Chapter 20
INTERNATIONAL TRADE
INTRODUCTION

This chapter addresses some basic issues
related to trade:
 What
benefit, if any, do we get from international
trade?
 How much harm do imports cause, and to whom?
 Should we protect ourselves from “unfair” trade by
limiting imports?
2
IMPORTS
Imports are goods and services purchased
from foreign sources.
 Although imports represent only 14 percent of
total GDP
GDP, they account for larger shares of
specific product markets.

I
Bauxite to manufacture aluminum and
chromium to manufacture chrome are not
found in the U
U.S.
S
3
IMPORTS

I
We import services as well as goods.
Flying on a foreign airline and staying in a
foreign hotel are both imports
imports.
4
EXPORTS
While we are buying goods and services from
the rest of the world, foreigners are buying our
exports.
 Exports are goods and services sold to foreign
buyers.
 U.S. exports include farm products, tobacco,
machineryy and computers,
p
, aircraft,,
automobiles and auto parts, raw materials, and
chemicals.
chemicals

5
TRADE BALANCES
While the U.S. is the largest exporter of goods
and services, exports represent a relatively
modest fraction of our total output compared to
the rest of the world.
 Although we export many products, we often
h
have
an iimbalance
b l
in
i our ttrade
d fl
flows.

T d balance
Trade
b l
= exports
t – imports
i
t
6
TRADE BALANCES

Trade deficit is the amount by which the value
of imports exceeds the value of exports in a
given time period.
I
Trade surplus is the amount by which the
value of exports exceeds the value of
imports in a given time period.
7
TRADE BALANCES
During 2000, we imported much more than we
p
and so had a trade deficit.
exported
Product
Category
Merchandise
Services
Total Trade
Exports
(in $billions)
773
296
1,069
Imports
(in $billions)
11,223
223
215
1,438
Surplus
(Deficit)
(450)
81
(369)
8
BILATERAL TRADE BALANCES: TOP DEFICIT COUNTRIES
Anyy imbalance in America’s trade must be offset byy
reverse imbalances elsewhere.
Country
China
Chi
Japan
C
Canada
Germany
Mexico
Trade
T
d B
Balance
l
(in billions of dollars)
–83.8
83 8
–81.6
–51.9
19
–29.1
–24.6
9
BILATERAL TRADE BALANCES: TOP SURPLUS COUNTRIES
Country
Netherlands
Australia
Belgium
Hong Kong
E
Egypt
t
Trade Balance
(in billions of dollars)
+12 2
+12.2
+6.0
+4 0
+4.0
+3.1
+2.4
24
10
MOTIVATION TO TRADE

Why trade when . . .
. . . we import many of the things we also export.
. . . we could produce many of the other things we
import.
import
. . . we seem to seem to worry so much about trade
i b l
imbalances.
11
SPECIALIZATION
Trade allows nations to specialize and
specialization increases total output.
 Trade increases world output and the
standards of living in all trading countries.
countries

12
PRODUCTION AND CONSUMPTION WITHOUT
TRADE
The gains from trade can be illustrated using
production possibilities curves.
 In the absence of trade, a country’s
consumption possibilities are identical to its
production possibilities.

G
Consumption
p
possibilities
p
- The alternative
combinations of goods and services that a
y could consume in a g
given time p
period.
country
13
CONSUMPTION POSSIBILITIES WITHOUT TRADE
U.S. Production
Possibilities
Bread
Wine
100
0
80
10
60
20
40
30
20
40
0
50
French Production
Possibilities
Bread
Wine
1
15
0
12
12
9
24
6
36
3
48
0
60
14
CONSUMPTION POSSIBILITIES WITHOUT TRADE
U.S. production possibilities
OUTPU
UT OF BREAD
((zillions off loaves pe
er year)
100 A
B
80
C
60
D
40
E
20
0
10
20
30
40
F
50
60
OUTPUT OF WINE (zillions of barrels per year)
15
CONSUMPTION POSSIBILITIES WITHOUT TRADE
French production possibilities
OUTPUT OF BRE
EAD
(zzillions of loaves pe
er year)
25
20
15 G
H
10
I
J
5
0
K
10
20
30
40
50
L
60
OUTPUT OF WINE (zillions of barrels per year)
16
PRODUCTION AND CONSUMPTION WITH TRADE
To assess the potential gain from trade, we
need to consider the combined output of
trading nations.
 Just by increasing the mix of output in each
trading country, we can increase total world
output.
t t

17
MUTUAL GAINS
Each country produces those goods it makes
best, then trades with other countries to
acquire the goods it desires to consume.
 When a country engages in international trade,
trade
its consumption possibilities always exceed its
production
d ti possibilities.
ibiliti

18
CONSUMPTION POSSIBILITIES WITHOUT TRADE
U.S.
U
S (at point D)
France (at point I)
World total
Bread
40
9
49
Wine
30
24
54
19
CONSUMPTION POSSIBILITIES WITH TRADE
U.S.
U
S (at point C)
France (at point K)
W ld totall
World
Bread
60
3
63
Wine
20
48
68
20
QUA
ANTITY O
OF BREAD
D
(zillion
ns of loave
es per yea
ar)
CONSUMPTION POSSIBILITIES WITH TRADE
(a) U.S. production and
consumption
120
100 A
80
60
40
20
0
Production with
trade
C
D
Consumption with
trade
N
Production and
consumption
ti without
ith t
trade
20
30
40
10
50
60
QUANTITY OF WINE (zillions of barrels per
year)
21
CONSUMPTION POSSIBILITIES WITH TRADE
(b) French production and consumption
Q
QUANTIT
TY OF BRE
EAD
(zillions of lo
oaves perr year)
20
15
I
10
M
Consumption with trade
Production
with trade
K
Production and
5 consumption without trade
0
10
20
30
40
50
60
QUANTITY OF WINE (zillions of barrels per
year)
22
GAINS FROM SPECIALIZATION
United States
F
France
W ld ttotal
World
t l
Old Mix of
Output
Bread Wine
40
30
(point D)
9
24
(point I)
49
54
New Mix of
Output
Bread Wine
60
20
(point C)
3
48
(point K)
63
68
23
PURSUIT OF COMPARATIVE ADVANTAGE

Although international trade can make
everyone better off, it’s not obvious which
goods should be traded, or on what terms.
24
OPPORTUNITY COSTS

The decision to export is based on comparative
advantage.
 Comparative
advantage - The ability of a country to
produce a specific good at a lower opportunity cost
than its trading partners.
 Opportunity cost - The most desired goods or
services that are forgone in order to obtain
something else.
else
25
COMPARATIVE ADVANTAGE
Comparative advantage refers to the relative
(opportunity costs) of producing particular
goods.
 World output
output, and thus potential gains from
trade, will be maximized when each country
pursues its
it comparative
ti advantage.
d
t

26
ABSOLUTE COSTS DON
DON’TT COUNT
Only the relative costs between countries
matter for determining who should be
producing what.
 The absolute advantages in production do not
matter.

G
Absolute advantage – The ability of a country
to produce a specific good with fewer
resources (per unit of output) than other
countries.
27
TERMS OF TRADE
It definitely pays to pursue one’s comparative
advantage by specializing in production.
 The terms of trade establish the trading rate.
 Terms
T
off trade
t d is
i th
the rate
t att which
hi h goods
g d are
exchanged – the amount of good A given up for
good B in trade.

28
LIMITS TO THE TERMS OF TRADE

A country will not trade unless the terms of
trade are superior to domestic opportunities.
29
LIMITS TO THE TERMS OF TRADE

The terms of trade between two countries will
lie somewhere between their respective
opportunity costs in production.
30
SEARCHING FOR THE TERMS OF TRADE
Bread
d
United
States
B
Bread
France
A
100
80 X
60
C
D
40
Production
20
possibilities
ibiliti
0
120
90
60
30
10
0
10
20
30
Y
Consumption
p
possibilities
N
40
50
60
70
80
90 100 110
Consumption possibilities
L
M
20
30
Production possibilities
K
40 50 60
Wine
70
80
90 100 110
31
THE ROLE OF MARKETS AND PRICES
The decision to import or export a particular
good is often left up to the market decisions of
individual consumers and producers.
 The terms of trade,
trade like the price of any good,
good
will depend on the willingness of market
participants
ti i
t to
t b
buy or sellll att various
i
prices.
i

32
PROTECTIONIST PRESSURES
Although the potential gains from trade are
impressive, not everyone favors free trade.
 Imports typically compete with a domestic
industry.
 The affected industries will try to restrict
imports in order to preserve their own jobs and
incomes.
 Workers and p
producers who compete
p
with
imported products – who work in importcompeting industries – have an economic
interest in restricting trade.

33
EXPORT INDUSTRIES
Trade not only alters the mix of output but also
redistributes income from import-competing
industries to export industries.
 Trade restrictions designed to protect specific
microeconomic interests reduce the total gains
trade
from trade.
 Selfish micro interests are not the only source
of trade restrictions.
 Other arguments are used to restrict trade.
trade

34
NATIONAL SECURITY CONCERNS
Essential defense-related goods are vital during
times of war.
 A war could disrupt this flow leaving us
vulnerable.
vulnerable
 Exporting vital technology to a potential enemy
is not wise.

35
DUMPING
Import competing industries are placed at risk
when goods are consistently dumped in a
nation.
 Dumping is the sale of goods in export markets
at prices below domestic prices.

36
INFANT INDUSTRIES
Even normal export prices might make it
difficult or impossible for a new domestic
industry to develop.
 These industries may need temporary
protection from imports.
 Trade restrictions are justified only if there is
tangible
g
evidence that the industryy can develop
p
a comparative advantage reasonably quickly.

37
IMPROVING THE TERMS OF TRADE
The distribution of the gains from trade
depends on the terms of trade.
 If the terms of trade moves in our favor, due to
trade restrictions,
restrictions we would end up with a
larger share of the gains from trade.
 The microeconomic losses associated with
trade ggive rise to a constant clamor for trade
restrictions.

38
EMBARGOES
The sure-fire way to restrict trade is simply to
eliminate it.
 An embargo is a prohibition against trading
particular goods.
goods

39
TARIFFS
A more frequent trade restriction is a tariff.
 A tariff is a tax (duty) imposed on imported
goods.
 A tariff
t iff on imported
i
t d goods
g d makes
k them
th
more
expensive to domestic consumers, and thus
less competitive with domestically priced
g
goods.

40
BEGGAR-THY-NEIGHBOR
“BEGGAR
THY NEIGHBOR”
The curtailment of imports looks like an easy
solution to the problem of domestic
unemployment.
 Tariffs inflict harm on foreign producers.
producers

41
BEGGAR-THY-NEIGHBOR
“BEGGAR
THY NEIGHBOR”
The Smoot-Hawley Tariff Act was designed to
save American jobs by restricting foreign
competition through 59% tariffs.
 When foreign countries retaliated with tariffs of
their own, world trade shrank and
unemployment
l
t increased
i
d iin allll countries.
ti

42
QUOTAS
The same effects of a tariff can be attained
more directly by imposing an import quota.
 A quota is a limit on the quantity of a good that
may be imported in a given time period.
period
 The effect of quotas on trade is different than
the effect of tariffs.

43
NO-TRADE
NO TRADE EQUILIBRIUM
The equilibrium price is completely determined
by domestic demand and supply curves.
 Free trade allows the import of unlimited
quantity of foreign supplies at the world price.
price
 Free trade results in reduced prices and
increased consumption.

44
RESTRICTED TRADE
Tariffs raise the price of imports and shifts the
import supply curve upward.
 Domestic prices rise, domestic production
rises and domestic consumption falls.
rises,
falls
 Quotas are a greater threat to competition than
tariffs because quotas preclude additional
imports
p
at anyy p
price.

45
IMPACT OF TRADE RESTRICTIONS
PRICE (dollars per unit)
(a) No-trade equilibrium
D1
S1
p1
0
q1
QUANTITY (units per year)
46
IMPACT OF TRADE RESTRICTIONS
PRICE (dollars per unit)
(b) Free-trade equilibrium
D1
S1
p1
B
p2
0
qd
q1
S2
q2
QUANTITY (units per year)
47
IMPACT OF TRADE RESTRICTIONS
PRICE (dollars per unit)
(c) Tariff-restricted trade
D1
S1
p1
C
p3
p2
0
qd qt
q1
S3
S2
q3 q2
QUANTITY (units per year)
48
IMPACT OF TRADE RESTRICTIONS
PRICE (dollars per unit)
(d) Quota-restricted trade
D1
S1
S4
Q
p1
p4
p2
0
q1
q4 q2
QUANTITY (units per year)
49
VOLUNTARY RESTRAINT AGREEMENTS
A light variant of quotas has been used in
recent years.
 A voluntary restraint agreement (VRA) is an
agreement to reduce the volume of trade in a
specific good – a “voluntary” quota.
 Embargoes, export controls, tariffs, and quotas
are the most visible barriers to trade,, but theyy
are only the tip of the iceberg.

50
NONTARIFF BARRIERS
The U.S. uses product standards, licensing
restrictions, restrictive procurement practices,
and other nontariff barriers to restrict roughly
15 percent of imports.
 Trade policy is a continuing conflict between
th proponents
the
t off ffree trade
t d and
d the
th special
i l
interests that profit from trade protection.
 The long-term trend is towards lowering trade
barriers thereby increasing global competition.
barriers,
competition

51
MULTILATERAL TRADE PACTS
The principle barrier to protectionist forces is
the worldwide recognition of the gains from
trade.
 The granddaddy of the multilateral
multilateral, multiyear
free-trade pacts was the General Agreement on
T iff and
Tariffs
d TTrade
d (GATT).
(GATT)

52
GATT
In 1947, twenty-three nations pledged to
reduce trade barriers and give equal access to
all GATT nations to their domestic markets.
 Since the first GATT pact, seven more “rounds”
of negotiations ha
have
e expanded
e panded the scope of
GATT.
 117 nations signed the 1994 pact.
 As a result of these GATT pacts
pacts, average tariff
rates in developed countries have fallen from
40 percent iin 1948 to lless than
h 4 percent
today.

53
WTO
The 1994 GATT pact also created the World
Trade Organization (WTO) to enforce free-trade
rules.
 In effect
effect, the WTO is the world
world’ss trade police
force.

54
WTO PROTESTS

Some people see free trade as a mixed
blessing.
 Environmentalists
worry about depletion of
resources, congestion and pollution.
 Labor organizations worry about depressed wages
and working conditions.
conditions
 Third World countries worry about an unfair trade
playing field.
field
55
WTO PROTESTS

Trade negotiators are trying to find ways to
continue dismantling trade barriers while
paying more attention to broader social
concerns.
56
REGIONAL PACTS: NAFTA AND EU
Groups of nations have moved even faster
toward open markets by developing regional
trade pacts.
 In December 1992
1992, the United States
States, Canada
Canada,
and Mexico signed the North American Free
T d Agreement
Trade
A
t (NAFTA).
(NAFTA)
 The Ultimate g
goal of NAFTA is to eliminate all
trade barriers between these three countries.

57
NAFTA
The NAFTA-initiated reduction in trade barriers
substantially increased trade flows between
Mexico, Canada, and the United States.
 Overall,
Overall NAFTA accelerated economic growth
and reduced inflationary pressures in all three
nations.
ti

58
EUROPEAN UNION
The European Union (EU) is a regional pact that
virtually eliminates national boundaries
between 15 countries.
 The EU has not only eliminated trade barriers,
barriers
but also permitted full inter-country mobility of
workers
k
and
d capital.
it l

59
EUROPEAN UNION
In 1999, eleven of the EU nations also created
a new currency (the euro) that will replace the
German mark, the French franc, and other
national currencies.
 In effect, Europe has become one large unified
market.
k t

60
End of Chapter 20
INTERNATIONAL TRADE