Econ 2301 Dr. Jacobson Mr. Stuckey Week 4 Chapters 4 & 5.

Econ 2301Econ 2301

Dr. JacobsonDr. Jacobson

Mr. StuckeyMr. Stuckey

Week 4 Chapters 4 & 5Week 4 Chapters 4 & 5

Chapter 4Chapter 4

Price Controls and Price Controls and Quotas: Modeling With Quotas: Modeling With

MarketsMarkets

Governmental Policies Governmental Policies Effect Us All. Whether Effect Us All. Whether

It Be a For Profit or It Be a For Profit or Non-Profit Businesses, Non-Profit Businesses,

An Organization, or An Organization, or Simply as Individuals.Simply as Individuals.

Controls on PricesControls on Prices

Price CeilingsPrice CeilingsPrice FloorsPrice FloorsTaxesTaxes

Price CeilingPrice Ceiling

A legal Maximum On A legal Maximum On The Price At Which a The Price At Which a Good Can Be Sold.Good Can Be Sold.

In Chapter 3 We Looked at In Chapter 3 We Looked at Supply and Demand Supply and Demand Combined and We Combined and We

Discussed The Point Called Discussed The Point Called Equilibrium.Equilibrium.

We Looked at What We Looked at What Occurred Above and Below Occurred Above and Below

The Equilibrium Point in The Equilibrium Point in Terms of Supply and Terms of Supply and

Demand.Demand.

In Simplest Terms On Any In Simplest Terms On Any Given Graph of Supply and Given Graph of Supply and

Demand One of Three Demand One of Three Situations ExistSituations Exist

In Simplest Terms On Any Given In Simplest Terms On Any Given Graph of Supply and Demand One Graph of Supply and Demand One

of Three Situations Can Exist:of Three Situations Can Exist:

1. 1. There Can Be Equilibrium. A Price Where There Can Be Equilibrium. A Price Where The Buyers Can Buy All They Want and The Buyers Can Buy All They Want and The Sellers Can Sell All They Want.The Sellers Can Sell All They Want.

2.2. There Can Be a Shortage. A Price Where There Can Be a Shortage. A Price Where The Buyers Want to Buy More Than The The Buyers Want to Buy More Than The Sellers Are Willing to Sell.Sellers Are Willing to Sell.

3.3. There Can Be a Surplus. A Price Where There Can Be a Surplus. A Price Where Sellers Are Willing To Sell More Than Sellers Are Willing To Sell More Than Buyers Want to Buy.Buyers Want to Buy.

Important Note:Important Note:

Whether The Price of a Whether The Price of a Good or Service Is Above Good or Service Is Above or Below The Equilibrium or Below The Equilibrium Point Determines If There Point Determines If There Is a Surplus or Shortage.Is a Surplus or Shortage.

EquilibriumEquilibriumP

rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

Supply

S1

Demand

D1

Equilibrium

Surplus

Shortage

ShortageShortage

Is a Situation In Which Is a Situation In Which The Quantity Demanded The Quantity Demanded

Is Greater Than The Is Greater Than The Quantity Supplied At a Quantity Supplied At a

Given Price.Given Price.

ShortageShortageP

rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

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----

----

----

----

----

----

-

Supply

S1

Demand

D1

Equilibrium

-----------------------------------------------

----

----

----

----

----

--

----

----

----

----

----

--

Quantity Demanded

Quantity

Supplied

Shortage

What Then Are The What Then Are The Effects of A Effects of A Price CeilingPrice Ceiling in Relation To The Price in Relation To The Price of Goods or Services?of Goods or Services?

Price CeilingPrice CeilingP

rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

---------------------------------------

----

----

----

----

----

----

----

-

S1

Supply

Demand

D1

Equilibrium

-----------------------------------------------

----

----

----

----

----

--

----

----

----

----

----

--

Quantity Demanded

Quantity

Supplied

Shortage

Price Ceiling Not Binding

Price CeilingPrice CeilingP

rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

---------------------------------------

----

----

----

----

----

----

----

-

S1

Supply

Demand

D1

Equilibrium

-----------------------------------------------

----

----

----

----

----

--

----

----

----

----

----

--

Quantity Demanded

Quantity

Supplied

Shortage

Price Ceiling Is Binding

Therefore a Binding Therefore a Binding Price Ceiling Causes Price Ceiling Causes

A Shortage.A Shortage.

Therefore When the Therefore When the Government Imposes a Government Imposes a

Binding Price Ceiling On a Binding Price Ceiling On a Competitive Market, A Competitive Market, A Shortage of The Good Shortage of The Good

Arises, and Sellers Must Arises, and Sellers Must Ration The Scarce Goods Ration The Scarce Goods Among The Large Number Among The Large Number

Of Potential Buyers.Of Potential Buyers.

Why and Where Why and Where Would The Would The

Government Want Government Want To Impose a Price To Impose a Price

Ceiling?Ceiling?

Places for Price CeilingsPlaces for Price Ceilings

Gasoline (1973)Gasoline (1973) Rent ControlRent Control Flu ShotsFlu Shots MedicinesMedicines Interest RatesInterest Rates TaxesTaxes

Now Let Us Look At Now Let Us Look At The Other Side of The Other Side of

The Spectrum, The Spectrum, SurplusSurplus..

SurplusSurplus

Is a Situation In Which Is a Situation In Which Quantity Supplied is Quantity Supplied is

Greater Than Quantity Greater Than Quantity Demanded at a Given Demanded at a Given

Price.Price.


rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

---------------------------------------

----

----

----

----

----

----

----

-

Supply

S1

Demand

D1

Equilibrium

-----------------------------------------------

----

----

----

----

----

----

----

----

----

----

----

----

----

----

----

----

----

----

---

Quantity Demanded

Quantity

Supplied

Surplus

Price FloorPrice Floor

A Legal Minimum On A Legal Minimum On The Price At Which a The Price At Which a Good Can Be Sold.Good Can Be Sold.

The Government May The Government May Also Impose a Legal Also Impose a Legal

Minimum On The Price of Minimum On The Price of Goods or Services. Goods or Services.

Because The Price Cannot Because The Price Cannot Fall Below This Level, The Fall Below This Level, The

Legislated Minimum Is Legislated Minimum Is Called a Called a Price FloorPrice Floor..

What Then Are The What Then Are The Effects of A Effects of A Price FloorPrice Floor in in Relation To The Price of Relation To The Price of

Goods or Services?Goods or Services?

Price FloorPrice FloorP

rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

---------------------------------------

----

----

----

----

----

----

----

-

Supply

S1

Demand

D1

Equilibrium

-----------------------------------------------

----

----

----

----

----

----

----

----

----

----

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----

----

----

----

----

----

----

---

Surplus

Price Floor Not Binding

Price FloorPrice FloorP

rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 1 2 3 4 5 6 7 8 9 10

---------------------------------------

----

----

----

----

----

----

----

-

Supply

S1

Demand

D1

Equilibrium

-----------------------------------------------

Surplus Price Floor That Is Binding

Therefore a Binding Therefore a Binding Price Floor Causes a Price Floor Causes a

SurplusSurplus

Therefore When the Therefore When the Government Imposes a Government Imposes a Binding Price Floor On a Binding Price Floor On a Competitive Market, A Competitive Market, A

Surplus of the Good Arises, Surplus of the Good Arises, and The Buyers Must and The Buyers Must

Decide Which Goods to Buy, Decide Which Goods to Buy, Among The Large Number Among The Large Number

Of Goods or Potential Of Goods or Potential Sellers.Sellers.

Why and Where Why and Where Would The Would The

Government Want Government Want To Impose a Price To Impose a Price

Floor?Floor?

Places for Price FloorsPlaces for Price Floors Minimum WageMinimum Wage Legal ServicesLegal Services Certain Occupations (Youth, Certain Occupations (Youth,

Seniors)Seniors) Farm ProductsFarm Products Tariffs Tariffs Taxes Minimum Alternative TaxTaxes Minimum Alternative Tax

Wage and Price ControlsWage and Price Controls

In 1971 Under President In 1971 Under President Nixon the Government Nixon the Government Instituted A Mandatory Instituted A Mandatory

Wage and Price Freeze In Wage and Price Freeze In Order To Combat Order To Combat

Inflation.Inflation.

SubsidiesSubsidies Housing Help Pay Portion of Housing Help Pay Portion of

Rent.Rent. Wage Pay Portion of a Persons Wage Pay Portion of a Persons

Salary.Salary.Earned Income Tax CreditEarned Income Tax CreditOn-The-Job TrainingOn-The-Job Training

Education ( Student Loans)Education ( Student Loans)

Government Policy Government Policy As It Relates To As It Relates To

Taxes.Taxes.

TAXES AND EFFICIENCYTAXES AND EFFICIENCY

Policymakers have two Policymakers have two objectives in designing a objectives in designing a tax system...tax system...

Efficiency Efficiency EquityEquity

TAXES AND EFFICIENCYTAXES AND EFFICIENCY

One tax system is more One tax system is more efficientefficient than another if it raises the same than another if it raises the same amount of revenue at a smaller cost amount of revenue at a smaller cost to taxpayers. to taxpayers.

An An efficientefficient tax system is one that tax system is one that imposes small deadweight losses imposes small deadweight losses and small administrative burdens. and small administrative burdens.

TAXES AND EFFICIENCY TAXES AND EFFICIENCY

The Cost of Taxes to TaxpayersThe Cost of Taxes to Taxpayers The tax payment itselfThe tax payment itself Deadweight lossesDeadweight losses Administrative burdensAdministrative burdens

Deadweight LossesDeadweight Losses

Because taxes distort incentives, Because taxes distort incentives, they entail deadweight losses.they entail deadweight losses. The deadweight loss of a tax is the The deadweight loss of a tax is the

reduction of the economic well-reduction of the economic well-being of taxpayers in excess of the being of taxpayers in excess of the amount of revenue raised by the amount of revenue raised by the government.government.

Administrative BurdensAdministrative Burdens

Complying with tax laws creates Complying with tax laws creates additional deadweight losses. additional deadweight losses. Taxpayers lose additional time and Taxpayers lose additional time and

money documenting, computing, and money documenting, computing, and avoiding taxes over and above the avoiding taxes over and above the actual taxes they pay.actual taxes they pay.

The administrative burden of any tax The administrative burden of any tax system is part of the inefficiency it system is part of the inefficiency it creates. creates.

TaxesTaxes

Are Used To Raise Are Used To Raise Revenue For Public Revenue For Public Projects, Such as Projects, Such as

Roads, Schools, and Roads, Schools, and National Defense.National Defense.

Tax IncidenceTax Incidence

Is The Manner In Is The Manner In Which The Burden of Which The Burden of Tax Is Shared Among Tax Is Shared Among

Participants In a Participants In a Market.Market.

Tax IncidenceTax Incidence

Refers to The Refers to The Distribution Of The Distribution Of The

Tax Burden. Tax Burden.

The Question The The Question The Government Must Government Must

Answer, Is Who (and Answer, Is Who (and How) They Are How) They Are

Going To Tax and Going To Tax and How Much?How Much?

This Question Has As This Question Has As Much Impact On The Much Impact On The

Individuals and Individuals and Companies Within a Companies Within a Nation As It Does On Nation As It Does On

The Government.The Government.

Let Us Look at The Let Us Look at The Government Tax Government Tax

Policies In Terms of Policies In Terms of Supply and Demand.Supply and Demand.

Let Us Say a That The Let Us Say a That The Government Places a Government Places a

$1 Tax on Movie $1 Tax on Movie Tickets. Who Pays The Tickets. Who Pays The

Tax?Tax?

Step #1Step #1

The Initial Impact of The The Initial Impact of The Tax Is on The Demand For Tax Is on The Demand For Movie Tickets. The Supply Movie Tickets. The Supply

Curve is Not Affected Curve is Not Affected Because Sellers Have The Because Sellers Have The

Same Incentive To Sell Same Incentive To Sell Movie Tickets.Movie Tickets.

Therefore, Initially The Therefore, Initially The Buyers Have to Pay The Tax Buyers Have to Pay The Tax To The Government As Well To The Government As Well As The Price to The Sellers. As The Price to The Sellers. This Causes a Shift In The This Causes a Shift In The

Demand Curve.Demand Curve.

Step #2Step #2

We Need To Determine We Need To Determine The Direction of The The Direction of The Shift. The Tax Makes Shift. The Tax Makes

Movie Going Less Movie Going Less Attractive, Therefore The Attractive, Therefore The

Demand Curve Shifts Demand Curve Shifts Downward By The Downward By The

Amount of The Tax.Amount of The Tax.


rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 30 90 100

Supply

S1

Demand

D1

Equilibrium

Without Tax

D2

Equilibrium With Tax

Tax Shifts Demand Curve By Size Of Tax

Price Buyers Pay

Price Without Tax

Step #3Step #3

The Effect of The Tax Can The Effect of The Tax Can Be Seen In Comparing Be Seen In Comparing The Old Equilibrium The Old Equilibrium

($2.00) With The New ($2.00) With The New Equilibrium ($1.50).Equilibrium ($1.50).

What We See Is That What We See Is That Because of The Tax, The Because of The Tax, The Movie Theater Has Lost Movie Theater Has Lost Patrons. Because Movie Patrons. Because Movie

Theater’s Also Make Theater’s Also Make Revenue on Concessions Revenue on Concessions They May Want to Pay They May Want to Pay

Some of The Tax.Some of The Tax.

Therefore, If The Movie Therefore, If The Movie Theater Wants Recover Theater Wants Recover Some of Its Lost Patrons Some of Its Lost Patrons

(Essentially Return to The (Essentially Return to The Original Demand Original Demand

Schedule) It Needs To Schedule) It Needs To Share In The Cost of The Share In The Cost of The

Tax.Tax.


rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 90 100

Supply

S1

Demand

D1

Equilibrium

Without Tax

D2



Price Buyers Pay

Price Sellers Receive

Price Without Tax

We See From This We See From This Example That In A Example That In A

Situation Where The Tax Situation Where The Tax Could Be Picked Up Could Be Picked Up

Entirely By the Buyer The Entirely By the Buyer The Seller Also Has A Stake In Seller Also Has A Stake In The Overall Effect Of The The Overall Effect Of The

Tax.Tax.

Let Us Look At Another Let Us Look At Another Example Where The Example Where The

Government May Place a Government May Place a Tax Directly On Tax Directly On

Employers For Each Item Employers For Each Item They Sell.They Sell.

Again Let Us Consider Again Let Us Consider That The Tax Imposed By That The Tax Imposed By The Government Is $1.00 The Government Is $1.00

For Each Ticket Sold. For Each Ticket Sold. What Are The Effects Of What Are The Effects Of

This Law?This Law?

Step #1Step #1

In This Case The Tax Is In This Case The Tax Is Imposed On The Sellers Imposed On The Sellers

Therefore The Demand Curve Therefore The Demand Curve Does Not Change, But The Tax Does Not Change, But The Tax Makes The Movie Tickets Less Makes The Movie Tickets Less

Profitable At Any Price. Profitable At Any Price. Therefore We Have A Shift In Therefore We Have A Shift In

The Supply Curve.The Supply Curve.


rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 90 100

Supply

S1

Demand

D1

Equilibrium

Without Tax

S2


Tax Shifts Supply Curve By Size Of Tax

Price Buyers Pay


Price Without Tax

Step #2Step #2

Because The Tax Raises The Because The Tax Raises The Sellers Cost, It Reduces The Sellers Cost, It Reduces The Quantity Supplied At Every Quantity Supplied At Every Price, So The Supply Curve Price, So The Supply Curve Shifts To The Left In The Shifts To The Left In The

Amount of The Tax.Amount of The Tax.

Step #3Step #3

After The Shift of The After The Shift of The Supply Curve We Again See Supply Curve We Again See That The Initial Equilibrium That The Initial Equilibrium Has Changed From $2.00 To Has Changed From $2.00 To

$2.50.$2.50.


rice

Quantity

P

Q

$3.00

2.50

2.00

1.50

1.00

.50

0 90 100

Supply

S1

Demand

D1

Equilibrium

Without Tax

D2



Price Buyers Pay


Price Without Tax

Again The Buyers and Again The Buyers and The Sellers End Up The Sellers End Up Sharing The Cost of Sharing The Cost of The Tax. The Tax The Tax. The Tax

Reduces The Size of Reduces The Size of The Market.The Market.

In Both Cases The Tax In Both Cases The Tax Changes The Equilibrium Changes The Equilibrium

Point Either Through A Shift Point Either Through A Shift In The Demand or Supply In The Demand or Supply

Curve. The Results In Curve. The Results In Either Case Are The Same.Either Case Are The Same.

Elasticity and Tax Elasticity and Tax IncidenceIncidence

In The Last Chapter In The Last Chapter We Examined We Examined

Elasticity As It Applied Elasticity As It Applied To Both The Demand To Both The Demand and Supply Curves.and Supply Curves.

When A Good Is Taxed, When A Good Is Taxed, Buyers And Sellers Share Buyers And Sellers Share

The Tax Burden. Only The Tax Burden. Only Rarely Is It Shared Rarely Is It Shared

Equally, So How Then Is Equally, So How Then Is The Tax Burden Really The Tax Burden Really

Divided?Divided?

RememberRemember That Elasticity of Either That Elasticity of Either

Supply or Demand Is Supply or Demand Is Measured By the Measured By the

Willingness of Either Buyers Willingness of Either Buyers (Demand Elasticity) or (Demand Elasticity) or

Sellers (Supply Elasticity) Sellers (Supply Elasticity) To Leave The Market When To Leave The Market When

Conditions Become Conditions Become Unfavorable.Unfavorable.

A Tax Burden Falls A Tax Burden Falls More Heavily On The More Heavily On The Side Of The Market Side Of The Market That Is Less ElasticThat Is Less Elastic

This Makes Sense As The This Makes Sense As The More Elastic, The More More Elastic, The More Willing The Buyer Or Willing The Buyer Or

Seller Is To Move Away Seller Is To Move Away From or To Produce The From or To Produce The

Product Due To Price Product Due To Price Increases or Decreases.Increases or Decreases.

Elastic Supply, Inelastic Elastic Supply, Inelastic DemandDemand

Pri

ce

Quantity

P

Q

Supply

S1

Demand

D1

The Incidence of Tax Falls More Heavily On Consumers

TAX

Price Buyers Pay

Price Without TaxPrice Sellers Receive Tax

Incidence on Sellers

Inelastic Supply, Elastic Inelastic Supply, Elastic DemandDemand

Pri

ce

Quantity

P

Q

Supply

S1

Demand

D1

The Incidence of Tax On ConsumersTAX

Price Buyers Pay

Price Without TaxPrice Sellers Receive Tax Incidence Falls

More Heavily on Sellers

The Law of Supply and The Law of Supply and Demand Describes The Demand Describes The Way Markets Allocate Way Markets Allocate Scarce Resources. In Scarce Resources. In

Short, We Have Short, We Have Looked At What Is, Looked At What Is, Rather Than What Rather Than What

Should Be.Should Be.

We Know That The Prices of We Know That The Prices of Toys During The Holidays Toys During The Holidays

Adjusts To Ensure That The Adjusts To Ensure That The Quantity of Toys Supplied Quantity of Toys Supplied

Equals The Quantity of Toys Equals The Quantity of Toys Demanded. But At This Demanded. But At This

Equilibrium Is That Quantity Equilibrium Is That Quantity Produced and Consumed Produced and Consumed

Too Large, Too Small or Just Too Large, Too Small or Just Right?Right?

That Takes Us To That Takes Us To The Topic of Welfare The Topic of Welfare

EconomicsEconomics

Welfare EconomicsWelfare Economics

Is The Study Of How Is The Study Of How The Allocation of The Allocation of Resources Affects Resources Affects

Economic Well-Being.Economic Well-Being.

Imagine That You Have Just Imagine That You Have Just Developed A New Product Developed A New Product

and Are About To Take It To and Are About To Take It To Market. You Ask 10 People Market. You Ask 10 People What They Are Willing To What They Are Willing To Pay For The Product and Pay For The Product and

They All Give You (As They All Give You (As Expected) Different Expected) Different

Answers.Answers.

From The Information From The Information Given You By These Given You By These Ten People Can You Ten People Can You Develop A Strategy Develop A Strategy

For Pricing Your For Pricing Your Product?Product?

Let Us Explore This Let Us Explore This Question From Several Question From Several Different Approaches.Different Approaches.

Willingness To PayWillingness To Pay

Is The Maximum Is The Maximum Amount That A Buyer Amount That A Buyer Will Pay For a Good.Will Pay For a Good.

But What If, In Our But What If, In Our Example, A Person Has Example, A Person Has Told You They Will Be Told You They Will Be Willing To Pay $50 For Willing To Pay $50 For

Your Product But, Your Product But, Actually They Would Be Actually They Would Be

Willing To Pay $75.Willing To Pay $75.

Product Demand Product Demand CurveCurvePrice

Quantity

$75

$65

$55

$45

$35

$25

$15

$5

1 2 3 4 5

A

Consumer SurplusConsumer Surplus

Is The Amount A Buyer Is The Amount A Buyer Is Willing To Pay For a Is Willing To Pay For a

Good Minus The Good Minus The Amount The Buyer Amount The Buyer

Actually Pays For It.Actually Pays For It.


Consumer Surplus =

Amount A Buyer Is Willing to Pay

Amount They Paid


Consumer Surplus = $75 $50 = $25

Now Let Us Assume That Now Let Us Assume That Your Product Is A Your Product Is A

Painting and You Have Painting and You Have Made Two Copies. This Made Two Copies. This Time Instead of Asking Time Instead of Asking People What They Will People What They Will

Pay For Them, You Pay For Them, You Decide Auction Them Off.Decide Auction Them Off.

We Conduct The Auction We Conduct The Auction Until Two Bidders Are Left Until Two Bidders Are Left

and The Price Is At $45. Let and The Price Is At $45. Let Us Again Say That One Of Us Again Say That One Of The Two Persons Would The Two Persons Would

Have Been Willing to Pay Have Been Willing to Pay $75 For the Painting, But $75 For the Painting, But the Other Person Would the Other Person Would

Only Have Paid $50.Only Have Paid $50.

Using Our Formula for Using Our Formula for Finding Consumer Finding Consumer

Surplus We Find That The Surplus We Find That The First Person Has A First Person Has A

Consumer Surplus of $30 Consumer Surplus of $30 and The Second Person A and The Second Person A Consumer Surplus of $5 Consumer Surplus of $5

For The Same Item.For The Same Item.


Consumer Surplus =


Amount They Paid

Consumer SurplusConsumer SurplusFor 1For 1stst Person Person


Consumer SurplusConsumer SurplusFor 2For 2ndnd Person Person



Quantity

$75

$65

$55

$45

$35

$25

$15

$5

1 2 3 4 5

A

B Price Actually Paid

Person A’s Consumer Surplus

Person B’s Consumer Surplus

Consumer Surplus Is Consumer Surplus Is Closely Related To The Closely Related To The

Demand Curve.Demand Curve.

The Area Below The The Area Below The Demand Curve and Above Demand Curve and Above The Price Measures The The Price Measures The

Consumer Surplus In The Consumer Surplus In The Market.Market.

The Area Below The The Area Below The Demand Curve and Above Demand Curve and Above The Price Measures The The Price Measures The Consumer Surplus In The Consumer Surplus In The

Market.Market.

The Reason Is That The Reason Is That The Height of The The Height of The

Demand Curve Demand Curve Measures The Value Measures The Value Buyers Place On The Buyers Place On The

Good, As Measured By Good, As Measured By Their Willingness To Their Willingness To

Pay For It.Pay For It.

The Difference The Difference Between This Between This

Willingness To Pay Willingness To Pay and The Market Price and The Market Price

Is Each Buyer’s Is Each Buyer’s Consumer Surplus.Consumer Surplus.

Therefore, The Total Area Therefore, The Total Area Below The Demand Curve Below The Demand Curve

and Above The Price Is and Above The Price Is The Sum Of The The Sum Of The

Consumer Surplus Of All Consumer Surplus Of All Buyers In The Market For Buyers In The Market For

A Good or Service.A Good or Service.


Quantity

$75

$65

$55

$45

$35

$25

$15

$5

1 2 3 4 5

A





Quantity

$75

$65

$55

$45

$35

$25

$15

$5

1 2 3 4 5

A




Total Of The Consumer Surplus Of All Buyers

Buyers Always Want To Buyers Always Want To Pay Less and Paying Less Pay Less and Paying Less Makes The Buyer Better Makes The Buyer Better Off. But How Much Does Off. But How Much Does a Buyers Well-Being Rise a Buyers Well-Being Rise In Response To a Lower In Response To a Lower

Price?Price?

Consumer Surplus Consumer Surplus Measures The Benefit Measures The Benefit That Buyers Receive That Buyers Receive From A Good As The From A Good As The Buyers Themselves Buyers Themselves

Perceive It.Perceive It.

This Is Because Buyers This Is Because Buyers Have Determined Have Determined What They Would What They Would Have Paid For The Have Paid For The Good Or Service.Good Or Service.

Government Policy Government Policy Makers However, May Or Makers However, May Or May Not Care About What May Not Care About What

Creates Consumer Creates Consumer Surplus. Example of A Surplus. Example of A Drug Addict Being Able Drug Addict Being Able

To Purchase Drugs To Purchase Drugs Cheaper Therefore Cheaper Therefore Creating Consumer Creating Consumer

Surplus.Surplus.

In This Case Consumer In This Case Consumer Surplus is Not A Good Surplus is Not A Good

Measure of Well-Measure of Well-Being, As The Drug Being, As The Drug

Addict is Not Looking Addict is Not Looking After Their Own Best After Their Own Best

Interests.Interests.

However, In Most Markets, However, In Most Markets, Consumer Surplus Does Consumer Surplus Does Reflect Economic Well-Reflect Economic Well-

Being. Rational People Do Being. Rational People Do The Best They Can To The Best They Can To

Achieve Their Objectives, Achieve Their Objectives, Given Their Opportunities.Given Their Opportunities.


Consumer Surplus =


Amount They Paid

Now Lets Look At It Now Lets Look At It From The Other Side From The Other Side and Discuss Producer and Discuss Producer

Surplus.Surplus.

Let Us Assume That You Let Us Assume That You Are Going To Have Your Are Going To Have Your

Taxes Done and You Taxes Done and You Contact 4 CPA’s That You Contact 4 CPA’s That You

Know Are Capable of Know Are Capable of Doing The Work and Ask Doing The Work and Ask

Them For A Price For Them For A Price For Them To Do Your Taxes.Them To Do Your Taxes.

Each CPA Will Determine Each CPA Will Determine Their Costs In Order To Their Costs In Order To Determine A Price. The Determine A Price. The Term “ Cost” is Really Term “ Cost” is Really The Opportunity Cost, The Opportunity Cost,

That Includes Materials, That Includes Materials, Overhead, Time to Do the Overhead, Time to Do the

Work and Expected Work and Expected Profit.Profit.

Cost &Cost &Producer SurplusProducer Surplus

CostCost

The Value of The Value of Everything A Seller Everything A Seller

Must Give Up To Must Give Up To Produce a Good.Produce a Good.

Producer SurplusProducer Surplus

The Amount A Seller The Amount A Seller Is Paid For A Good Is Paid For A Good Minus The Seller’s Minus The Seller’s

Cost Of Producing or Cost Of Producing or Providing It.Providing It.

Producers SurplusProducers Surplus

Measures The Benefit Measures The Benefit To Sellers of To Sellers of

Participating In A Participating In A Market.Market.


Producer Surplus =

Amount That a Seller Is Paid

Sellers Cost

Note:Note:

Because We Have Set Up Because We Have Set Up a Bidding Situation In Our a Bidding Situation In Our

Example, The CPA With Example, The CPA With The Lowest Cost Should The Lowest Cost Should

Win The Bid.Win The Bid.

Now Let Us Use The Now Let Us Use The Supply Curve To Supply Curve To

Measure Producer Measure Producer Surplus.Surplus.

Let Us Say That All 4 Let Us Say That All 4 CPA’s Submitted Bids CPA’s Submitted Bids

As Follows:As Follows:

CPA A = $10,000CPA A = $10,000CPA B = $12,000CPA B = $12,000CPA C = $14,000CPA C = $14,000CPA D = $16,000CPA D = $16,000

Let Us Now Plot A Let Us Now Plot A Supply Schedule For Supply Schedule For

Preparing Taxes.Preparing Taxes.

The Supply Curve The Supply Curve Shows The Cost of The Shows The Cost of The

Marginal Seller, The Marginal Seller, The Seller Who Would Seller Who Would

Leave The Market First Leave The Market First If The Price Were Any If The Price Were Any

LowerLower

Product Supply CurveProduct Supply CurvePrice

Quantity

$18

$16

$14

$12

$10

$8

$6

$4

$2

0

1 2 3 4 5

A

# of Suppliers

Thousands

B

C

D


Producer Surplus =

Amount A Seller Is Paid For a Good or Service

Cost of Providing The Good or Service

Therefore Any Therefore Any Amount Above The Amount Above The

Suppliers Cost Suppliers Cost Would Be Producers Would Be Producers

Surplus.Surplus.

In Our Example The In Our Example The Area Below The Price Area Below The Price and Above The Supply and Above The Supply Curve Measures The Curve Measures The

Producer Surplus In A Producer Surplus In A Market.Market.

However, Producers However, Producers Always Want To Always Want To

Receive a Higher Price Receive a Higher Price For Their Goods and For Their Goods and Services That They Services That They

Sell.Sell.

Market EfficiencyMarket Efficiency

Consumer Surplus and Consumer Surplus and Producer Surplus Are The Producer Surplus Are The

Basic Tools Economists Use Basic Tools Economists Use To Study The Welfare Of To Study The Welfare Of Buyers and Sellers In a Buyers and Sellers In a

Market.Market.

If We Want To Maximize If We Want To Maximize The Economic Well-Being The Economic Well-Being Of Everyone In a Society. Of Everyone In a Society.

We Must First Decide We Must First Decide How We Are Going to How We Are Going to

Measure The Economic Measure The Economic Well-Being Of a Society.Well-Being Of a Society.

One Possible One Possible Measure Is The Sum Measure Is The Sum

of Consumer of Consumer Surplus and Surplus and

Producer Surplus, Producer Surplus, Which We Call Which We Call Total Total

SurplusSurplus..

Remember That Remember That Consumer Consumer SurplusSurplus Is The Benefit That Is The Benefit That

Buyers Receive From Buyers Receive From Participating In The Market Participating In The Market and and Producer SurplusProducer Surplus Is The Is The Benefit That Sellers Receive Benefit That Sellers Receive

From Participating In The From Participating In The Market.Market.

Remember Also, Remember Also, That The Formulas That The Formulas

For Each Are As For Each Are As Follows:Follows:


Consumer Surplus =


Amount They Paid

Or

= Value To Buyers - Amount Paid By Buyers


Producer Surplus =

Amount That a Seller Is Paid

Sellers Cost

Or

= Amount Received By Sellers – Cost To Sellers

Total Surplus Then Total Surplus Then Becomes:Becomes:

Total Surplus = Value To Total Surplus = Value To Buyer - Amount Paid By Buyer - Amount Paid By

Buyers + Amount Buyers + Amount Received By Sellers – Received By Sellers –

Cost To Sellers.Cost To Sellers.

OrOr

Because The Amount Paid Because The Amount Paid By Buyers Equals The By Buyers Equals The

Amount Received By Sellers Amount Received By Sellers The Equation Can Be The Equation Can Be

Rewritten As:Rewritten As:

Total Surplus = Value To Total Surplus = Value To Buyers – Cost To SellersBuyers – Cost To Sellers

If An Allocation of If An Allocation of Resources Maximizes Total Resources Maximizes Total Surplus, We Say That The Surplus, We Say That The

Allocation Exhibits Allocation Exhibits Efficiency.Efficiency. If An Allocation If An Allocation Is Is InefficientInefficient, Then Some Of , Then Some Of

The Gains Among Buyers The Gains Among Buyers and Sellers Are Not Being and Sellers Are Not Being Realized. i.e. Not Taking Realized. i.e. Not Taking

The Minimum Bid.The Minimum Bid.

EfficiencyEfficiency

The Property Of A The Property Of A Resource Allocation Of Resource Allocation Of Maximizing The Total Maximizing The Total Surplus Received By Surplus Received By

All Members Of All Members Of Society.Society.

Thus, Moving Production Thus, Moving Production From a High-Cost From a High-Cost

Producer To a Low-Cost Producer To a Low-Cost Producer Will Lower The Producer Will Lower The Total Cost To Sellers and Total Cost To Sellers and

Raise Total Surplus.Raise Total Surplus.

Also An Allocation Is Also An Allocation Is InefficientInefficient If A Good Is Not If A Good Is Not

Being Consumed By The Being Consumed By The Buyers Who Value It Most Buyers Who Value It Most Highly. Highly. Therefore, Moving Therefore, Moving Consumption Of The Good Consumption Of The Good From A Buyer With A Low From A Buyer With A Low Valuation To A Buyer With Valuation To A Buyer With A High Valuation Will Raise A High Valuation Will Raise

Total Surplus.Total Surplus.

EquityEquity

The Fairness Of The The Fairness Of The Distribution of Well-Distribution of Well-

Being Among The Being Among The Members of Society.Members of Society.

While While EfficiencyEfficiency Can Can Be Measured and Be Measured and

Judged On Judged On Performance, Performance, EquityEquity Involves Normative Involves Normative

Judgments That Enter Judgments That Enter Into The Area of Into The Area of

Political Philosophy.Political Philosophy.

Putting The Supply Putting The Supply Curve and Demand Curve and Demand Curve Together and Curve Together and Finding Equilibrium.Finding Equilibrium.

Remember That Remember That Consumer SurplusConsumer Surplus Equals Equals The Area Above The Price The Area Above The Price and Under The Demand and Under The Demand

Curve and Curve and Producer Producer SurplusSurplus Equals The Area Equals The Area

Below The Price and Below The Price and Above The Supply Curve.Above The Supply Curve.

Therefore, The Total Area Therefore, The Total Area Under Between The Supply Under Between The Supply

Curve and The Demand Curve and The Demand Curves Up To The Point of Curves Up To The Point of

Equilibrium Represents The Equilibrium Represents The Total Surplus.Total Surplus.

Observations:Observations:

1. Free Markets Allocate 1. Free Markets Allocate The Supply Of Goods To The Supply Of Goods To The Buyers Who Value The Buyers Who Value Them Most Highly, As Them Most Highly, As

Measured By Their Measured By Their Willingness To Pay.Willingness To Pay.


2. Free Markets Allocate 2. Free Markets Allocate The Demand For Goods The Demand For Goods To The Sellers Who Can To The Sellers Who Can Produce Them At Least Produce Them At Least

Cost.Cost.


3. Free Markets Produce 3. Free Markets Produce The Quantity of Goods The Quantity of Goods

That Maximizes The Sum That Maximizes The Sum Of Consumer and Of Consumer and Producer Surplus.Producer Surplus.

Consumer and Producer Surplus Consumer and Producer Surplus In Market EquilibriumIn Market Equilibrium

Price

Quantity

A

Equilibrium Quantity

BC

DSupply

Demand

EEquilibrium Price

Consumer Surplus

Producer Surplus

The Next Figure Shows The Next Figure Shows That At Quantities Less That At Quantities Less Than The Equilibrium Than The Equilibrium

Quantity Such As Q1, The Quantity Such As Q1, The Value To The Buyers Value To The Buyers

Exceeds The Cost To The Exceeds The Cost To The Sellers.Sellers.

At Quantities Greater Than At Quantities Greater Than The Equilibrium Quantity The Equilibrium Quantity Such As Q2, The Cost To Such As Q2, The Cost To The Sellers Exceeds The The Sellers Exceeds The Value To The Buyers. Value To The Buyers. Therefore The Market Therefore The Market

Equilibrium Maximizes The Equilibrium Maximizes The Sum Of Producer and Sum Of Producer and Consumer Surplus.Consumer Surplus.

The Efficiency of the Equilibrium The Efficiency of the Equilibrium QuantityQuantity

Price

QuantityEquilibrium Quantity

Supply

Demand

Cost To Sellers

Value

To Buyers

Value To Buyers

Cost

To Sellers

Q1 Q2

Value to Buyers Is Greater Than Cost To Sellers

Value to Buyers Is Less Than Cost To Sellers

QuestionsQuestions??

Chapter 5Chapter 5

International TradeInternational Trade

7-51

Adam Smith’s Dos and Adam Smith’s Dos and Don’tsDon’ts

DoDo Protect society from the violence and Protect society from the violence and

invasion of other countriesinvasion of other countries Establish an exact administration of Establish an exact administration of

justicejustice Erect and maintain certain public works Erect and maintain certain public works

and institutions where private enterprise and institutions where private enterprise could not profit from doing socould not profit from doing so

Don’t do anything elseDon’t do anything else

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Figure 1 The Internationalization of Figure 1 The Internationalization of the U.S. Economythe U.S. Economy

Percentof GDP

0

5

10

15

1950 1955 1960 1965 1970 1975 1980 19901985 2000 20051995

Imports

Exports

Table 1 International Flows of Goods Table 1 International Flows of Goods and Capital: Summaryand Capital: Summary

Government Government InterventionIntervention

ProtectionProtection

AllocationAllocation

BenefitBenefit

One of The Nine One of The Nine Principles of Economics Principles of Economics (From Chapter 1) Is That (From Chapter 1) Is That Trade Makes Everybody Trade Makes Everybody

Better Off.Better Off.

Comparative Comparative Advantage and TradeAdvantage and Trade

Gains From Specialization and Gains From Specialization and Trade Are Not Based on Absolute Trade Are Not Based on Absolute Advantage, But on Comparative Advantage, But on Comparative Advantage. When Each Person Advantage. When Each Person

Specializes in Producing the Good Specializes in Producing the Good For which They Have a For which They Have a

Comparative Advantage, Total Comparative Advantage, Total Production in the Economy Rises Production in the Economy Rises

an Everyone is Better Off.an Everyone is Better Off.

However, There Can Be However, There Can Be Other Factors Including Other Factors Including the Price of the Goods the Price of the Goods and How the Gains Are and How the Gains Are

Shared Among the Shared Among the Trading Partners.Trading Partners.

Applications of Applications of Comparative AdvantageComparative Advantage

Should Tiger Woods Mow Should Tiger Woods Mow His Own Lawn or Play His Own Lawn or Play

Golf?Golf?

The Principle of Comparative The Principle of Comparative Advantage Holds That a Advantage Holds That a

Country Can Benefit From Country Can Benefit From Trade Even If it is Absolutely Trade Even If it is Absolutely More Efficient (or Absolutely More Efficient (or Absolutely Less Efficient) Than Every Less Efficient) Than Every

Other Country in the Other Country in the Production of Every Good.Production of Every Good.

Therefore, Trade Therefore, Trade According to According to

Comparative Advantage Comparative Advantage Provides Mutual Benefits Provides Mutual Benefits

to All Countries.to All Countries.

In Addition-In Addition-

The Principle of The Principle of Comparative Advantage Comparative Advantage Holds That Each Country Holds That Each Country

Will Benefit If it Specializes Will Benefit If it Specializes in the Production and in the Production and

Export of Those Goods That Export of Those Goods That it Can Produce at Relatively it Can Produce at Relatively

Low Cost.Low Cost.

Conversely, Each Conversely, Each Country Will Benefit If it Country Will Benefit If it

Imports Those Goods Imports Those Goods Which it Produces at a Which it Produces at a Relatively High Cost.Relatively High Cost.

Trade Among Countries-Trade Among Countries-

Imports-Imports- Are Goods Produced Are Goods Produced Abroad and Sold Domestically.Abroad and Sold Domestically.

Exports-Exports- Are Goods Produced Are Goods Produced Domestically and Sold AbroadDomestically and Sold Abroad..

Nations Also Can Enjoy a Nations Also Can Enjoy a Comparative Advantage, Comparative Advantage, However That Does Not However That Does Not Necessarily Mean It Will Necessarily Mean It Will

or Will Not Produce a or Will Not Produce a Good.Good.

The United States Has A The United States Has A Comparative Advantage in Comparative Advantage in Certain Items Involving the Certain Items Involving the

Military and Warfare. Military and Warfare. However, This Does Not However, This Does Not

Mean That it is in The U.S.’s Mean That it is in The U.S.’s Best Interest to Sell these Best Interest to Sell these

Items.Items.

International Trade Can International Trade Can Make Some Individuals Make Some Individuals Worse Off, Even as it Worse Off, Even as it

Make the Country as a Make the Country as a whole Better Off.whole Better Off.

What Does It Matter?What Does It Matter?

We buy much more from foreigners than they We buy much more from foreigners than they buy from usbuy from us In effect, they lend or give us the money to make up In effect, they lend or give us the money to make up

the difference between our imports and our exportsthe difference between our imports and our exports We are essentially selling them a piece of the We are essentially selling them a piece of the

(American) rock consisting of corporate stock, real (American) rock consisting of corporate stock, real estate, corporate and government bonds and other estate, corporate and government bonds and other debt instrumentsdebt instruments

Should this continue for another three or four Should this continue for another three or four decades, foreign investors will own most of Americadecades, foreign investors will own most of America

32-9Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Four Main Arguments for Four Main Arguments for ProtectionProtection

The National Security The National Security ArgumentArgument

The Infant Industry ArgumentThe Infant Industry Argument The Low-Wage ArgumentThe Low-Wage Argument The Employment ArgumentThe Employment Argument


The National Security The National Security ArgumentArgument

Our dependence on foreign suppliers Our dependence on foreign suppliers could make us vulnerable in time of could make us vulnerable in time of warwar It is possible that we need to maintain It is possible that we need to maintain

certain defense-related industriescertain defense-related industries What if we depended on foreign What if we depended on foreign

suppliers for critical components of suppliers for critical components of entire weapons systems?entire weapons systems?

The continued spread of nuclear arms The continued spread of nuclear arms technology may soon make the national technology may soon make the national security argument much more relevant security argument much more relevant


The Infant Industry The Infant Industry ArgumentArgument

American products are no longer American products are no longer produced by infant industries being produced by infant industries being swamped by foreign giantsswamped by foreign giants

About the best that can be said is About the best that can be said is that some of our infant industries that some of our infant industries never matured while others have never matured while others have evolved into senilityevolved into senility Textiles, steel, clothing, and Textiles, steel, clothing, and

automobiles may be in the senile automobiles may be in the senile categorycategory


The Low-wage ArgumentThe Low-wage Argument How can American workers compete with How can American workers compete with

foreigners who are paid sweatshop wages in foreigners who are paid sweatshop wages in labor intensive industries?labor intensive industries? There is no reason for American firms to There is no reason for American firms to

compete with foreign firms in these industriescompete with foreign firms in these industries We should import labor-intensive goods and We should import labor-intensive goods and

produce goods and services in which we can produce goods and services in which we can excel and competeexcel and compete

We should use the proceeds to buy the goods We should use the proceeds to buy the goods and services produced by people who are and services produced by people who are forced to work for very low wagesforced to work for very low wages


The Employment ArgumentThe Employment Argument The flood of imports throw millions of The flood of imports throw millions of

Americans out of workAmericans out of work But if we restrict imports, the governments of our But if we restrict imports, the governments of our

foreign competitors will restrict our exportsforeign competitors will restrict our exports By curbing imports, we will be depriving other By curbing imports, we will be depriving other

nations of the earnings they need to buy our exportsnations of the earnings they need to buy our exports If we restrict our imports, our exports will go down If we restrict our imports, our exports will go down

as wellas well We would just lose the jobs connected with these lost We would just lose the jobs connected with these lost

exportsexports Which would be best? Lose the jobs of workers who work Which would be best? Lose the jobs of workers who work

for companies who can’t or won’t compete or lose the jobs for companies who can’t or won’t compete or lose the jobs of workers who work for companies who can compete but of workers who work for companies who can compete but can’t export their products because of restrictions we can’t export their products because of restrictions we ourselves caused?ourselves caused?


Tariffs or QuotasTariffs or Quotas

A tariff is a tax on importsA tariff is a tax on imports The government gets the resulting revenueThe government gets the resulting revenue A tariff affects all foreign sellers equally. Efficient A tariff affects all foreign sellers equally. Efficient

foreign producers will be able to pay a uniform tariff. foreign producers will be able to pay a uniform tariff. Less efficient producers will not Less efficient producers will not

A quota is a limit on the import of certain goodsA quota is a limit on the import of certain goods Import quotas produce no federal revenuesImport quotas produce no federal revenues Imports quotas are directed against particular Imports quotas are directed against particular

sellers on an arbitrary basissellers on an arbitrary basis Arbitrary quotas may allow relatively inefficient Arbitrary quotas may allow relatively inefficient

producers in and keep out more efficient producersproducers in and keep out more efficient producers


Tariffs or QuotasTariffs or Quotas

A tariff, like any other excise tax, causes A tariff, like any other excise tax, causes a decrease in supplya decrease in supply

Both tariffs and quotas raise the price Both tariffs and quotas raise the price that consumers in the importing that consumers in the importing countries must paycountries must pay

Tariffs are better than quotasTariffs are better than quotas But free trade is bestBut free trade is best


A Tariff Lowers the SupplyA Tariff Lowers the Supply


ConclusionConclusion Economics is all about the efficient allocation Economics is all about the efficient allocation

of scarce resourcesof scarce resources There is no reason why this efficient allocation There is no reason why this efficient allocation

of resources should not be applied beyond of resources should not be applied beyond national boundariesnational boundaries

International trade helps every countryInternational trade helps every country To the degree that we can remove the tariffs, To the degree that we can remove the tariffs,

import quotas, and other impediments to free import quotas, and other impediments to free trade, we will all be better offtrade, we will all be better off

The economics profession nearly unanimously The economics profession nearly unanimously backs free tradebacks free trade


Our Balance of TradeOur Balance of Trade Our balance of trade Our balance of trade compares the dollar compares the dollar

value of merchandise and services we value of merchandise and services we buy from foreigners with the dollar value buy from foreigners with the dollar value of the merchandise and services they buy of the merchandise and services they buy from usfrom us

Our balance of trade is Our balance of trade is our country’s our country’s record of all transactions between its record of all transactions between its residents and the residents of all foreign residents and the residents of all foreign nationsnations


What Are the Causes of What Are the Causes of Our Trade ImbalanceOur Trade Imbalance

““We are consuming more than we We are consuming more than we are producing, borrowing more than are producing, borrowing more than we are saving, and spending more we are saving, and spending more than we are earning.” – Murray than we are earning.” – Murray Weidenbaum Weidenbaum



We have become a nation of We have become a nation of consumption junkiesconsumption junkies We are borrowing about $2 billion a We are borrowing about $2 billion a

day to finance our consumption day to finance our consumption habit.habit.

Most Americans believe that Most Americans believe that somehow we’re entitled to all of somehow we’re entitled to all of these goods and services, even if we these goods and services, even if we need to borrow to pay for them.need to borrow to pay for them.



Our Low Saving RateOur Low Saving Rate Americans are notoriously poor savers. Americans are notoriously poor savers.

In 2005 we managed to spend 100.5 In 2005 we managed to spend 100.5 percent of our disposable incomepercent of our disposable income

If you don’t save, you can’t investIf you don’t save, you can’t invest If you don’t invest, you don’t growIf you don’t invest, you don’t grow Foreign savers have been picking up the Foreign savers have been picking up the

slackslack This will not continue indefinitelyThis will not continue indefinitely



Huge Oil ImportsHuge Oil Imports We import two-thirds of our oilWe import two-thirds of our oil We pay just a fraction of what citizens in other industrial We pay just a fraction of what citizens in other industrial

countries pay for gasolinecountries pay for gasoline Our dependency on oil imports will keep growingOur dependency on oil imports will keep growing In 2005, the cost of oil reached a record high of $252 In 2005, the cost of oil reached a record high of $252

billionbillion High Defense SpendingHigh Defense Spending

Today the United States spends more on defense than Today the United States spends more on defense than the rest of the world put togetherthe rest of the world put together

Stretching our armed forces around the world comes at Stretching our armed forces around the world comes at an extremely high pricean extremely high price

Can we afford to do this?Can we afford to do this?31-36Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

U.S. Trade Deficit With Japan and U.S. Trade Deficit With Japan and China, 1995-2005China, 1995-2005


Japanese Trading PracticesJapanese Trading Practices Japanese compete on the basis of price and Japanese compete on the basis of price and

qualityquality This is driving out American competitorsThis is driving out American competitors

The fundamental difference between ourselves The fundamental difference between ourselves and the Japanese is qualityand the Japanese is quality Better quality also means lower pricesBetter quality also means lower prices

We sell Japan agricultural products and buy We sell Japan agricultural products and buy manufactured products from themmanufactured products from them This is a colonial relationshipThis is a colonial relationship

The Japanese picks winners and then makes The Japanese picks winners and then makes sure they win sure they win


Japanese Trading PracticesJapanese Trading Practices The Japanese consumer has long accepted a The Japanese consumer has long accepted a

lower standard of living because it was lower standard of living because it was necessary for the greater economic goodnecessary for the greater economic good They are willing to pay more for goods they They are willing to pay more for goods they

produce when they could have them cheaper produce when they could have them cheaper if they imported the same goodif they imported the same good

Can you imagine Americans being willing to Can you imagine Americans being willing to make that kind of sacrificemake that kind of sacrifice

Americans would not stand for restricting Americans would not stand for restricting Japanese imports because they are addicted to Japanese imports because they are addicted to Japanese goodsJapanese goods


Our Trade Deficit with ChinaOur Trade Deficit with China We began trading with China in the mid-1970sWe began trading with China in the mid-1970s Although exports to China have grown rapidly, Although exports to China have grown rapidly,

our exports are only about one-sixth of our our exports are only about one-sixth of our importsimports

We import so much from China because U.S. We import so much from China because U.S. retailers are seeking the cheapest goods retailers are seeking the cheapest goods available and are finding them in Chinaavailable and are finding them in China

The Chinese are making unauthorized copies of The Chinese are making unauthorized copies of American movies, CDs, and computer softwareAmerican movies, CDs, and computer software


Trading with China and JapanTrading with China and Japan There are more differences than There are more differences than

similaritiessimilarities Our trading position with Japan is Our trading position with Japan is

much like a colony and a colonial much like a colony and a colonial powerpower

We send airplanes, computers, movies, We send airplanes, computers, movies, compact disk, cars, cigarettes, power-compact disk, cars, cigarettes, power-generating equipment, and computer generating equipment, and computer software to China in exchange for toys, software to China in exchange for toys, clothing, shoes, and low-end consumer clothing, shoes, and low-end consumer electronics electronics


Trading With China and Trading With China and JapanJapan

Japan has never been open to foreign tradeJapan has never been open to foreign trade China has been open to tradeChina has been open to trade Japanese gains in production have led directly Japanese gains in production have led directly

to the loss of millions of well-paying American to the loss of millions of well-paying American jobsjobs

Chinese exports so far have generally not Chinese exports so far have generally not translated into job losses in the United Statestranslated into job losses in the United States

In 2005 we ran a $202 billion trade deficit with In 2005 we ran a $202 billion trade deficit with China and one of $83 billion with JapanChina and one of $83 billion with Japan


Trading with China and Trading with China and JapanJapan

The Chinese and the Japanese The Chinese and the Japanese both insist on licensing both insist on licensing agreements and large-scale agreements and large-scale transfer of technology as the price transfer of technology as the price for agreeing to importsfor agreeing to imports

These agreements, of course, lead These agreements, of course, lead to eventual elimination of imports to eventual elimination of imports from the United Statesfrom the United States


Final WordFinal Word Reducing Our Overall Trade DeficitReducing Our Overall Trade Deficit

We need to maintain our high rate of productivity We need to maintain our high rate of productivity growth and keep improving the quality of American growth and keep improving the quality of American goods and servicesgoods and services

We need to lower our dependence on oil imports by We need to lower our dependence on oil imports by raising the tax on gasolineraising the tax on gasoline

We must, somehow, reduce our trade deficit with We must, somehow, reduce our trade deficit with JapanJapan

We need to do something about our rapidly rising We need to do something about our rapidly rising trade deficit with Chinatrade deficit with China

We need to face up to the fact that we are a nation of We need to face up to the fact that we are a nation of consumption junkiesconsumption junkies

We need to reduce our trade deficit with the rapidly We need to reduce our trade deficit with the rapidly expanding internet which make it much easier to expanding internet which make it much easier to provide services of all types provide services of all types


Current Issue: Current Issue: Buy American? Buy American?

Are we as a nation becoming Are we as a nation becoming more inclined to “buy more inclined to “buy American?”American?”

The bottom line is that The bottom line is that Americans are consumers first, Americans are consumers first, while paying just lip service to while paying just lip service to economic nationalismeconomic nationalism


QuestionsQuestions??

Quick Write-Quick Write-What Kind of Absolute What Kind of Absolute

Advantage or Comparative Advantage or Comparative Advantage Do You Think Advantage Do You Think

You Have Over Other You Have Over Other Students and How Can This Students and How Can This be Used to Your Advantage be Used to Your Advantage

When You Graduate?When You Graduate?

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Econ 2301 Dr. Jacobson Mr. Stuckey Week 4 Chapters 4 & 5.

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