The big picture marcoeconomics 12e parkin chapter 15

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W H AT I S E C O N O M I C S ? 137 C h a p t e r The Big Picture INTERNATIONAL TRADE POLICY Where we have been: Chapter introduced the gains from trade in a simple model with a linear PPF’s This chapter continues the explanation of the gains from trade by looking at individual markets using the demand and supply model, first developed in Chapter The chapter also reviews the effects of, case against, and reasons for trade restrictions and protection with a focus on the loss resulting from trade restrictions You might want to this chapter after Chapter and before getting into traditional Macro topics It could be especially helpful background information to have prior to discussing exchange rates in Chapter It can also be helpful to assist the students in Chapter 4’s discussion of net exports N e w i n t h e Tw e l f t h E d i t i o n This chapter is mostly the same as the 11 th edition with updates to data through 2013 The chapter ends with a new Economics in the News article about the difficulty of achieving a free trade agreement A new Worked Problem section has been introduced The Worked Problem covers comparative advantage and prices in the global market It gives U.S demand and supply schedules for honey and the world price of honey It shows the students how to calculate the no-trade equilibrium price and quantity and, from these results, how to determine whether the United States imports or exports honey Then it demonstrates how the quantity produced, consumed, and traded internationally changes when honey is opened to trade Finally it shows the students how to calculate the U.S gain from trade and the distribution of the gains and losses The study plan problems have been revised and expanded To include the new Worked Problem without lengthening the chapter, some problems have been removed from the Study Plan Problem and Applications These problems are in the MyEconLab and are called Extra Problems 137 Lecture Notes International Trade Policy    I Comparative advantage means that all countries can gain from trade Society gains from international trade There are many arguments in favor of restricting international trade, but restricting free trade results in loss to society How Global Markets Work The Big Assumption: Counties cannot be identical! Of all the assumptions economist make this one is easy to swallow The basis for international trade is simply recognizing that countries are different and then exploiting those differences to benefit all countries involved Ask your class how countries differ (quality and quantity of resources, climate, etc.) Now point out to them that one reason to trade is to acquire goods that you cannot make yourself A tougher question is why we want to trade for goods that we can make ourselves  The goods and services that we buy from people in other countries are called imports The goods and services that we sell to people in other countries are called exports International Trade Today The United States is the world’s largest international trader and accounts for 10 percent of world exports and 13 percent of world imports  In 2013, total U.S exports were $2.3 trillion, which is about 14 percent of the value of U.S production  Total U.S imports were $2.7 trillion, which is about 17 percent of total expenditure in the United States  The value of exports minus the value of imports is called net exports In 2013, U.S net exports were negative $0.4 trillion (Exports were $2.3 trillion and imports were $2.7 trillion.) What Drives International Trade?  The fundamental force that generates international trade is comparative advantage A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country By specializing in producing the good for which each country has comparative advantage, both countries gain from international trade For more data on international trade: Data on U.S international trade can be accessed at the Bureau of Economic Analysis web site www.bea.gov/international/index.htm Key facts worth emphasizing are the enormous growth in volume of trade over time and huge two-way trade in manufactures Explain that the balance of trade results from spending and saving decisions in the United States and the rest of the world and is independent of the forces that generate the volume of trade, which this chapter covers U.S Exports  The United States will export goods for which it has comparative advantage In the figure the world price of coal is $60 per ton and the price in the United States before trade is $40 per ton The United States has a comparative advantage in I N T E R N AT I O N A L T R A D E P O L I C Y  producing coal because the price before trade is lower than the world price In this case the United States will export coal In the figure, before international trade the price of coal in the United States was $40 per ton and at that price the United States produced million tons of coal per year and consumed million tons per year With international trade the price in the United States rises to the world price, $60 per ton At that price the United States produces million tons of coal per year, consumes million tons per year, and exports the difference, million tons per year U.S Imports   The United States will import goods in which it does NOT have a comparative advantage In the figure, the world price of automobiles is $20,000 per car and the price in the United States before trade is $40,000 per car, so the United States does not have a comparative advantage in producing automobiles In this case the United States will import cars In the figure, before international trade the price of a car in the United States was $40,000 per car and at that price the United States produced million cars per year and consumed million cars per year With international trade the price in the United States falls to the world price, $20,000 per car At that price the United States produces million cars per year, consumes million cars per year, and imports the difference, million cars per year Winners and Losers From International Trade   When a country starts to export goods, its domestic price rises to the higher world price Therefore, exports raise the U.S price of the good or service domestically With the higher price domestic consumers lose and domestic producers gain On net, society gains because the winners’ “wins” are larger than the losers’ “losses.” When a country begins importing, its current domestic price falls to the lower world price Therefore, imports lower the U.S price of the good or service With the lower price domestic consumers win and domestic producers lose On net, society gains because the winners’ “wins” are larger than the losers’ “losses.” The Fable of Adam Blackbox: There is an enormously rich heritage of stories, parables, fables, and satires that you can use to enliven your classes on this topic The following fable, inspired by James Ingram (from International Economic Problems, John Wiley, 1970) is a powerful way to begin Make up your own version with local flavor and embellishment Adam Blackbox announces that he has discovered an amazing way to produce low-price, high-quality automobiles He sets up a plant on a large tract of land along the coast of Massachusetts, hires 10,000 employees, swears them to secrecy, and begins delivering his low-price, high-quality autos to the nation’s showrooms Adam Blackbox is hailed as an American industrial hero Blackbox Enterprises floats stock and Wall Street booms Consumers love him His automobiles are better and cheaper than those they could buy before he came along Automakers hate him, but their attempts to pass laws to restrict his operations fail The president and Congressional leaders explain that economic adjustment is an inevitable consequence of technological advance And Adam Blackbox’s new technology for delivering low-price, high-quality automobiles is clearly part of the process of achieving greater prosperity for all 147 148 CHAPTER 15 The press becomes increasingly curious about what is going on in the giant New England auto plant Investigative journalists create endless hours of speculative television programming on the amazing new technology Then a tabloid journalist with a big checkbook finds a worker who is willing to talk Adam Blackbox's secret is revealed Nothing is produced at the plant Adam Blackbox is a trader, not a producer He buys grain from American farmers, exports it to Japan, and imports automobiles from Japan His secret revealed, Adam Blackbox is hauled before Congressional committees on fair trade and denounced as an evil destroyer of American jobs The president makes a special State of the Union speech in which he denounces Adam Blackbox, praises a vigilant press for saving Americans from the threat of cheap foreign labor, and announces a new budget initiative that will spend $50 billion on research in technologies to produce low cost, highquality automobiles Ask your students why the president and Congress accepted Adam Blackbox initially but then changed their tune Was Adam Blackbox hurting America or helping America? II International Trade Restrictions  Governments restrict international trade to protect domestic industries from foreign competition using tariffs, import quotas, other import barriers, and subsidies Tariffs    A tarif is a tax that is imposed by the importing country when an imported good crosses its international boundary A tariff increases the price of the good in the nation As a result, the following occur:  Consumers buy less of the good and producers increase the quantity supplied;  Government collects tariff revenue equal to the tariff times the quantity imported of the good;  Less of the good is imported;  A social loss results These results are shown in the figure The government imposes a $10,000 per car tariff on imported automobiles so the U.S price rises to $30,000 U.S consumption of cars decreases from million per year to million and U.S production increases from million per year to million so that imports decrease from million per year to million The government gains tariff revenue Import Quotas  An import quota is a restriction that limits the maximum quantity of a good that may be imported in a given period  A quota increases the price of the good in the nation As a result, the following occur:  Consumers buy less of the good and producers increase the quantity supplied;  The importers collect additional profit;  Less of the good is imported;  A social loss results I N T E R N AT I O N A L T R A D E P O L I C Y  These results are shown in the figure The government imposes a million per year import quota on automobiles as shown With this quota the supply curve becomes the U.S supply curve below the world price of $20,000 per car and then the U.S curve plus the million import quota at prices above the $20,000 world price The U.S price rises to $30,000 per car As a result U.S consumption of cars decreases from million per year to million and U.S production increases from million per year to million Imports decrease from million per year to million Other Import Barriers   Although they are not designed to limit international trade, health, safety, and regulation barriers have that effect Voluntary export restraints, while not common, act like a quota and exist if a country voluntarily limits its exports Export Subsidies  An export subsidy is a payment by the government to the producer of an exported good Although export subsidies are illegal under many international agreements, the United States and the European Union pay subsidies to their farmers that result in increased domestic production, some of which is imported III The Case Against Protection Arguments for protection include the following:  Helps an infant industry grow: The so-called infant-industry argument for protection is that it is necessary to protect a new industry to enable it to grow into a mature industry that can compete in world markets The idea relates to dynamic comparative advantage in comparative advantages change over time due to learning-by-doing (from Chapter 2) However, the infant industries argument only applies if the benefits of learning-by-doing spill over to other industries  Counteracts dumping: Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production Dumping might be used by a firm that wants to gain a global monopoly However, it is difficult to measure the cost of production so whether dumping is taking place is difficult to determine And charging a different export price than domestic price is not necessarily evidence of dumping because firms often sell goods and services for different prices in different markets  Saves domestic jobs: The argument that trade protection saves jobs is flawed International trade changes the type of jobs in an economy, but it does not decrease employment in the aggregate because jobs lost in one sector are offset by jobs created in other sectors  Allows us to compete with cheap foreign labor: The argument that trade protection allows us to compete with cheap foreign labor is flawed Differences in real wage rates generally reflect differences in productivity, and competitiveness is determined by both differences in wages and differences in productivity  Penalizes lax environmental standards: The argument that trade liberalization leads to a “race-to-the-bottom” in environmental standards is weak Many poorer countries have comparable environmental standards and should not be targeted And environmental standards are positively related to income (they are a normal good) The best way to encourage improved environmental standards is to allow trade and the economic benefits it brings to poorer countries  Prevents rich countries from exploiting developing countries: The argument for protection to prevent people of the rich industrial world from exploiting the poorer people of the developing countries is wrong While wage rates in many developing countries are very low, they would be even lower without foreign demand for the goods that these countries produce 149 150  CHAPTER 15 Reduces offshore outsourcing that sends good U.S Jobs to other countries Offshore Outsourcing   When U.S firms send jobs that could be done in America to another country, they are offshoring If U.S firms buy finished goods from other U.S or foreign firms, they are outsourcing Offshoring brings gains from specialization, but those who have invested in human capital to a specific job that has now gone offshore will be hurt Does free trade exploit workers in developing countries? Students might be somewhat familiar with the terminology of “exploitation.” Have the students think about what “exploitation” means in the context of voluntary trade If I benefit from someone I trade with, did I exploit them? Did they exploit me? If trade is voluntary, how did I manage to exploit the person whom I traded with? Is it because I am smarter than the other person? This seems to be the condescending assumption of those who talk about exploitation of workers in developing countries Indeed, representatives from many developing countries not see trade as exploitation, but rather see it as a way to improve standards of living When these representatives are upset at WTO meetings, it is usually about the trade restrictions rich countries place on imports from developing countries keeping developing countries poor Why is International Trade Restricted? Despite arguments against protection, trade is still restricted because key economic interests benefit from protection  Tariff revenues provide a relatively inexpensive way for the government to collect revenues  Rent seeking is lobbying and other political activity that seek to capture the gains from trade While the benefits from liberalized trade are large in the aggregate, they are widespread across all consumers Meanwhile, the costs are concentrated on a smaller number of producers It is in the interests of those who pay the costs of liberalized trade to undertake a large quantity of political lobbying to promote protection  If the gains from free trade exceed the losses, it is possible to compensate the losers so that everyone is in favor of free trade To some extent, unemployment compensation and job-retraining programs are designed to serve this purpose However, providing compensation is difficult because it is hard to identify exactly who has lost a job as a result of free international trade and not because of other reasons Another fable: There is also a rich heritage of stories, parables, fables, and satires on protectionism But it is hard to beat Bastiat’s Claude Frederic Bastiat (1801–1850) is a very interesting French economist An ardent advocate of free trade, he wrote articles with Richard Cobden (the famous English free trader and opponent of the Corn Laws) His most wonderful piece is his satirical “Pétition des marchands de chandelles …” “Petition from the Manufacturers of Candles, Tapers, Lanterns, Sticks, Street Lamps, Snuffers, and Extinguishers, and from Producers of Tallow, Oil, Resin, Alcohol, and Generally of Everything Connected with Lighting,” to give it its full title The basic idea is that the sun creates unfair competition for candle merchants and a law must be passed to ban all windows and other openings that enable it to shine its light inside buildings You can have a lot of fun with it not only in the context of trade, but also to talk about opportunity cost and production possibilities For further reading: If you haven’t already done so, read this nice little book and use its basic ideas to illustrate and illuminate the analysis of the false arguments of protectionists: I N T E R N AT I O N A L T R A D E P O L I C Y Russell D Roberts, The Choice: A Fable of Free Trade and Protectionism, Updated and Revised Edition, 2000, Prentice Hall (ISBN: 0130870528) The book tells the story of David Ricardo being granted God’s permission to return to Earth and meet with Ed Johnson, a 1950s U.S television manufacturer Ricardo has some powers that enable him to create counterfactuals and to travel through time The dialog between Ricardo and Johnson provides a powerful commentary on the benefits of free trade and the costs of protectionism Unrestricted international trade benefits all the countries involved with trade Emphasize the key benefits from unrestricted international trade: The gains from international trade arise from the diversity of opportunity costs of production across countries The source of prosperity in free trade arises from each country generating gains from specialization in their comparative advantage, minimizing its own opportunity cost of production, and sharing in each of the other country’s gains Both exporting and importing domestic industries benefit from free trade Free trade liberates each country’s consumption possibilities from the bonds of their own production possibilities frontier, enabling the consumers in both the importing and exporting country to enjoy consumption bundles of goods and services that would be unobtainable without trade Restrictions on international trade hurt the importing firms, the consumers of imports, the domestic exporting firms, and even the non-exporting firms Protecting domestic industry from international competition backfires: i) it increases the relative price that other countries pay for domestically produced goods and services that are exported; ii) it raises the price of the imported goods consumed by domestic consumers; and iii) it lowers the income of producers of the goods for which the country has a comparative advantage in production by more than the increase in the incomes of those industries that gain from trade restrictions Together, these influences decrease the total demand for domestic goods and services in the country imposing trade restrictions by more than the increase in demand for those domestic goods and services in industries for which the country does not have a comparative advantage International trade is a “win-win” situation for all countries involved in trade This is the most important message that can be delivered from this chapter All legitimate counterpoints are rooted in the concern over unequal distributions of the gains from trade that are created Emphasize that economic efficiency and economic prosperity can be achieved only through free trade among nations, and that the gains generated are more than sufficient to reimburse those individuals whose lives are made worse off from free trade Point out that it is the difficulties of implementing such a reimbursement program are what prevent such programs from being established on a large scale There is no good economic argument in support of trade restrictions Dispel the many myths surrounding various justifications for imposing trade restrictions The section of the chapter entitled “Cases Against Protection” contains concise and complete counterarguments to the often heard justifications for restraining international trade Emphasize that economists are overwhelmingly agreed that there is no good argument against free trade The chapter ends with a new Economics in the News on the problems with reaching an agreement in the Transpacific Partnership trade negotiations The talks have focused on cars and agriculture Failing to reach agreement between the United States and Japan on these issues is a setback in terms of achieving broader agreement The analysis shows the potential gains from reaching a trade agreement 151 152 CHAPTER 15 Additional Problems Suppose that the world price of bananas is 18 U.S cents a pound and that when Australia does not trade bananas internationally, their equilibrium price in Australia is 12 U.S cents a pound If Australia opens up to international trade, does it export or import bananas? Explain how the price of bananas in Australia changes How does the quantity of bananas consumed in Australia change? How does the quantity of bananas grown in Australia change? Suppose that in response to huge job losses in the U.S textile industry, Congress imposes a 100 percent tariff on imports of textiles from China a Explain how the tariff on textiles will change the price of textiles, the quantity of textiles imported, and the quantity of textiles produced in the United States b Explain how the U.S and Chinese gains from trade will change Who in the United States will lose and who will gain? In the 1950s, Ford and General Motors established a small car-producing industry in Australia and argued for a high tariff on car imports The tariff has remained through the years Until 2000, the tariff was 22.5 percent What might have been Ford’s and General Motor’s argument for the high tariff? Is the tariff the best way to achieve the goals of the argument? Use the information below to answer the following question U.S Expands China Paper Anti-Dumping Tarif Responding to a case brought by the NewPage Corporation of Dayton, Ohio, the U.S Commerce Department announced it was imposing a tariff of 99.65 percent on imported glossy paper from China Glossy paper is the type of paper used to manufacture art books, high-end magazines, textbooks, and annual reports In 2006 imports of glossy paper from China was estimated to be $224 million Reuters, May 30, 2007 a What is dumping? Who in the United States loses from China’s dumping of glossy paper? b What argument might NewPage Corp have used to persuade the U.S Commerce Department to impose a 99.65 percent tariff? c Explain who, in the United States, will gain and who will lose from the tariff on glossy paper How you expect the prices of magazines and textbooks that you buy to change? Solutions to Additional Problems With no international trade, the price in Australia is less than that in the world, so Australia has a comparative advantage in producing bananas As a result, if Australia opens up to international trade, it will export bananas With international trade, the price of bananas in Australia rises The higher price leads to a decrease in the quantity of bananas consumed in Australia The higher price also leads to an increase in the quantity of bananas grown in Australia a Higher tariffs increase the price U.S consumers pay for textiles imported from China Because the price of Chinese imported textiles rises, the quantity imported decreases The quantity of textiles produced in the United States increases I N T E R N AT I O N A L T R A D E P O L I C Y b This trade restriction means that the U.S and Chinese gains from trade definitely decrease Textile workers and owners of textile firms will gain from the higher price Textile consumers will lose from the higher price Most likely the argument in favor of the tariff was the infant-industry argument According to proponents of this argument, protection is necessary to a new industry to enable it to grow into a mature industry that can compete in world markets Alternatively, Ford and General Motors might also have argued that a high tariff was necessary to protect Australian jobs Protection is not the best way to achieve these goals A more efficient way to protect infant industries is to subsidize the firms in the industry And the jobs lost in the auto sector will be regained in other sectors devoted to exporting Australian goods a Dumping is when a foreign firm sells its exports at a lower price than the cost of production U.S producers of glossy paper lose from China’s dumping of glossy paper b Dumping is illegal under the rules of international trade, so dumping is regarded as a justifiable reason for a temporary tariff NewPage might have argued that Chinese exporters of glossy paper were charging a price of (approximately) one half the cost of production In this case a tariff of 99.65 percent will (approximately) double the U.S price of the imported glossy paper, thereby raising the price to the (alleged) cost of production c The U.S producers of glossy paper (such as NewPage!) will gain The U.S government also will gain because it will receive additional tariff revenue U.S consumers of glossy paper will lose The higher price of glossy paper increases the costs of magazine and textbook publishers The supply of magazines and textbooks decreases so their price rises Additional Discussion Questions How can we know that the benefits to the economy from free trade are greater than the benefits accruing to the domestic industry that is protected from foreign competition? Stress to the students that if unrestrained international trade creates the efficient outcome for both countries involved, it also must mean that prosperity for each country is maximized  Emphasize that free trade between nations encourages each country to pursue specialization in production in those industries for which the country has a comparative advantage relative to other countries  If the total quantity of goods and services consumed in each country after international trade is greater than without international trade, then total incomes accruing to individuals must be greater, which means the prosperity of each nation’s economy as a whole is greater under free trade How will countries know which domestic industries have a comparative advantage in order to allocate resources towards specialization in producing those goods and services? Specialization and gains from international trade will arise naturally through relative price changes on the world market  When domestic firms within an industry have a lower opportunity cost of production than firms in other countries, these firms discover that the price they can receive from foreign buyers (importers from other countries) is higher than the price they can receive from domestic consumers These 153 154 CHAPTER 15   domestic firms increase output, demand more labor, capital, and raw materials, and resources flow toward these industries When domestic firms within an industry have a higher opportunity cost of production than firms in other countries, domestic consumers discover that the price they must pay to foreign sellers for a good than the price they must pay domestic producers Domestic consumers switch their purchases to foreign imports The domestic firms producing this good decrease output, decrease their use of labor, capital, and raw materials, and resources flow away from these firms Each country’s economy naturally becomes specialized in producing output in those industries for which the country enjoys a comparative advantage However, for each country to gain, each country must allow consumers and producers to have free access to foreign markets Shouldn’t we protect the workers of those industries that are hurt by foreign competition? Point out that protecting the workers in industries for which our country does not have a comparative advantage is akin to making everyone in the economy suffer a lower level of prosperity than under unrestricted trade—all to ensure that a small minority of people does not suffer the economic losses associated with relocating to another community and finding employment in another industry Use some specific examples in recent history:  If Congress imposes import quotas on Japanese vehicles being imported into the United States, tens of thousands of American autoworkers would be forced to find employment in another industry Compare this to the tens of millions of car buyers each year that must pay hundreds or even thousands of extra dollars for their cars  In 2002, President George W Bush signed into law a tariff on foreign steel by some 30 percent He effectively cost the hundreds of millions of American consumers tens of billions of dollars in higher prices for the myriad of goods containing steel, as well as those goods and services requiring transportation in trucks, trains, airplanes, and ships that are made from steel He did this seeking political support from those states with a large presence of steel workers who work for firms that could not make a profit at the unregulated world market price of steel The president’s defense was that other nation’s steel industries were receiving subsidies and had an “unfair “ advantage in production costs, effectively “dumping” steel in the U.S markets at prices below production costs Ask the students: What is “unfair” about having foreign governments effectively subsidizing the purchase of automobiles, trucks, and rail and air transportation by hundreds of millions of American citizens? Point out it is only “unfair” to the tens of thousands of steel workers who stand to face job relocation costs of finding work in another industry  Emphasize that in each of these cases of trade restrictions, the economy as a whole would have gained from free international trade, but the autoworkers and the steel workers are groups of people that are much more easily organized and stand to benefit much more individually from trade restrictions than the wide-spread American consumers The result is successful lobbying efforts to restrict trade to the detriment to all consumers in the American economy ... these issues is a setback in terms of achieving broader agreement The analysis shows the potential gains from reaching a trade agreement 151 152 CHAPTER 15 Additional Problems Suppose that the. .. receive from foreign buyers (importers from other countries) is higher than the price they can receive from domestic consumers These 153 154 CHAPTER 15   domestic firms increase output, demand... very low, they would be even lower without foreign demand for the goods that these countries produce 149 150  CHAPTER 15 Reduces offshore outsourcing that sends good U.S Jobs to other countries
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