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International TradeInternational Trade
ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014
International Trade
Basis for trade: Comparative Advantage
Who has the lower “opportunity Who has the lower “opportunity cost?”cost?”
Mistaken basis for trade: Absolute Advantage
Who has the lower resource cost?Who has the lower resource cost?
Consider Senegal and Peru:
Example: Absolute Advantage
Who can more cheaply produce wool?Who can more cheaply produce wool?
Who can more cheaply produce beef?Who can more cheaply produce beef?
Wool (#) Beef (#) # of R.U.Senegal 2.5 1 100,000
Peru 3 2 150,000
Resource Units to produce:
Example: Comparative AdvantageReconsider Senegal and Peru:
What does it “cost” to produce wool?What does it “cost” to produce wool?
What does it “cost” to produce beef?What does it “cost” to produce beef?
Wool (#) Beef (#)Senegal 40,000 100,000
Peru 50,000 75,000
Maximum production of:
Comparative AdvantageOpportunity costs in Senegal and Peru:
With trade, wool would “sell” for . . .?With trade, wool would “sell” for . . .?
With trade, beef would “sell” for . . .?With trade, beef would “sell” for . . .?
Price = Terms of Trade; say 1# W=2# B
1# Wool 1# BeefSenegal 2.50 0.40
Peru 1.50 0.67in # beef in # wool
Opportunity Cost:
Trade ObservationsNot all countries have absolute advantages.Not all countries have absolute advantages.
All countries do have comparative All countries do have comparative advantages.advantages.
Country size is irrelevant.Country size is irrelevant.
Opportunity cost = what you give up.Opportunity cost = what you give up.
The international trading price of goods is The international trading price of goods is called the “terms of trade.”called the “terms of trade.”
Back to Senegal/Peru trade example:Assume without trade, resources are split evenly.
Senegal always wants 50,000 #B;Peru always wants 25,000 #W.
Advantages to Trade
A - the “no trade” outcome; production=consumptionA - the “no trade” outcome; production=consumption
B - the specialized production outcome, with tradeB - the specialized production outcome, with trade
#Wool
#Beef
Senegal
40,000
100,000
50,0050,0000
20,0020,0000
#Wool
#Beef
Peru
50,000
75,00037,5037,5000
AA AA
BB
BB
25,0025,0000
Advantages to Trade
A - the “no trade” outcome; production=consumptionA - the “no trade” outcome; production=consumption
B - the specialized production outcome, with tradeB - the specialized production outcome, with trade
C - the consumption outcome, with trade.C - the consumption outcome, with trade.
#Wool
#Beef
Senegal
40,000
100,000
#Wool
#Beef
Peru
50,000
75,000
BB
BB
CC
50,0050,0000
25,0025,0000
CC
50,0050,0000
25,0025,0000
Advantages to Trade
Before trade, world production was:Before trade, world production was:Wool: 45,000 lbs.Wool: 45,000 lbs.Beef: 87,500 lbs.Beef: 87,500 lbs.
With trade, world production has become:With trade, world production has become:Wool: 50,000 lbs.Wool: 50,000 lbs.Beef: 100,000 lbs.Beef: 100,000 lbs.
Gains to trade:Gains to trade:Wool: +5,000 lbs.Wool: +5,000 lbs.Beef: +12,500 lbs.Beef: +12,500 lbs.
Effects of Trade BarriersIn Senegal, unrest among the shepherds.
Workers must relocate.
Owners must relocate.
Politicians seek to “protect” domestic producers. Here, wool . . .
Consider two trade barriers – an import quota and a tariff.
Policy #1 - Import QuotaPolicy #1 - Import Quota
Limit imports to 10,000 pounds of wool.Limit imports to 10,000 pounds of wool.
Now, neither can completely specialize.Now, neither can completely specialize.
Each has a lower standard of living.Each has a lower standard of living.
World production:World production:
Wool: 47,000#Wool: 47,000#
Beef: 92,500#Beef: 92,500#
#Wool
#Beef
Senegal
40,000
100,000
#Wool
#Beef
Peru
50,000
75,000
QQQ*Q*
50,0050,0000
22,0022,0000
Q*Q*
42,5042,5000
25,0025,0000
35,0035,0000
22,5022,5000
They can only trade They can only trade 10,000#, so they only 10,000#, so they only
produce 35,000#.produce 35,000#.This takes 70% of This takes 70% of their RUs, so rest is their RUs, so rest is
used to produce beef.used to produce beef.They can only They can only get 20,000# get 20,000# B in trade.B in trade.
70,0070,0000
12,0012,0000
They can only trade They can only trade 20,000#, so they only 20,000#, so they only produce 70,000# B.produce 70,000# B.Trade Trade
20,000# B for 20,000# B for 10,000# W.10,000# W.
Use remaining Use remaining resources to produce resources to produce
12,000 # W.12,000 # W.
Policy #2 - TariffPolicy #2 - Tariff
Tariff (tax) changes ToT: 1# W = 2.25# BTariff (tax) changes ToT: 1# W = 2.25# B
Tax goes to government of Senegal.Tax goes to government of Senegal.
But, still no domestic wool production!But, still no domestic wool production!
#Wool
#Beef
40,000
100,000
#Wool
#Beef
50,000
75,000
FF
FF
F*F*
50,0050,0000
22,2222,2222
F*F*
48,6148,6111
25,0025,0000
47,2247,2222
Senegal Peru
4,164,1677
World production:World production:
Wool: 47,222#Wool: 47,222#
Beef: 100,000#Beef: 100,000#
50,000# B 50,000# B now “cost” now “cost”
22,222# W!!22,222# W!!
(50,000/2.25)(50,000/2.25)
But, 22,222# But, 22,222# wool will still wool will still
earn Peruvians earn Peruvians 44,444# beef.44,444# beef.
Advantages to Trade & Disadvantages to Trade Barriers
Before trade, world production was:Before trade, world production was:Wool: 45,000 lbs. Beef: 87,500 lbs.Wool: 45,000 lbs. Beef: 87,500 lbs.
With trade, world production was:With trade, world production was:Wool: 50,000 lbs. Beef: 100,000 lbs.Wool: 50,000 lbs. Beef: 100,000 lbs.
With tariff, world production was:With tariff, world production was:Wool: 47,222 lbs. Beef: 100,000 lbs.Wool: 47,222 lbs. Beef: 100,000 lbs.
With quota, world production was:With quota, world production was:Wool: 47,000 lbs. Beef: 92,500 lbs.Wool: 47,000 lbs. Beef: 92,500 lbs.
Trade LessonsWe trade on the basis of our comparative We trade on the basis of our comparative advantage.advantage.
Everyone has a comparative advantage.Everyone has a comparative advantage.
Trade raises our material standard of Trade raises our material standard of living.living.
Trade barriers lower our standard of Trade barriers lower our standard of living.living.
Responding to trade barriersResponding to trade barriersin kind makes us worse off.in kind makes us worse off.
Trade BarriersImport quotas to keep foreign goods out.Import quotas to keep foreign goods out.
Tariffs that serve as a tax on foreign Tariffs that serve as a tax on foreign goods.goods.
Subsidies for producers of export goods.Subsidies for producers of export goods.
Impose standards on foreign goods (Impose standards on foreign goods ( costs).costs).
The false rhetoric of protection:The false rhetoric of protection:cheap foreign labor, infant industry,cheap foreign labor, infant industry,national defense, beggar-thy-neighbornational defense, beggar-thy-neighbor
International TradeInternational Trade
ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014