How Tariffs Work
– What happens if Farmland places a tariff on the
importation of cars.
• The supply of cars in Farmland decreases
• The price of a car in Farmland rises.
• The quantity of cars imported by Farmland
decreases.
44
Trade Restrictions
• How Tariffs Work
– What happens if Farmland places a tariff on the
importation of cars.
• The government of Farmland collects the tariff
revenue
• Resource use is inefficient
• The value of exports changes by the same amount as
the value of imports and trade remains balanced.
Price (thousands of bushels of grain per car)
The Effects of a Tariff
9
6
3
2
1
0
2
4
6
Quantity (millions of cars per year)
45
Price (thousands of bushels of grain per car)
The Effects of a Tariff
9
6
Mobilia’s
export supply
of cars
3
2
1
0
Farmland’s import
demand for cars
2
4
6
Quantity (millions of cars per year)
46
Price (thousands of bushels of grain per car)
The Effects of a Tariff
9
Mobilia’s
export supply of
cars plus tariff
6
Mobilia’s
export supply
of cars
Tariff
revenue
3
2
1
0
Farmland’s import
demand for cars
2
4
6
Quantity (millions of cars per year)
47
48
Trade Restrictions
• Nontariff Barriers
– Quotas are a quantitative restriction on the
import of a particular good.
– Voluntary export restraints (VER) are
agreements between two governments in which
the government of the exporting country agrees
to restrain the volume of its own exports.
Price (thousands of bushels of grain per car)
The Effects of a Quota
9
6
Mobilia’s
export supply
of cars
3
2
1
0
Farmland’s import
demand for cars
2
4
6
Quantity (millions of cars per year)
49
Price (thousands of bushels of grain per car)
The Effects of a Quota
Quota
9
6
Mobilia’s
export supply
of cars
Importer’s
profit
3
2
1
0
Farmland’s import
demand for cars
2
4
6
Quantity (millions of cars per year)
50
51
Learning Objectives (cont.)
• Explain why trade restrictions reduce the
volume of imports and exports and reduce
our consumption possibilities
• Explain the arguments used to justify trade
restrictions and show how they are flawed
• Explain why we have trade restrictions
52
The Case Against Protection
• The National Security Argument
– “A country must protect industries that produce
defense equipment and armaments and those on
which the defense industries rely for their raw
materials and other intermediate inputs.”
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The Case Against Protection
• The National Security Argument
– This argument is false because:
• In a time of war, all industries contribute to national
defense.
• It is more efficient to subsidize firms, financed from
taxes, if a country wishes to increase the output of a
strategic industry.
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The Case Against Protection
• The Infant-Industry Argument
– “It is necessary to protect a new industry to
enable it to grow into a mature industry that can
compete in world markets.”
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The Case Against Protection
• The Infant-Industry Argument
– This argument is false because:
• It only applies if the benefits of learning-by-doing
not only accrue to the owners and workers of the
firms in the infant industry but also spill over to
other industries and parts of the economy.
• It is more efficient to protect an infant industry by
using a subsidy financed from taxes.
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The Case Against Protection
• The Dumping Argument
– Dumping occurs when a foreign firm sells its
exports at a lower price that its cost of
production.
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The Case Against Protection
• The Dumping Argument
– The dumping argument should be resisted
because:
• Dumping is virtually impossible to detect.
• A natural global monopoly is not likely.
• Regulation would be the best way of dealing with a
natural global monopoly.
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Other Arguments for Protection
1) Saves jobs
2) Allows us to compete with cheap foreign
labor
3) Brings diversity and stability
4) Penalizes lax environmental standards
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Other Arguments for Protection
5) Protect National Culture
6) Prevents rich countries from exploiting
developing countries
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Learning Objectives (cont.)
• Explain why trade restrictions reduce the
volume of imports and exports and reduce
our consumption possibilities
• Explain the arguments used to justify trade
restrictions and show how they are flawed
• Explain why we have trade restrictions
Why Is International
Trade Restricted?
• Tariff Revenue
• Rent Seeking
– Free trade brings benefits to some but imposes
costs on others, with total benefits exceeding
total costs
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Why Is International
Trade Restricted?
• Compensating Losers
– Losers are compensated, to some degree, in
reality:
• NAFTA and retraining workers
• Unemployment compensation
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Why Is International
Trade Restricted?
• Difficulties
– Cost of identifying losers and estimating losses
would be enormous.
– Losers today, may be winners tomorrow.
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