Transcript Chapter 1: Human Misery

Chapter 9:
International Trade
Argument Against Free Trade
Foreign goods crowd out our markets, reducing
employment and sales
Trade deficit increases demand for $, whose
appreciation increases imports and decreases exports,
causing the deficit to grow
Protect our vital industries (auto, aircraft) against foreign
competition in case of war
Argument For Free Trade
Principle of Comparative Advantage states:
Free trade is mutually beneficial if countries
specialize in production of low cost goods and
exchange those for high cost goods
Simple Demonstration
Two countries: Alpha, Omega
Two goods: milk, bread
Equal terms of trade: 1 bread = 1 milk
Labor Costs
One day of work will produce in
– Alpha: 1 bread, but 2 milk
– Omega: 2 bread, but 1 milk
Comparative advantage:
– Alpha: milk
– Omega: bread
Alpha’s Trade Sheet
Good Pretrade
PPC
Milk
Bread
Specialization
PPC
Trade
Posttrade
CPC
Gains
from
Trade
100
200
-100
100
0
50
0
+100
100
50
Alpha’s PPC/CPC
Bread
Trade gain=50 bread
200
Post-trade CPC
100
Pre-trade CPC
50
100
200
Milk
Omega’s Trade Sheet
Good Pretrade
PPC
Specialization
PPC
Trade
Posttrade
CPC
Gains
from
Trade
Milk
25
0
+50
50
25
Bread
50
100
-50
50
0
Omega’s PPC/CPC
Bread
Pre-trade CPC
Trade gain=25 milk
100
Post-trade CPC
50
25
50
100
Milk
Balance of Trade
Current Account-- Flow of traded goods and
services: exports less imports
Capital Account-- Flow of investment: change in
U.S. assets abroad less change in foreign assets
in U.S.
Balance of Payments = Current plus Capital
International Finance
Two trading countries: U.S. & U.K.
U.S. exports supply dollars for U.S.
U.S. imports require pounds to pay to U.K.
U.S. converts its dollars to pounds to pay U.K.
Market for Foreign Exchange
Dollar/Pound ratio
D
1.60
S
1 pound = $1.60
$1 = 0.625 pounds
S
D
Pound per month
Effects of Exchange Control
May improve the balance of trade:
– exports become less costly to foreign buyers
– imports become more costly to domestic buyers
Cause a shortage and develops a black market
Exchange Control
Dollar/Pound ratio
D
1.70
1.60
1.60=market rate
1.50=controlled rate
S
1.70=black market rate
Shortage
1.50
S
D
Pound per month
Import Tariff
Tax imposed on imported goods to:
–
–
–
–
Reduce the supply of imports
Increase the price to domestic consumers
Decrease the volume of imports
Generate revenues for the government
Tariff on Japanese Automobiles
Price
D
S’
S
22,500
Consumers pay $2,500 more
Dealers receive $2,500 less
Government makes $40 million
20,000
17,500
S’
S
D
8,000 10,000
Quantity
Import Quota
Quantity restriction on imported goods:
–
–
–
–
Reduce the volume of imports
Increase the price to domestic buyers
Reduce the price to foreign supplies
Create profits to holders of import licenses
Quota on Sugar Imports
Price
($/ton)
S’
D
S
35
Consumer pay $5 more
Producers receive $5 less
Exporters make $7,500 profit
30
25
S
D
S’
750
1,000
tons/year
Common Markets
Free trade within the market, restrictions against
outsiders
– European Union (EU): 15 countries
– North American Free Trade Agreement (NAFTA):
U.S., Canada, Mexico