Transcript Chapter 14

Chapter 14
An Introduction to the
Open Economy
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Chapter 14: An Introduction to the Open
Economy
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Open economy issues
Global trends and patterns in international trade
A supply and demand perspective on trade
Protectionist policies: tariffs and quotas
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Some Facts
• World trade grows faster than world production
• Asia, Europe and US are large traders compared
with Africa, Middle East and Latin America
• Large trade imbalances, with US in deficit and Asia
in surplus
• Reduction of tariff barriers over time
• Growth of regional trade agreements since 1992
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Global Exports and Production
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Share of World Exports and Imports
14–5
Regional Trade Agreements
14–6
Import Demand
• Domestic demand curve for product
• Domestic supply curve for product
• For a small country, domestic price is given by the
world price
• Import demand = domestic demand – domestic
supply at that world price
• These products are called ‘importables’
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Illustration: Importables
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Export Supply
• Domestic demand curve for product
• Domestic supply curve for product
• For a small country, domestic price is given by the
world price
• Export supply = domestic supply – domestic
demand at that price
• These products are called ‘exportables’
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Illustration: Exportables
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Trade Pattern Depends on Price
• As price rises, the quantity demanded falls and the
quantity supplied by domestic producers
increases, causing import volume to fall
• If this continues, the country produces a surplus
for export
• Whether a commodity is an importable or an
exportable for a country depends on its price
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Price Impact of Restricting Trade
• For an importable, the introduction of trade lowers
price, and restricting trade would raise price
• For an exportable, the introduction of trade raises
price, and restricting trade would lower price
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Who Gains (Loses) from Trade?
• Trade lowers the domestic price of importables, so
domestic consumers gain and domestic producers
lose
• Trade raises the domestic price of exportables, so
domestic consumers lose and domestic producers
gain
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Trade Gains Exceed Losses
• Trade causes the domestic prices of importables to
fall
• For importables, domestic demand always
exceeds domestic production
• So, for a given fall in price, the fall in costs for
consumers must be less than the fall in income for
producers
• Consumers gain more than producers lose
• Consumers could compensate producers and still
be better off
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Trade Gains Exceed Losses
• Trade causes the domestic price of exportables to
rise
• For exportables, domestic production exceeds
domestic consumption
• So, for a given rise in price, the increase in income
for domestic producers must exceed the rise in
costs for consumers
• Producers gain more than consumers lose
• Producers could compensate consumers and still
be better off
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Why Losers Oppose Trade
• With compensation for losers, everyone could be
made better off by trade
• But compensation is rarely made
• So losers usually oppose trade
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Restricting Imports – Tariffs
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Tariffs raise domestic price above world price
Quantity demanded falls
Quantity supplied rises
Volume of imports falls
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The Impact of a Tariff
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Winners and Losers from Tariffs
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Consumers lose from higher prices
Producers gain from higher prices
Government gains from tariff revenue
But consumers lose more than producers and
government gain
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Restricting Imports – Quotas
• Government allows tariff-free entry of goods at
world prices
• But imposes a physical limit on the volume of
imports by the issue of licences to import
• Domestic supply = domestic production + quota on
imports
• Domestic price rises and volume of imports falls to
quota level
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Import Quota
14–21
Tariffs vs Quotas
• For any given tariff rate, an alternative import
quota could be imposed with the same effects on
price and quantities
• Tariff generates revenue for the government
• Quota generates profits for the lucky recipients of
the quotas who import goods at world prices and
sell at higher domestic prices
• Quotas are administratively cumbersome
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Third Parties May Oppose Trade
• Sympathy for the uncompensated losers in both
poor and rich countries who may already be at the
lower end of their income distributions
• Trade changes cultures
• Trade introduces new products which consumers
may not have the expertise/backup to use wisely:
infant milk formula requires access to clean water
• If rich countries gain more from trade than poor
countries, even though all gain, there is a
perception that the distribution of world income has
worsened
• Farm/export subsidies hurt poor countries
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Trade and the Environment
• Also a concern for third parties
• Trade, combined with pollution-emission controls
in rich countries, sometimes shifts emissions to
poorer countries, who may have deliberately
chosen lower environmental standards because of
their lower incomes
• This does not mean that total emissions must have
increased
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Income and Environment
14–25
Trade and the Environment
• The ultimate cause of environmental problems is
lack of, or inappropriate, emission controls, not
trade
• So these problems should be solved by using the
right emission controls, not by restricting trade
• The income-enhancing effects of trade increase
both the desire and the means to improve the
environment
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Free Trade and World Inequality
• Inequality between rich and poor countries tends
to fall, because free trade causes real wages to
converge between rich and poor countries
• Wages earned by low-skilled labour engaged in
producing traded goods tend to rise in poor
countries and fall in rich countries
• In its effect on wages, trade in goods is like free
immigration of labour
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But Trade is Not Free
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Europe and the US subsidise farm exports
This reduces their world price
This hurts farmers in poor countries
This turns the terms of trade against poor
countries and is a factor which tends to increase
world inequality
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Income Distribution at Home
• The reduction of unskilled wages in rich countries
and the increase in the return to human and
physical capital raises inequality in rich countries
• This was illustrated in Chapter 5
• The rise in unskilled wages in poor countries and
the fall in the return to physical capital reduces
inequality in poor countries
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