CHAPTER 20: INTERNATIONAL TRADE

THE ECONOMIC BASIS FOR TRADE

“Why do nations trade?” hinges on three facts:

·         The distribution of natural, human and capital resources among nations is uneven; nations differ in their endowments of economic resources.

·         Efficient production of various goods requires different technologies or combinations of resources.

·         Products are differentiated as to quality and other nonprice attributes.

Labor-intensive goods – products requiring a relatively large amount of labor to be produced.

Land-intensive goods – products requiring a relatively large amount of land to be produced.

Capital-intensive goods – products that require a relatively large amount of capital to be produced.

COMPARATIVE ADVANTAGE: GRAPHICAL ANALYSIS

• Two isolated nations

2 characteristics of theses production possibilities curves:

·         Constant costs

·         Different costs

• United States

• Brazil

Brazil’s production possibilities curve represents a different full-employment opportunity-cost ratio.

• Self-Sufficiency Output Mix

If the United States and Brazil are isolated and are to be self-sufficient, then each country must choose some output mix on its production possibilities curve. It will choose the mix that provides the greatest utility, or satisfaction.

•  Specializing based on Comparative Advantage

·         Principle of Comparative Advantage

Total output will be greatest when each good is produced by the nation that has the lowest domestic opportunity cost for that good.

• Terms of Trade

The international exchange ratio or terms of trade:

1W = 1C (United States’ cost conditions

And

1W =2C (Brazil’s cost conditions)

• Gains from Trade

Trading possibilities line – shows the amounts of two products a nation can obtain by specializing in one product and trading for the other.

• Improved Options

• Added Output

Specialization according to comparative advantage results in a more efficient allocation of world resources, and larger outputs of both products are therefore available to both nations.

As a result of specialization and trade, both countries have more of both products.

A nation can expand its production possibilities boundary by (1) expanding the quantity and improving the quality of its resources or (2) realizing technological progress.

• Trade With Increasing Costs

• The Case For Free Trade

Through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well-being than it can without a free trade.

SUPPLY AND DEMAND ANALYSIS OF ExPORTS AND IMPORTS

World Price – price that equates the quantities supplied and demanded globally.

Domestic Price – price that would prevail in a closed economy that does not engage in international trade.

• Supply and Demand in the United States

·         U.S. Export Supply

U.S. export supply curve slopes upward, indicating a direct or positive relationship between the world price and the amount of U.S. exports. As world prices increase relative to domestic prices, U.S. exports rise.

·         U.S. Import Demand

It reveals that as world prices falls relative to U.S. domestic prices, U.S. imports increase.

TRADE BARRIERS

Tariffs – excise taxes on imported goods.

Revenue Tariff – usually applied to a product that is not being produced domestically.

Protective Tariff – is designed to shield domestic producers from foreign competition.

Import Quota – specifies the maximum amount a commodity that may be imported in any period.

Nontariff Barrier – is a licensing requirement that specifies unreasonable standards pertaining to product quality and safety, or unnecessary bureaucratic red tape that is used to restrict imports.

Voluntary Export Restriction – is a trade barrier by which foreign firms “voluntarily” limit the amount of other exports to a particular country.

• Economic Impact of Tariffs

·         Direct Effects

-Decline in consumption

-Increased domestic production

-Decline in imports

-Tariff revenues

• Indirect Effect

Tariffs directly promote the expansion of inefficient industries that do not have a comparative advantage; they also indirectly cause the contraction of relatively efficient industries that do not have a comparative advantage.

• Economic Impact of Quotas

While tariffs generate revenues for the domestic government, a quota transfers that revenue to foreign produces.

• Net Cost of Tariffs and Quotas

Protection raises the price of a product in three ways:

1)      The price of the imported product goes up

2)      The higher price of imports causes some consumers to shift their purchases to higher-priced domestically produced goods.

3)      The prices of domestically produced goods rise because import competition has declined.

• Import on Income Distribution

Tariffs and quotas affect low-income families proportionately more than high-income families. Because they are much like sales or excise taxes, these trade restrictions are highly regressive. That is, the “overcharge” associated with trade protection falls as a percentage of income as income increases.

THE CASE FOR PROTECTION: ACRITICAL VIEW

• Military Self-Sufficiency Argument

The argument here is not economic but political-military. Protective tariffs are needed to preserve or strengthen industries that produce the materials essential for national defense. In an uncertain world, the political-military objectives sometimes must take precedence over economic goals.

• Increased Domestic Employment Argument

This argument has several shortcomings:

·         Job creation from imports

·         Fallacy of composition

·         Possibility of retaliation

•  Diversification-for-Stability Agreement

There are also two serious shortcomings:

·         The argument has a little or no relevance to the United States and other advanced economics.

·         The economic costs of diversification may be great; for example, on-crop economics may be highly inefficient at manufacturing.

• Infant industry Argument

·         Counterarguments. There are some logical problems with the infant industry argument.

·         In the developing nations it is difficult to determine which industries are the infants that are capable of achieving economic maturity and therefore deserving protection.

·         Protective tariffs may persist even after industrial maturity has been realized.

·         Most economists feel that if infant industries are to be subsidized, there are better means of them tariffs for doing so.

• Strategic Trade Policy

The problem with this strategy and therefore with this argument for tariffs is that the nations put at a disadvantage by strategic trade policies tend to retaliate with tariffs of their own. The outcome may be tariffs worldwide, reduction of world trade, and the loss of potential gains from technological advances.

•  Protection-against-Dumping Argument

Dumping – is the selling of excess goods in a foreign market at a price below costs.

2 plausible reasons for this behavior:

1)      Firms may use dumping ahead to drive out domestic competitors there, thus obtaining monopoly prices and profits for the importing firm.

2)      Dumping may be a form of price discrimination, which is charging different prices to different customers even though costs are the same.

• Cheap Foreign Labor Argument

The cheap foreign labor argument says that domestic firms and workers must be shielded from the ruinous competitions of countries where wages are low.