Zimbabwe tusk burning

TRADEBenefits, Costs, and Obstacles

Outline• Why do countries trade?

• Comparative Advantage

• How much trade?• Go to the data

• Within countries who benefits from trade?• It depends, look at demand and supply

Why trade?• Mercantilism

• Trade to increase nation’s wealth

• Smith• Absolute advantage allows us to consume more than our resources alone would produce

• Ricardo• Comparative advantage explains trade with unequal

nations

Trade leads to:

• Specialization thus advancement of knowledge

• Economies of scale and competition

• Comparative advantage thus greater overall production

Production Possibilities Frontier• Shows what a country can make with their resources• AND it shows the opportunity cost of producing each good•

• Each bale of wheat• costs 3b cotton• And each b cotton• costs 1/3b wheat

Calculating those opportunity costs:

Back to PPF Cost in wheat per bushel cotton 200 wheat / 600 cotton = 1/3 wheat per cotton

1 cotton costs 1/3 wheat

Cost in cotton per bushel of wheat 600 cotton / 200 wheat = 3 cotton per wheat

1 wheat costs 3 cotton

Compare PPFs

Cost of wheat is 3b cotton Cost of wheat is 1/3 b cottonWhich country produces wheat cheaper?

Cost of cotton is ____ wheat. Cost of cotton is ______ wheat.Which country produces cotton cheaper?

Comparative Advantage• When countries have different opportunity costs of production there is room for trade

If each country specializes at 600b of cotton or wheat and trades 1 for 1. Both countries can get to 300 wheat and 300 cotton.

Free trade can:

•Increase the consumption possibilities for each nation

From Smith to Ricardo

Absolute Advantage

• Each country has an absolute strength.

Comparative Advantage

• Even if one country does everything better, still room for trade.

• Why would Skipper trade?

PCs Oranges

India 8 4

US 4 8

PCs Oranges

Skipper 10 5

Gilligan 9 3

Finding Comparative Advantage

PCs OrangesSkipper 10 5

Gilligan 9 3

Find cost of one good in terms of the otherSkipper 1 PC costs 5/10 or

½ orange1 orange costs 5 or 2 PCs

Gilligan 1 PC = 3/9 = 1/3 orange

1 orange = 3 PCs

Ask:

Who has the lower opportunity or production costs?

PRACTICE PROBLEM

Determine the opportunity costs to find the comparative advantages.

Who should cut wood and who should gather food?A.Colleen bothB.Bill bothC.Colleen fuel and Bill food D.Colleen food and Bill fuel

Production per Day

Fuel (Logs) Food (Bushels)

Colleen 10 10

Bill 5 8

Who has the absolute advantage in chips production?i.US ii. UK

What is the cost of 1 chip for the UK?i.½ fish ii. 1 fish iii. 2 fish

Who has the comparative advantage in fish?i. US ii. UK

Fish ChipsUS 50 150

UK 20 40

Sources of Comparative Advantage

• Natural Resources

• Factor Proportions: lots-low skill labor

• Increasing Returns to Scale• Division of Labor: Decreasing LRATC• Division of Knowledge: heart surgeons vs opthamologist

• Institutions• Banking, Labor mobility, Education, Contract enforcement

WHO BENEFITS WITHIN COUNTRIES?Look to demand and supply

Free trade

Works when:

• Transport prices are low

• No trade barriers are in place

Is hindered by:

• Different currencies

• Language and Culture barriers

• Different safety and environmental standards

• Tariffs and quotas

Use world market to determine whether to import or export

World price aboveDomestic price

Sellers better offSurplus production at world priceEXPORT

World price below Domestic price

Demanders better offShortage at world priceIMPORT

Trade makes countries better off overall

• But in some cases, consumers pay more

• And in other cases, suppliers lose sales and profits

The costs of trade can lead to protectionism.

Usually from producers who cannot compete against cheaper imports.

But what about

Protectionism

• Quotas –• Limit on the amount of a

good imported

• Tariffs – • Tax on imported goods

Quota • Restricts how muchOf foreign good comes in• Now trade at Pquota

• Impacts:• Consumers: P up, Q down• Domestic Producers: P up, Q up, TR up• Foreign Producers: P up, Q set, TR up• Government: enforcement costs

Domestic + foreign supply

S with world trade

Pno trade

Before Trade After Trade With Quota

P = $6, Q = 3P = $3Domestic Supply = 1.5With World Supply = 4.5

P = $4Domestic supply = 2With World Supply = 4

World PriceWith Quota

Tariff • Shifts the world price up

• Impacts:• Consumer: P up, Q down• Domestic Producer: P up, Q up, TR up• Foreign Producer: P down, Q down, TR down• Government: Increase revenue, Enforcement costs

Before Trade After Trade With Tariff

P = $6, Q = 3P = $3Domestic Supply = 1.5With World Supply = 4.5

P = $4Domestic supply = 2With World Supply = 4Govt revenue box

World Price Plus tariff

Reasons for Protectionism• National Security – secrecy of defense systems

• Domestic unemployment – save jobs

• Infant Industry – establish a new product space

• Strategic trade reasons – tit for tat

Costs of Protectionism• Loss of Efficiency• Consumers pay more for downstream goods• Spillover effects, raising the costs for other industries• Risk retaliation from other countries• Makes a scarcer dollar thus fewer exports sold

• In 1984, consumers paid• $42,000 for every textile job saved• $105,000 for every auto manufacturing job, and• $750,000 for every job in the steel industry

Candlemaker’s PetitionFrederic BastiatMid 1800sFrance

Because trade hurts someone – there will always be calls for help

Usually from the producers

Not everyone is happy

• Quinoa in Bolivia• Radio story min, • http://www.cbc.ca/player/News/Canada/Audio/ID/2331907855/?

page=3

• Pistachios in Iran

Trade Agreements

Trans Pacific Partnership (TPP)

What about Fair trade?

What elseThe International Monetary Fund and the World Bank at a Glance•International Monetary Fundoversees the international monetary system•promotes exchange stability and orderly exchange relations among its member countries•assists all members--both industrial and developing countries--that find themselves in temporary balance of payments difficulties by providing short- to medium-term credits•supplements the currency reserves of its members through the allocation of SDRs (special drawing rights); to date SDR 21.4 billion has been issued to member countries in proportion to their quotas•draws its financial resources principally from the quota subscriptions of its member countries•has at its disposal fully paid-in quotas now totaling SDR 145 billion (about $215 billion)•has a staff of 2,300 drawn from 182 member countries

•World Bankseeks to promote the economic development of the world's poorer countries•assists developing countries through long-term financing of development projects and programs•provides to the poorest developing countries whose per capita GNP is less than $865 a year special financial assistance through the International Development Association (IDA)•encourages private enterprises in developing countries through its affiliate, the International Finance Corporation (IFC)•acquires most of its financial resources by borrowing on the international bond market•has an authorized capital of $184 billion, of which members pay in about 10 percent•has a staff of 7,000 drawn from 180 member countries

Another tryRotoid Tauron

Mandovia 50 100

Ducennia 150 200

What is the opportunity cost in each country for production?

Who will export what?