International Economy

International Economy

What is trade? It is the act of buying and selling goods and services.

The main difference between domestic trade and international trade is that the later is more controversial. Most polls show that Americans viewing economic

liberalization positively, but this can range from a plurality to a large majority, depending on the poll.

Trade makes use better off. It increases GDP, but it does create winners and losers. However, the gains often offset the losses.

International Trade

International Trade has grown tremendously over the past 50 years.

Significant decreases in quotas and tariffs.

In the 1930’s, the average tariff rate was 50%. Today, it is less than 2%.

Increases in Free Trade Agreements

The rise of neoliberalism with the fall of the Communist bloc

International Trade

U.S. International Trade

U.S. exports for 2011 - $1.511 trillion

Agricultural (soybean, fruit, corn) ~ 9.2%

Industrial Supplies (organic chemical) ~ 26.8%

Capital Goods (transistors, aircrafts, motor vehicle parts, computers and telecommunication) ~ 49%

Consumer goods (medicine and cars) ~15%

Export Partners

Canada 19.4%, Mexico 12.8%, China 7.2%, Japan 4.7% (2010) Source: CIA World Factbook

U.S. International Trade

U.S. imports for 2011 - $2.314 trillion

Agricultural product ~4.9%

Industrial Supplies ~ 32.9%, crude oil ~8.2%

Capital Goods (computers, telecommunications equipment, motor vehicle parts, office machines, electric power machinery) ~ 30.4%

Consumer goods (automobiles, clothing, medicines, furniture, toys) ~ 31.8%

Import Partners

China 19.5%, Canada 14.2%, Mexico 11.8%, Japan 6.3%, Germany 4.3% (2010).

Comparative Advantage

Comparative Advantage – Ability of an economic agent to produce a good or service at a lower opportunity cost than competitors

Absolute Advantage – Ability of an economic agent to produce more of a good or service using the same amount of resources.

Specialization and gains from trade are based off of comparative advantage, not absolute advantage.

Comparative Advantage & Int’l Trade

Output per Hour Worked

Cell Phones Computers

Japan 12 6

U.S. 2 4

Comparative Advantage & Int’l Trade

Opportunity Cost of making each good.

Cell Phones Computers

Japan 1/2 Computer 2 Cell Phones

U.S. 2 Computers 1/2 Cell Phones

Comparative Advantage & Int’l Trade

Production and Consumption with a 1,000 hours of labor in autarky (i.e. no trade).

750 hours of production towards Cell Phones

250 hours of production towards Computers

Cell Phones Computers

Japan 9,000 1,500

U.S. 1,500 1,000

Increasing Consumption Through Trade

Terms of trade - the rate of exchange of one good or service for another when two countries trade with each other.

In our example, the terms of trade will be one cell phone for one computer.

Increasing Consumption Through Trade

Before we trade, lets specialize based on Comparative Advantage.

Cell Phones Computers

Japan 12,000 0

U.S. 0 4,000

Increasing Consumption Through Trade

Now trade 1,500 cell phones for 1,500 computers.

Cell Phones Computers

Japan 10,500 1,500

U.S. 1,500 2,500

Increasing Consumption Through Trade

Compared to autarky, Japan gained 1,500 cell phones and the U.S. gained 1,500 computers.

The increase in each countries PPF simply came about through specialization based off of Comparative Advantage and Trade. Both countries increased their consumption without having to increase the F.o.P. or implement new technology.

Why Don’t We See Complete Specialization?

Not all goods can be traded internationally (e.g. haircuts, tattoos, appendectomies).

Production of most goods involves increasing opportunity costs. As one country increases its production of a good, the opportunity cost may rise to the level of the opportunity cost of the other country, stopping short of complete specialization.

Where Does Comparative Advantage Come From?

Climate and Natural Resource.

Saudi Arabia has a comparative advantage in oil.

Costa Rica has a comparative advantage in bananas.

U.S. has a comparative advantage in wheat.

Iowa has a comparative advantage in corn and pork.

Where Does Comparative Advantage Come From?

Relative Abundance of Labor and Capital

U.S. has a relative abundance of skilled workers and sophisticated capital and therefore manufactures aircrafts, semiconductors, and computer software.

China has a relative abundance of unskilled workers and basic capital. They manufacture tools, clothing, and toys.

Where Does Comparative Advantage Come From?

Technology

Product Technology – technology to develop new products.

U.S. was one of the first countries to produce radios, televisions, computers, and automobiles

Process Technology – technology to improve existing products.

Japan capitalized on the production of the above goods with process technology and gained the comparative advantage in producing them.

Where Does Comparative Advantage Come From?

External Economies – reduction in a firms costs that results from an increase in the size of an industry.

Southern California has a comparative advantage in the production of movies

NYC has a comparative advantage in financial services

Dalton, GA has a comparative advantage in the production of carpets.

Switzerland has a comparative advantage in precision engineered watches.

Analyzing Trade

Using Consumer, Producer, and Social Surplus to analyze international trade.

Trade creates a net benefit. Trade makes some people better off and some worse off, but typically the gains offset the losses.

Government Policies that Restrict Trade

Tariff – taxes on imports.

Quota – a numerical limit in the quantity of a product that can be imported.

Protectionism

Some people are against free trade and promote policies that shield domestic firms from competition.

Savings jobs

Protecting high wages

Protecting infant industries

Protecting national security

Health and safety concerns

Opposing low labor standards and child labor

Protecting culture

High Cost of Protectionism

How much does it cost to protect a job? An average of $231,289, figured across just 20 of the many protected industries. Costs range from $132,870 per job saved in the costume jewelry business to $1,376,435 in the benzenoid chemical industry. Protectionism costs U.S. consumers nearly $100 billion annually. It increases not just the cost of the protected items but downstream products as well. Protecting sugar raises candy and soft drink prices; protecting lumber raises home-building costs; protecting steel makes car prices higher; and so forth.

The Fruits of Free Trade. Federal Reserve Bank of Dallas, 2002 Annual Report http://www.dallasfed.org/assets/documents/fed/annual/2002/ar02.pdf Primary Source: G. C. Hufbauer and K. A. Elliott, Measuring the Costs of Protection in the

United States, (Washington, D.C.: Institute for International Economics, 1994), pp. 11–13.