Transcript 2 pizzas - UCSB Economics

International trade
Today: Winners and losers of
various international trade policies
Today: More on international
trade
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Addressing concerns about trade
Review of comparative advantage
Examining consumption possibilities
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Without trade
With trade
Supply and demand analysis of trade
Tariffs and Quotas
“Outsourcing”
Addressing concerns about
trade
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“A majority of Americans, including 60
percent of Republicans, now believe
free trade is bad for the U.S. economy,
according to recent NBC News-Wall
Street Journal polls.”
(Source: “Trade jitters, anti-China sentiment rouse
US voters,” Reuters, Nov. 14, 2007)
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Why do so many Americans have this
opinion about trade?
Trade has costs and benefits
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When another country can produce
goods lower than in the United States,
two things happen
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Jobs are lost in the United States
Consumers pay lower prices for the good
that is now imported
The news media usually focuses on the
jobs issue more than about prices
Why is media coverage
skewed?
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Any job lost seriously deteriorates the
quality of life of an individual
Most people don’t care to read
headlines advertising “The price of rice
goes down by two cents per pound”
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However, small gains on many products
lead to substantial increases in the
purchasing power of the dollar
Suppose there is protectionism
elsewhere
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The United States is a leading exporter of
fresh fruit (see on-line reading list for source)
Suppose that other countries outlawed the
import of fresh fruit
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US jobs lost
Decrease in price of fruit in the US
Increase in the price of fruit in other countries
Another issue: Lead in toys
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Recently, many toys manufactured in
China have been recalled due to unsafe
levels of lead
This has raised concerns about the
viability of toy exports
China will stop exporting toys if the
world does not view the toys as safe
enough, given the price
Monitoring is costly
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Monitoring toys for lead is costly, adding
to the cost of toys purchased
However, testing costs may be small
relative to the additional revenues that
can be generated if “safe toys” can be
guaranteed
Another example: American
cars
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Over the last 30 years, American cars have
often been looked at as “inferior” compared
to some foreign models
With competition from trade, domestic car
producers must keep costs down and quality
up in order to successfully sell cars in the
domestic market
The same thing goes for foreign toys
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If quality control standards are not maintained
abroad, people will buy their toys domestically
Trade issues
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There are many other issues that are
related to trade
If you would like an in-depth analysis of
trade, you can enroll in a class that
deals with trade
Today, we will talk about the basic
issues of trade, and who the winners
and losers are
Review of comparative
advantage
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Recall the principle of comparative
advantage
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“Everyone does best when each person (or
each country) concentrates on the
activities for which his or her opportunity
cost is lowest.” (F/B p. 39)
Today, we will apply this concept on a
countrywide scale
Comparative advantage: Same
numbers, different names
Productivity in
pizza production
Productivity in salad
production
United 20 pizzas cooked
States
per hour
10 salads made per
hour
Chile
4 salads made per
hour
16 pizzas cooked
per hour
Comparative advantage
U.S.
Chile
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Opportunity cost Opportunity cost of
of cooking a pizza
making a salad
½ salad
2 pizzas
¼ salad
4 pizzas
To find comparative advantage for each
person, find the lowest number in each
column
Recall increasing opportunity
cost
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Opportunity cost increases as
production increases within each
country
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Each country uses its best pizza maker to
make its first pizzas
Then, the next best pizza maker is used,
etc.
The same applies to salads
Production possibilities curve
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Recall from last
lecture that all of the
points along PGQ are
the efficient points of
the production
possibilities curve
Recall that this shape
occurs due to
increasing
opportunity costs as
more is produced
Production possibilities curve
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Without trade,
only points along
arc PGQ (or points
between this arc
and the origin)
can be consumed
We will see that
gains can be
made by trade
The world market
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In the world market, there is an
equilibrium price (based on world
supply and world demand)
Any one country that enters or exits the
market usually does not change the
market price much
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For ease of discussion, assume that entry
or exit by any one country does not
change the world price
Consumption possibilities
curve
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If we produce at
point G, we can
trade goods at the
given market price
Production at G
(with trade) 
Consumption
anywhere along
FGH
Which consumption possibility
curve is best?
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We could produce
at one of the red
dots before we
start trading
However, note
that there are
fewer
consumption sets
possible than
producing at G
Optimal production in an open
economy
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Since the red line is
suboptimal, we will
not utilize it
Similarly, any point
except G will produce
a similar result to the
red line
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Suboptimal
consumption
possibilities for any
production except G
Optimal production in an open
economy
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Solution
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Produce such that
the “line of trade
possibilities” is
tangent to the
production
possibilities curve
In this case, point
G is tangent to line
FGH
Supply and demand analysis
of trade
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As we just analyzed, we saw that total
surplus goes up when world trade is
possible
However, we will see that there are
winners and losers to trade
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Note that the winners’ gain is larger than
the losers’ loss
Market for cars, w/o trade
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Suppose that
without trade,
40,000 cars are
sold at a price of
$14,000
Market for cars, w/o trade
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Consumer
surplus is blue
shaded area
Producer surplus
is red shaded
area
Market for cars, with trade
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Notice that the
world price for
cars is $10,000
At this price,
notice that
20,000 cars will
be supplied and
60,000 cars will
be demanded in
this market
Market for cars, with trade
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What will happen?
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This is unlike the
case of rent control,
since the shortage is
picked up by the
world market
20,000 domestic
cars will be
purchased
40,000 foreign cars
will be purchased
Imports
Surplus with trade
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Consumer
surplus increases
substantially
Producer surplus
decreases, but
does not change
as much as
consumer
surplus does
Imports
Without imports (left)
With imports (right)
Imports
Net gain
Imports
A similar exercise can be done for
a country that is a net exporter
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When a country is a net exporter, the
world price is above what it would be if
trade was not possible (See Figure 9.7
for an example)
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Consumer surplus decreases when trade
occurs
Producer surplus increases when trade
occurs
Overall, total surplus increases
Tariffs and quotas
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Even when trade is not prohibited, countries
sometimes control the amount of a particular
good imported
Tariff
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Tax that must be paid for each unit of the good
imported
Quota
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A binding limit set on the amount of a good that
can be imported
What happens when we
impose a tariff?
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In this case, the
tariff imposed is
$1000 per ton of
sugar imported
We will see that
some potential
economic surplus
is lost when the
tariff is imposed
What happens when we
impose a tariff?
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Total surplus
without tariffs
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Shaded area
What happens when we
impose a tariff?
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With a tariff, the price paid by
consumers is the world price plus the
amount of the tariff
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Think of a tariff just like a tax
This increases the quantity supplied
domestically and decreases the amount
imported
What happens when we
impose a tariff?
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Quantity supplied
domestically
increases
Imports decrease
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Before, 100 tons
minus 20 tons, or
80 tons
After, 80 tons
minus 40 tons, or
40 tons
Total surplus and tariff money
collected
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Consumer
surplus (CS)
Producer
surplus (PS)
Tariff revenue
generated
What is
missing?
Total surplus and tariff money
collected
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CS
PS
Tariffs
What is
missing?
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Two triangles
are lost with
the imposition
of tariffs
Total surplus and tariff money
collected
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The two triangles lost are potential surplus
that could be gained
Notice that relative to open global trade,
producer surplus is higher
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See Economic Naturalist 9.2 to see an example of
why there is pressure to impose tariffs
Consumer surplus is lower with the tariff
(relative to open global trade)
Quotas
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Quotas are similar to
tariffs, except:
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Domestic supply plus
quota determines
supply available in a
country’s market
Equilibrium in this
example is price of
125, 80,000 TV’s
What else is different with
quotas?
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With quotas, no revenues are directly
generated
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Those with right to import and export gain
economic rents
Example: See Economic Naturalist 9.3 for
groups that benefited with “voluntary
export restraints,” which is a form of quota
“Outsourcing”
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“Outsourcing” has been a controversial
term in the media in recent years
There are definitely short-run costs of
outsourcing
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Displaced workers
Buildings and machinery that gets unused
“Outsourcing”
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Long-run benefits of outsourcing
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Each country can specialize what it has
comparative advantage in
Technological improvements lower the
costs of trade
Lower costs to consumers
How to make sure your job
does not get outsourced
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Make sure it requires a lot of face-toface contact
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Construction work
Repair labor
Health care
Make sure that you have skills that
nobody else has
Final thoughts about
“outsourcing”
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Trade policy can be formed such that those
that are displaced are not any worse off
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Some of the gains from “making the pie bigger”
can be transferred to those that get displaced
Justification for re-training programs for displaced
workers
Overall, the standard of living of a country
improves with trade
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Example: Think how much bananas would cost if
we could not import them
Summary
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Trade improves overall surplus
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Some people win, while others lose
Trade barriers, such as protectionism,
quotas, and tariffs limit the gains from
trade
Outsourcing has short-run costs but
long-run benefits in a country’s
economy