Transcript Chapters 4&5 - Pearland ISD

Econ 2301
Dr. Jacobson
Mr. Stuckey
Week 4 Chapters 4 & 5
Chapter 4
Price Controls and
Quotas: Modeling With
Markets
Governmental Policies
Effect Us All. Whether
It Be a For Profit or
Non-Profit Businesses,
An Organization, or
Simply as Individuals.
Controls on Prices
Price Ceilings
Price Floors
Taxes
Price Ceiling
A legal Maximum On
The Price At Which a
Good Can Be Sold.
In Chapter 3 We Looked at
Supply and Demand
Combined and We Discussed
The Point Called Equilibrium.
We Looked at What Occurred
Above and Below The
Equilibrium Point in Terms of
Supply and Demand.
In Simplest Terms On Any
Given Graph of Supply and
Demand One of Three
Situations Exist
In Simplest Terms On Any Given
Graph of Supply and Demand One
of Three Situations Can Exist:
1. There Can Be Equilibrium. A Price Where
The Buyers Can Buy All They Want and
The Sellers Can Sell All They Want.
2. There Can Be a Shortage. A Price Where
The Buyers Want to Buy More Than The
Sellers Are Willing to Sell.
3. There Can Be a Surplus. A Price Where
Sellers Are Willing To Sell More Than
Buyers Want to Buy.
Important Note:
Whether The Price of a
Good or Service Is Above
or Below The Equilibrium
Point Determines If There
Is a Surplus or Shortage.
Equilibrium
$3.00
Supply
S1
P
Surplus
2.50
Equilibrium
Price
2.00
1.50
1.00
Demand
.50
D1
Shortage
0
1
2
3
4
5
6
7
Quantity
8
9
10
Q
Shortage
Is a Situation In Which
The Quantity
Demanded Is Greater
Than The Quantity
Supplied At a Given
Price.
Shortage
$3.00
Supply
S1
P
2.50
Equilibrium
-----------------------------
-----------------------------------------------
1.00
Quantity
.50
Supplied
0
1
2
3
4
5
Shortage
6
----------------------
1.50
----------------------
Price
2.00 ---------------------------------------
Demand
Quantity
Demanded D1
7
Quantity
8
9
10
Q
What Then Are The
Effects of A Price
Ceiling in Relation To
The Price of Goods or
Services?
Price Ceiling
$3.00
S1
P
Supply
Price Ceiling
Not Binding
2.50
Equilibrium
-----------------------------
1.50
1.00
Shortage
Quantity
.50
Supplied
0
1
2
3
4
5
6
7
Quantity
8
----------------------
-----------------------------------------------
----------------------
Price
2.00 ---------------------------------------
Demand
Quantity D1
Demanded
9
10
Q
Price Ceiling
$3.00
S1
P
Supply
Price Ceiling
Is Binding
2.50
Equilibrium
-----------------------------
1.50
1.00
Shortage
Quantity
.50
Supplied
0
1
2
3
4
5
6
7
Quantity
8
----------------------
-----------------------------------------------
----------------------
Price
2.00 ---------------------------------------
Demand
Quantity D1
Demanded
9
10
Q
Therefore a Binding
Price Ceiling Causes
A Shortage.
Therefore When the
Government Imposes a
Binding Price Ceiling On a
Competitive Market, A
Shortage of The Good Arises,
and Sellers Must Ration The
Scarce Goods Among The
Large Number Of Potential
Buyers.
Why and Where
Would The
Government Want To
Impose a Price
Ceiling?
Places for Price Ceilings
 Gasoline (1973)
 Rent Control
 Flu Shots
 Medicines
 Interest Rates
 Taxes
Now Let Us Look At
The Other Side of
The Spectrum,
Surplus.
Surplus
Is a Situation In Which
Quantity Supplied is
Greater Than Quantity
Demanded at a Given
Price.
Equilibrium
Supply
$3.00
S1
P
Surplus
1.50
1.00
-----------------------------
Price
2.00 ---------------------------------------
Quantity
.50
Supplied
0
1
2
3
4
5
6
7
Quantity
-------------------------------------
-------------------------------------
2.50 -----------------------------------------------
8
Equilibrium
Demand
Quantity D1
Demanded
9
10
Q
Price Floor
A Legal Minimum On
The Price At Which a
Good Can Be Sold.
The Government May Also
Impose a Legal Minimum
On The Price of Goods or
Services. Because The
Price Cannot Fall Below
This Level, The Legislated
Minimum Is Called a Price
Floor.
What Then Are The
Effects of A Price Floor
in Relation To The
Price of Goods or
Services?
Price Floor
Supply
$3.00
S1
P
Surplus
1.50
1.00
.50
0
1
2
3
4
5
-----------------------------
Price
2.00 ---------------------------------------
6
7
Quantity
-------------------------------------
-------------------------------------
2.50 -----------------------------------------------
8
9
Equilibrium
Price Floor
Not Binding
Demand
D1
10
Q
Price Floor
Supply
$3.00
S1
P
Price Floor
That Is
Binding
Surplus
2.50 -----------------------------------------------
Equilibrium
-----------------------------
Price
2.00 --------------------------------------1.50
1.00
.50
0
1
2
3
4
5
6
7
Quantity
Demand
D1
8
9
10
Q
Therefore a Binding
Price Floor Causes a
Surplus
Therefore When the
Government Imposes a
Binding Price Floor On a
Competitive Market, A
Surplus of the Good Arises,
and The Buyers Must Decide
Which Goods to Buy, Among
The Large Number Of Goods
or Potential Sellers.
Why and Where
Would The
Government Want To
Impose a Price
Floor?
Places for Price Floors
 Minimum Wage
 Legal Services
 Certain Occupations (Youth,
Seniors)
 Farm Products
 Tariffs
 Taxes Minimum Alternative Tax
Wage and Price Controls
In 1971 Under President
Nixon the Government
Instituted A Mandatory
Wage and Price Freeze In
Order To Combat Inflation.
Subsidies
 Housing Help Pay Portion of
Rent.
 Wage Pay Portion of a Persons
Salary.
Earned Income Tax Credit
On-The-Job Training
 Education ( Student Loans)
Government Policy
As It Relates To
Taxes.
TAXES AND EFFICIENCY
 Policymakers have two
objectives in designing a
tax system...
 Efficiency
 Equity
TAXES AND EFFICIENCY
 One tax system is more efficient
than another if it raises the same
amount of revenue at a smaller cost
to taxpayers.
 An efficient tax system is one that
imposes small deadweight losses
and small administrative burdens.
TAXES AND EFFICIENCY
 The Cost of Taxes to Taxpayers
 The tax payment itself
 Deadweight losses
 Administrative burdens
Deadweight Losses
 Because taxes distort incentives,
they entail deadweight losses.
 The deadweight loss of a tax is the
reduction of the economic wellbeing of taxpayers in excess of the
amount of revenue raised by the
government.
Administrative Burdens
 Complying with tax laws creates
additional deadweight losses.
 Taxpayers lose additional time and
money documenting, computing, and
avoiding taxes over and above the
actual taxes they pay.
 The administrative burden of any tax
system is part of the inefficiency it
creates.
Taxes
Are Used To Raise
Revenue For Public
Projects, Such as
Roads, Schools, and
National Defense.
Tax Incidence
Is The Manner In Which
The Burden of Tax Is
Shared Among
Participants In a
Market.
Tax Incidence
Refers to The
Distribution Of The Tax
Burden.
The Question The
Government Must
Answer, Is Who (and
How) They Are Going
To Tax and How
Much?
This Question Has As
Much Impact On The
Individuals and
Companies Within a
Nation As It Does On
The Government.
Let Us Look at The
Government Tax
Policies In Terms of
Supply and Demand.
Let Us Say a That The
Government Places a
$1 Tax on Movie
Tickets. Who Pays The
Tax?
Step #1
The Initial Impact of The Tax
Is on The Demand For Movie
Tickets. The Supply Curve is
Not Affected Because
Sellers Have The Same
Incentive To Sell Movie
Tickets.
Therefore, Initially The
Buyers Have to Pay The
Tax To The Government
As Well As The Price to
The Sellers. This Causes
a Shift In The Demand
Curve.
Step #2
We Need To Determine
The Direction of The Shift.
The Tax Makes Movie
Going Less Attractive,
Therefore The Demand
Curve Shifts Downward By
The Amount of The Tax.
Equilibrium
Price
Buyers
Pay
Price
Without
Tax
$3.00
S1
P
2.50
Equilibrium
2.00
Without Tax
Tax Shifts
Demand Curve
By Size Of Tax
1.50
1.00
Price
Supply
Equilibrium
With Tax
Demand
.50
D1
D2
0
30
90
100
Quantity
Q
Step #3
The Effect of The Tax Can
Be Seen In Comparing The
Old Equilibrium ($2.00)
With The New Equilibrium
($1.50).
What We See Is That
Because of The Tax, The
Movie Theater Has Lost
Patrons. Because Movie
Theater’s Also Make
Revenue on Concessions
They May Want to Pay Some
of The Tax.
Therefore, If The Movie
Theater Wants Recover
Some of Its Lost Patrons
(Essentially Return to The
Original Demand
Schedule) It Needs To
Share In The Cost of The
Tax.
Equilibrium
Price
Buyers
Pay
Price
Price
Without
Tax
Price
Sellers
Receive
$3.00
Supply
S1
P
2.50
Equilibrium
2.00
Without Tax
Tax Shifts
Demand Curve
By Size Of Tax
1.50
1.00
Equilibrium
With Tax
Demand
.50
D1
D2
0
90
100
Quantity
Q
We See From This
Example That In A
Situation Where The Tax
Could Be Picked Up
Entirely By the Buyer The
Seller Also Has A Stake In
The Overall Effect Of The
Tax.
Let Us Look At Another
Example Where The
Government May Place a
Tax Directly On Employers
For Each Item They Sell.
Again Let Us Consider
That The Tax Imposed By
The Government Is $1.00
For Each Ticket Sold.
What Are The Effects Of
This Law?
Step #1
In This Case The Tax Is
Imposed On The Sellers
Therefore The Demand Curve
Does Not Change, But The Tax
Makes The Movie Tickets Less
Profitable At Any Price.
Therefore We Have A Shift In
The Supply Curve.
Equilibrium
S2
Price
Buyers
Pay
Price
Price
Without
Tax
Price
Sellers
Receive
$3.00
S1 Tax Shifts
Supply Curve
By Size Of Tax
P
Equilibrium
With Tax
2.50
Supply
Equilibrium
Without Tax
2.00
1.50
1.00
Demand
.50
D1
0
90
100
Quantity
Q
Step #2
Because The Tax Raises The
Sellers Cost, It Reduces The
Quantity Supplied At Every
Price, So The Supply Curve
Shifts To The Left In The
Amount of The Tax.
Step #3
After The Shift of The Supply
Curve We Again See That
The Initial Equilibrium Has
Changed From $2.00 To
$2.50.
Equilibrium
Price
Buyers
Pay
Price
Price
Without
Tax
Price
Sellers
Receive
$3.00
Supply
S1
P
2.50
Equilibrium
2.00
Without Tax
Tax Shifts
Demand Curve
By Size Of Tax
1.50
1.00
Equilibrium
With Tax
Demand
.50
D1
D2
0
90
100
Quantity
Q
Again The Buyers and
The Sellers End Up
Sharing The Cost of
The Tax. The Tax
Reduces The Size of
The Market.
In Both Cases The Tax
Changes The Equilibrium
Point Either Through A Shift
In The Demand or Supply
Curve. The Results In Either
Case Are The Same.
Elasticity and Tax
Incidence
In The Last Chapter We
Examined Elasticity As
It Applied To Both The
Demand and Supply
Curves.
When A Good Is Taxed,
Buyers And Sellers Share
The Tax Burden. Only
Rarely Is It Shared
Equally, So How Then Is
The Tax Burden Really
Divided?
Remember
That Elasticity of Either
Supply or Demand Is
Measured By the Willingness
of Either Buyers (Demand
Elasticity) or Sellers (Supply
Elasticity) To Leave The
Market When Conditions
Become Unfavorable.
A Tax Burden Falls
More Heavily On The
Side Of The Market
That Is Less Elastic
This Makes Sense As The
More Elastic, The More
Willing The Buyer Or Seller
Is To Move Away From or
To Produce The Product
Due To Price Increases or
Decreases.
Elastic Supply, Inelastic
Demand
Price
Buyers
Pay
Price
Price
Without
Tax
Price
Sellers
Receive
P
Supply
S1
TAX
Tax
Incidence on
Sellers
Quantity
The Incidence
of Tax Falls
More Heavily
On Consumers
Demand
D1
Q
Inelastic Supply, Elastic
Supply
Demand S1
Price
Buyers
Pay
Price
Price
Without
Tax
Price
Sellers
Receive
P
The Incidence
of Tax On
Consumers
TAX
Demand
D1
Tax Incidence Falls
More Heavily on
Sellers
Q
Quantity
The Law of Supply and
Demand Describes The
Way Markets Allocate
Scarce Resources. In
Short, We Have Looked
At What Is, Rather Than
What Should Be.
We Know That The Prices of
Toys During The Holidays
Adjusts To Ensure That The
Quantity of Toys Supplied
Equals The Quantity of Toys
Demanded. But At This
Equilibrium Is That Quantity
Produced and Consumed Too
Large, Too Small or Just
Right?
That Takes Us To
The Topic of Welfare
Economics
Welfare Economics
Is The Study Of How
The Allocation of
Resources Affects
Economic Well-Being.
Imagine That You Have Just
Developed A New Product
and Are About To Take It To
Market. You Ask 10 People
What They Are Willing To
Pay For The Product and
They All Give You (As
Expected) Different
Answers.
From The Information
Given You By These
Ten People Can You
Develop A Strategy For
Pricing Your Product?
Let Us Explore This
Question From Several
Different Approaches.
Willingness To Pay
Is The Maximum
Amount That A Buyer
Will Pay For a Good.
But What If, In Our
Example, A Person Has
Told You They Will Be
Willing To Pay $50 For
Your Product But, Actually
They Would Be Willing To
Pay $75.
Product Demand
Curve
Price
A
$75
$65
$55
$45
$35
$25
$15
$5
1
2
3
4
5
Quantity
Consumer Surplus
Is The Amount A Buyer
Is Willing To Pay For a
Good Minus The
Amount The Buyer
Actually Pays For It.
Consumer Surplus
Consumer
Surplus
=
Amount A
Buyer Is
Willing to Pay
Amount
They
Paid
Consumer Surplus
Consumer
Surplus
=
$75
$50
=
$25
Now Let Us Assume That
Your Product Is A Painting
and You Have Made Two
Copies. This Time Instead
of Asking People What
They Will Pay For Them,
You Decide Auction Them
Off.
We Conduct The Auction
Until Two Bidders Are Left
and The Price Is At $45. Let
Us Again Say That One Of
The Two Persons Would
Have Been Willing to Pay $75
For the Painting, But the
Other Person Would Only
Have Paid $50.
Using Our Formula for
Finding Consumer Surplus
We Find That The First
Person Has A Consumer
Surplus of $30 and The
Second Person A
Consumer Surplus of $5
For The Same Item.
Consumer Surplus
Consumer
Surplus
=
Amount A
Buyer Is
Willing to Pay
Amount
They
Paid
Consumer Surplus
st
For 1 Person
Consumer
Surplus
=
$75
$45
=
$30
Consumer Surplus
nd
For 2 Person
Consumer
Surplus
=
$50
$45
=
$5
Product Demand
Curve
Price
Person A’s Consumer Surplus
A
$75
Person B’s Consumer Surplus
$65
B
$55
Price Actually
Paid
$45
$35
$25
$15
$5
1
2
3
4
5
Quantity
Consumer Surplus Is
Closely Related To The
Demand Curve.
The Area Below The
Demand Curve and Above
The Price Measures The
Consumer Surplus In The
Market.
The Area Below The Demand
Curve and Above The Price
Measures The Consumer
Surplus In The Market.
The Reason Is That The
Height of The Demand
Curve Measures The
Value Buyers Place On
The Good, As Measured
By Their Willingness
To Pay For It.
The Difference
Between This
Willingness To Pay and
The Market Price Is
Each Buyer’s
Consumer Surplus.
Therefore, The Total Area
Below The Demand Curve
and Above The Price Is
The Sum Of The Consumer
Surplus Of All Buyers In
The Market For A Good or
Service.
Product Demand
Curve
Price
Person A’s Consumer Surplus
A
$75
Person B’s Consumer Surplus
$65
B
$55
Price Actually
Paid
$45
$35
$25
$15
$5
1
2
3
4
5
Quantity
Product Demand
Curve
Price
Person A’s Consumer Surplus
A
$75
Person B’s Consumer Surplus
$65
B
$55
Price Actually
Paid
$45
$35
Total Of The
Consumer Surplus
Of All Buyers
$25
$15
$5
1
2
3
4
5
Quantity
Buyers Always Want To
Pay Less and Paying Less
Makes The Buyer Better
Off. But How Much Does a
Buyers Well-Being Rise In
Response To a Lower
Price?
Consumer Surplus
Measures The Benefit
That Buyers Receive
From A Good As The
Buyers Themselves
Perceive It.
This Is Because Buyers
Have Determined What
They Would Have Paid
For The Good Or
Service.
Government Policy Makers
However, May Or May Not
Care About What Creates
Consumer Surplus.
Example of A Drug Addict
Being Able To Purchase
Drugs Cheaper Therefore
Creating Consumer
Surplus.
In This Case Consumer
Surplus is Not A Good
Measure of Well-Being,
As The Drug Addict is
Not Looking After Their
Own Best Interests.
However, In Most Markets,
Consumer Surplus Does
Reflect Economic WellBeing. Rational People Do
The Best They Can To
Achieve Their Objectives,
Given Their Opportunities.
Consumer Surplus
Consumer
Surplus
=
Amount A
Buyer Is
Willing to Pay
Amount
They
Paid
Now Lets Look At It
From The Other Side
and Discuss Producer
Surplus.
Let Us Assume That You
Are Going To Have Your
Taxes Done and You
Contact 4 CPA’s That You
Know Are Capable of
Doing The Work and Ask
Them For A Price For
Them To Do Your Taxes.
Each CPA Will Determine
Their Costs In Order To
Determine A Price. The
Term “ Cost” is Really The
Opportunity Cost, That
Includes Materials,
Overhead, Time to Do the
Work and Expected Profit.
Cost &
Producer Surplus
Cost
The Value of Everything
A Seller Must Give Up
To Produce a Good.
Producer Surplus
The Amount A Seller Is
Paid For A Good Minus
The Seller’s Cost Of
Producing or Providing
It.
Producers Surplus
Measures The Benefit
To Sellers of
Participating In A
Market.
Producer Surplus
Producer
Surplus
=
Amount That
a Seller Is
Paid
Sellers
Cost
Note:
Because We Have Set Up
a Bidding Situation In Our
Example, The CPA With
The Lowest Cost Should
Win The Bid.
Now Let Us Use The
Supply Curve To
Measure Producer
Surplus.
Let Us Say That All 4
CPA’s Submitted Bids
As Follows:
CPA
CPA
CPA
CPA
A
B
C
D
=
=
=
=
$10,000
$12,000
$14,000
$16,000
Let Us Now Plot A
Supply Schedule For
Preparing Taxes.
The Supply Curve
Shows The Cost of The
Marginal Seller, The
Seller Who Would
Leave The Market First
If The Price Were Any
Lower
Price
Product Supply
Curve
$18
T
h
o
u
s
a
n
d
s
D
$16
C
$14
$12
$10
B
A
$8
$6
$4
$2
0
1
2
3
4
# of Suppliers
5
Quantity
Producer Surplus
Producer
Surplus
=
Amount A
Seller Is Paid
For a Good or
Service
Cost of
Providing
The Good
or Service
Therefore Any
Amount Above The
Suppliers Cost Would
Be Producers
Surplus.
In Our Example The
Area Below The Price
and Above The Supply
Curve Measures The
Producer Surplus In A
Market.
However, Producers
Always Want To
Receive a Higher Price
For Their Goods and
Services That They
Sell.
Market Efficiency
Consumer Surplus and
Producer Surplus Are The
Basic Tools Economists Use
To Study The Welfare Of
Buyers and Sellers In a
Market.
If We Want To Maximize
The Economic Well-Being
Of Everyone In a Society.
We Must First Decide How
We Are Going to Measure
The Economic Well-Being
Of a Society.
One Possible
Measure Is The Sum
of Consumer Surplus
and Producer
Surplus, Which We
Call Total Surplus.
Remember That Consumer
Surplus Is The Benefit That
Buyers Receive From
Participating In The Market
and Producer Surplus Is The
Benefit That Sellers Receive
From Participating In The
Market.
Remember Also,
That The Formulas
For Each Are As
Follows:
Consumer Surplus
Consumer
Surplus
=
Amount A
Buyer Is
Willing to Pay
Amount
They
Paid
Or
= Value To Buyers - Amount
Paid By Buyers
Producer Surplus
Producer
Surplus
=
Amount That
a Seller Is
Paid
Sellers
Cost
Or
= Amount Received By Sellers –
Cost To Sellers
Total Surplus Then
Becomes:
Total Surplus = Value To
Buyer - Amount Paid By
Buyers + Amount
Received By Sellers –
Cost To Sellers.
Or
Because The Amount Paid
By Buyers Equals The
Amount Received By Sellers
The Equation Can Be
Rewritten As:
Total Surplus = Value To
Buyers – Cost To Sellers
If An Allocation of Resources
Maximizes Total Surplus, We
Say That The Allocation
Exhibits Efficiency. If An
Allocation Is Inefficient,
Then Some Of The Gains
Among Buyers and Sellers
Are Not Being Realized. i.e.
Not Taking The Minimum
Bid.
Efficiency
The Property Of A
Resource Allocation Of
Maximizing The Total
Surplus Received By All
Members Of Society.
Thus, Moving Production
From a High-Cost
Producer To a Low-Cost
Producer Will Lower The
Total Cost To Sellers and
Raise Total Surplus.
Also An Allocation Is
Inefficient If A Good Is Not
Being Consumed By The
Buyers Who Value It Most
Highly. Therefore, Moving
Consumption Of The Good
From A Buyer With A Low
Valuation To A Buyer With A
High Valuation Will Raise
Total Surplus.
Equity
The Fairness Of The
Distribution of WellBeing Among The
Members of Society.
While Efficiency Can Be
Measured and Judged
On Performance, Equity
Involves Normative
Judgments That Enter
Into The Area of
Political Philosophy.
Putting The Supply
Curve and Demand
Curve Together and
Finding Equilibrium.
Remember That Consumer
Surplus Equals The Area
Above The Price and
Under The Demand Curve
and Producer Surplus
Equals The Area Below
The Price and Above The
Supply Curve.
Therefore, The Total Area
Under Between The Supply
Curve and The Demand
Curves Up To The Point of
Equilibrium Represents The
Total Surplus.
Observations:
1. Free Markets Allocate
The Supply Of Goods To
The Buyers Who Value
Them Most Highly, As
Measured By Their
Willingness To Pay.
Observations:
2. Free Markets Allocate
The Demand For Goods To
The Sellers Who Can
Produce Them At Least
Cost.
Observations:
3. Free Markets Produce
The Quantity of Goods
That Maximizes The Sum
Of Consumer and Producer
Surplus.
Consumer and Producer
Surplus In Market Equilibrium
Price
A
Equilibrium
Price
Consumer
Surplus
E
D
Supply
Producer
Surplus
B
C
Equilibrium
Quantity
Demand
Quantity
The Next Figure Shows
That At Quantities Less
Than The Equilibrium
Quantity Such As Q1, The
Value To The Buyers
Exceeds The Cost To The
Sellers.
At Quantities Greater Than
The Equilibrium Quantity
Such As Q2, The Cost To The
Sellers Exceeds The Value
To The Buyers. Therefore
The Market Equilibrium
Maximizes The Sum Of
Producer and Consumer
Surplus.
The Efficiency of the
Equilibrium Quantity
Price
Value to Buyers Is
Greater Than Cost
To Sellers
Value to Buyers
Is Less Than
Cost To Sellers
Value
To
Buyers
Supply
Cost To
Sellers
Value
Cost
To Buyers
To Sellers
Q1
Demand
Equilibrium Q2
Quantity
Quantity
Questions
?
Chapter 5
International Trade
Adam Smith’s Dos and
Don’ts
 Do
 Protect society from the violence and
invasion of other countries
 Establish an exact administration of
justice
 Erect and maintain certain public works
and institutions where private enterprise
could not profit from doing so
 Don’t do anything else
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-51
Figure 1 The Internationalization
of the U.S. Economy
Percent
of GDP
15
Imports
10
Exports
5
0
1950 1955
1960 1965 1970 1975 1980 1985 1990 1995 2000
2005
Table 1 International Flows of
Goods and Capital: Summary
Government
Intervention
Protection
Allocation
Benefit
One of The Nine
Principles of
Economics (From
Chapter 1) Is That
Trade Makes Everybody
Better Off.
Comparative
Advantage and
Trade
Gains From Specialization and
Trade Are Not Based on
Absolute Advantage, But on
Comparative Advantage. When
Each Person Specializes in
Producing the Good For which
They Have a Comparative
Advantage, Total Production in
the Economy Rises an
Everyone is Better Off.
However, There Can
Be Other Factors
Including the Price of
the Goods and How
the Gains Are Shared
Among the Trading
Partners.
Applications of
Comparative
Advantage
Should Tiger Woods
Mow His Own Lawn or
Play Golf?
The Principle of
Comparative Advantage
Holds That a Country Can
Benefit From Trade Even If
it is Absolutely More
Efficient (or Absolutely Less
Efficient) Than Every Other
Country in the Production of
Every Good.
Therefore, Trade
According to
Comparative
Advantage Provides
Mutual Benefits to All
Countries.
In Addition-
The Principle of
Comparative Advantage
Holds That Each Country
Will Benefit If it
Specializes in the
Production and Export of
Those Goods That it Can
Produce at Relatively
Low Cost.
Conversely, Each
Country Will Benefit If
it Imports Those Goods
Which it Produces at a
Relatively High Cost.
Trade Among Countries-
Imports- Are Goods
Produced Abroad and Sold
Domestically.
Exports- Are Goods
Produced Domestically and
Sold Abroad.
Nations Also Can Enjoy
a Comparative
Advantage, However
That Does Not
Necessarily Mean It
Will or Will Not Produce
a Good.
The United States Has A
Comparative Advantage
in Certain Items Involving
the Military and Warfare.
However, This Does Not
Mean That it is in The
U.S.’s Best Interest to
Sell these Items.
International Trade
Can Make Some
Individuals Worse Off,
Even as it Make the
Country as a whole
Better Off.
What Does It Matter?
 We buy much more from foreigners than
they buy from us
 In effect, they lend or give us the money to make
up the difference between our imports and our
exports
 We are essentially selling them a piece of the
(American) rock consisting of corporate stock,
real estate, corporate and government bonds
and other debt instruments
 Should this continue for another three or four
decades, foreign investors will own most of
America
32-9
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Main Arguments for
Protection
 The National Security
Argument
 The Infant Industry Argument
 The Low-Wage Argument
 The Employment Argument
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-23
The National Security
Argument
 Our dependence on foreign suppliers
could make us vulnerable in time of
war
 It is possible that we need to maintain
certain defense-related industries
 What if we depended on foreign
suppliers for critical components of
entire weapons systems?
 The continued spread of nuclear arms
technology may soon make the national
security argument much more relevant
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-24
The Infant Industry
Argument
 American products are no longer
produced by infant industries being
swamped by foreign giants
 About the best that can be said is
that some of our infant industries
never matured while others have
evolved into senility
 Textiles, steel, clothing, and
automobiles may be in the senile
category
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-25
The Low-wage Argument
 How can American workers compete with
foreigners who are paid sweatshop wages in
labor intensive industries?
 There is no reason for American firms to
compete with foreign firms in these industries
 We should import labor-intensive goods and
produce goods and services in which we can
excel and compete
 We should use the proceeds to buy the goods
and services produced by people who are
forced to work for very low wages
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-26
The Employment Argument
 The flood of imports throw millions of
Americans out of work
 But if we restrict imports, the governments of our
foreign competitors will restrict our exports
 By curbing imports, we will be depriving other
nations of the earnings they need to buy our exports
 If we restrict our imports, our exports will go down as
well
 We would just lose the jobs connected with these lost
exports
 Which would be best? Lose the jobs of workers who work
for companies who can’t or won’t compete or lose the jobs
of workers who work for companies who can compete but
can’t export their products because of restrictions we
ourselves caused?
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-27
Tariffs or Quotas
 A tariff is a tax on imports
 The government gets the resulting revenue
 A tariff affects all foreign sellers equally. Efficient
foreign producers will be able to pay a uniform tariff.
Less efficient producers will not
 A quota is a limit on the import of certain
goods
 Import quotas produce no federal revenues
 Imports quotas are directed against particular
sellers on an arbitrary basis
 Arbitrary quotas may allow relatively inefficient
producers in and keep out more efficient producers
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-28
Tariffs or Quotas
 A tariff, like any other excise tax, causes
a decrease in supply
 Both tariffs and quotas raise the price
that consumers in the importing
countries must pay
 Tariffs are better than quotas
 But free trade is best
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-29
A Tariff Lowers the Supply
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-30
Conclusion
 Economics is all about the efficient allocation
of scarce resources
 There is no reason why this efficient allocation
of resources should not be applied beyond
national boundaries
 International trade helps every country
 To the degree that we can remove the tariffs,
import quotas, and other impediments to free
trade, we will all be better off
 The economics profession nearly unanimously
backs free trade
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-31
Our Balance of Trade
 Our balance of trade compares the dollar
value of merchandise and services we
buy from foreigners with the dollar value
of the merchandise and services they buy
from us
 Our balance of trade is our country’s
record of all transactions between its
residents and the residents of all foreign
nations
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-32
What Are the Causes of
Our Trade Imbalance
 “We are consuming more than we
are producing, borrowing more than
we are saving, and spending more
than we are earning.” – Murray
Weidenbaum
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-33
What Are the Causes of
Our Trade Imbalance
 We have become a nation of
consumption junkies
 We are borrowing about $2 billion a
day to finance our consumption
habit.
 Most Americans believe that
somehow we’re entitled to all of
these goods and services, even if
we need to borrow to pay for them.
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-34
What Are the Causes of
Our Trade Imbalance
 Our Low Saving Rate
 Americans are notoriously poor savers.
In 2005 we managed to spend 100.5
percent of our disposable income
 If you don’t save, you can’t invest
 If you don’t invest, you don’t grow
 Foreign savers have been picking up the
slack
 This will not continue indefinitely
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-35
What Are the Causes of
Our Trade Imbalance
 Huge Oil Imports
 We import two-thirds of our oil
 We pay just a fraction of what citizens in other industrial
countries pay for gasoline
 Our dependency on oil imports will keep growing
 In 2005, the cost of oil reached a record high of $252
billion
 High Defense Spending
 Today the United States spends more on defense than
the rest of the world put together
 Stretching our armed forces around the world comes at
an extremely high price
 Can we afford to do this?
31-36
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Trade Deficit With Japan and
China, 1995-2005
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-40
Japanese Trading
Practices
 Japanese compete on the basis of price and
quality
 This is driving out American competitors
 The fundamental difference between ourselves
and the Japanese is quality
 Better quality also means lower prices
 We sell Japan agricultural products and buy
manufactured products from them
 This is a colonial relationship
 The Japanese picks winners and then makes
sure they win
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-41
Japanese Trading
Practices
 The Japanese consumer has long accepted a
lower standard of living because it was
necessary for the greater economic good
 They are willing to pay more for goods they
produce when they could have them cheaper
if they imported the same good
 Can you imagine Americans being willing to
make that kind of sacrifice
 Americans would not stand for restricting
Japanese imports because they are addicted to
Japanese goods
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-42
Our Trade Deficit with China
 We began trading with China in the mid-1970s
 Although exports to China have grown rapidly,
our exports are only about one-sixth of our
imports
 We import so much from China because U.S.
retailers are seeking the cheapest goods
available and are finding them in China
 The Chinese are making unauthorized copies of
American movies, CDs, and computer software
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-43
Trading with China and
Japan
 There are more differences than
similarities
 Our trading position with Japan is
much like a colony and a colonial
power
 We send airplanes, computers, movies,
compact disk, cars, cigarettes, powergenerating equipment, and computer
software to China in exchange for toys,
clothing, shoes, and low-end consumer
electronics
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-44
Trading With China and
Japan
 Japan has never been open to foreign trade
 China has been open to trade
 Japanese gains in production have led
directly to the loss of millions of well-paying
American jobs
 Chinese exports so far have generally not
translated into job losses in the United
States
 In 2005 we ran a $202 billion trade deficit
with
China
and
one
of
$83
billion
with
Japan
31-45
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Trading with China and
Japan
 The Chinese and the Japanese
both insist on licensing
agreements and large-scale
transfer of technology as the
price for agreeing to imports
 These agreements, of course,
lead to eventual elimination of
imports from the United States
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-46
Final Word
 Reducing Our Overall Trade Deficit
 We need to maintain our high rate of productivity
growth and keep improving the quality of American
goods and services
 We need to lower our dependence on oil imports by
raising the tax on gasoline
 We must, somehow, reduce our trade deficit with
Japan
 We need to do something about our rapidly rising
trade deficit with China
 We need to face up to the fact that we are a nation of
consumption junkies
 We need to reduce our trade deficit with the rapidly
expanding internet which make it much easier to
provide services of all types
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-47
Current Issue:
Buy American?
 Are we as a nation becoming
more inclined to “buy
American?”
 The bottom line is that
Americans are consumers first,
while paying just lip service to
economic nationalism
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-48
Questions
?
Quick WriteWhat Kind of Absolute
Advantage or
Comparative Advantage
Do You Think You Have
Over Other Students and
How Can This be Used to
Your Advantage When
You Graduate?