International Trade and competition (slides)

slides week 1-7 and knowledge clips

consumption effect

Welfare gain due to increase in quantity consumed.

production effect

Welfare gain due to shifting to cheaper foreign producers

market equilibrium

when the demand for imports equals the supply of exports/ global supply equals global demand

demand for imports (MD)

curve shows the excess of domestic demand over domestic supply:

MD = 0 if P = P*

MD > 0 if P < P*

MD is derived form supply and demand conditions in Home.

supply of exports (XS)

curve shows the excess of domestic supply over domestic demand.

XS = 0 if P = P*

XS > 0 if P > P*

XS is derived from supply and demand conditions in ROW

global market equilibrium

MD = XS (or: global demand = global supply)

absolute advantages

Being able to produce something at lower costs than other producers.

(—> what you can do better than anybody else.)

comparative advantage

Being able to produce a certain product at relatively lower costs (compared to other products) than other producers.

opportunity costs

how much of another good has to be given up in order to produce this good

Under autarky, the opportunity costs of producing product 1 (product 2) is equal to the relative price of product 1 (product 2)

production possibility curve (PPC)

show how much output can be produced with given inputs.

all combinations of a product(s) that can be produced with the available resources (example: labor hours)

negative slope

arbitrage

means taking advantage of a price difference between two or more markets: By striking a combination of matching deals that capitalize upon the imbalance, you can make a profit equal to the difference between the market prices at which the unit is traded

David Ricardo comparative advantage

what you can do relatively better than anybody else.

Produce and export what you can produce at lower opportunity costs than other countries. Import what involves higher opportunity costs.

real wage

wage expressed in units of a good (rather than money)

the value of one hour of work measured in terms of the quantity of goods it can buy ( proxy for wellbeing).

nominal wage

W = P x labor productivity

real wage

W / P

nominla wage

the value of one hour of work measured in terms of money

indifference curve (IC)

combination of goods that yield the same level of utility.

—> ICs further northeast imply higher utility

tangency point

determines the equilibrium relative price under autarky.

—> between PPC (supply) and IC (demand).

terms of trade

price of exports/price of imports

—> The higher the price of exports the more imports you can buy: Larger gains from trade

differences in relative prices can be the result of:

• Differences in production technology (productivity) —> Ricardo-model.

• Differences in demand (indifference curves).

• Differences in factor endowments coupled with differences in factor intensities (Heckscher-Ohlin theory).

factor intensities

?

factor endowments

stolper- samuelson theorem

An increase in the relative price of a good increases the real return to the factor used intensively in the production of this good

—> Trade —> relative price of exported product increases.

—> Returns to the factor used intensively in the exportoriented sector (= abundant factor) increase, returns to the factor used intensively in the import-competing sector (= scarce factor) fall

The Stolper-Samuelson theorem predicts that trade will reduce real wages of low-skilled workers in industrialized countries relative to those of high-skilled workers.

factor- price equalization (FPE) assumes

• … equal production technologies

• … both goods are produced in both countries

• ... no transport and other trade-related costs

—> • … equal product prices (wheat, cloth)

—> • … equal factor prices (wages, land rents)

In real world: International factor prices are not the same, but evidence for convergence.

2 sources of growth:

• Increase in country’s endowment with production factors.

• Improvement in production technology.

balanced growth

PPC shifts out in same proportions in direction of the two goods.

—> Proportionately, relative production patterns do not change.

—> Proportionate shift of PPC results in proportionate increases in production of both goods.

biased growth

PPC shift biased in favor of one good.

—> Production patterns change in favor of this good

Rybczynski theorem

In a two-good world, if the endowment with one factor (or its productivity) increases with the other factor and relative goods prices unchanged:

—> The production of the good that uses this factor intensively increases.

—> The production of the other good declines.

immiserizing growth

If growth in production factors leads to a decline in overall welfare

—> Happens if growth is strongly biased toward expanding the supply of exports and the terms of trade deteriorate strongly because the foreign demand for the country’s products is very price inelastic.

—> Less likely if a country has a balanced export portfolio.

—> Implies that large countries should favor policies that expand import-competing industries.

R&D and Heckscher-Ohlin predicts:

R&D undertaken in industrialized countries.

—> new technologies can be used anywhere (global diffusion) and the production location of these technologies can shift over time.

Vernon’s product life-cycle hypothesis

• New technologies and new products are typically invented and first produced in industrialized countries where skilled labor is abundant.

• As they become more standardized, less skilled labor is needed in production: Production location shifts to poorer countries abundant in low-skilled labor.

• The original inventor (and exporter) of the good becomes an importer of it.

—> Laptops first produced in U.S., nowadays in China

increasing trade also promotes economic growth:

• Access to foreign technologies.

• Access to new and improved intermediate goods raises productivity of domestic production.

• Competitive pressure creates incentives to innovate.

• Gains from economies of scale due to larger market size.

Technological progress tends to be skill-biased.

• It complements high-skilled labor (e.g. managers) and replaces low-skilled labor (e.g. factory workers).

• Reduces the relative demand for low-skilled labor and increases the productivity of high-skilled workers.

• Leads to increases in wage inequality.

forms of trade barriers:

• Tariffs

• Non-tariff barriers (e.g. quotas)

tariff

tax on imported goods and services

specific tariff

per unit

ad valorem

on the value

consumption effect tariff (d)

Welfare loss due to reduced consumption.

—> Sum of differences between willingness to pay and pre-tariff price for the units eliminated through the tariff.

—> Deadweight loss

production effect tariff (b)

Welfare loss from replacing low-cost foreign production with high-cost domestic production.

—> Sum of price differences for the units that are replaced by domestic production.

—> Deadweight loss

Increase in the domestic price of the product:

• Fall in consumer surplus, rise in producer surplus.

• Fall in quantity imported.

one dollar, one vote metric (b+d)

Net loss for the importing country and the world

nationally optimal tariff

The tariff that creates the largest net gain for the country (e – b – d).

fixed favoritism

The government allocates the import licenses to firms free of charge. Typically, licenses are allocated to firms that were already importing before the quota was introduced. The difference between world price and domestic price (area c) is the profit of the importer and thus part of the country’s net national wellbeing. Net welfare loss for the country: b + d

competitive auction

The government sells the import licenses on a competitive basis to the highest bidder. With an import license firms can earn a profit equal to the difference between world price and domestic price (area c). Firms compete for the licenses and are willing to sacrifice this profit to get the license: The area c becomes government revenue and thus part of the country’s net national wellbeing. Net welfare loss for the country: b + d.

resource- using procedure

Import licenses are allocated to firms based on a competitive application procedure. Encourages firms to spend resources to prove their worthiness, lobby the government, etc. (rent-seeking activities). Since a profit of c can be earned with the license, firms are willing to spend up to c on rent-seeking activities. For the country as a whole, these resources are wasted and not part of its net national wellbeing

Voluntary export restraints (VER)

Agreement that the exporting country will voluntarily limit its exports

—> Typically the result of threat by the importing country to otherwise impose other trade restrictions.

—> Similar welfare effect as a quota (quantity limit), but the profit from importing is now earned by the exporting country.

—> Net loss for the importing country: b + c + d.

product standards

Requirement that imported products satisfy certain standards in terms of product quality, production method, etc.(example: e.g. product requirements, labor safety)

—> Not necessarily discriminatory, but often written in such a way that they are easier to meet by domestic producers.

—> Reduces imports indirectly by raising the cost of imported products.

domestic content requirement

Requirement that domestically sold products have a minimum amount of domestic production value (similar: ‘Rules of origin’).

—> Limits imports of goods that do not meet the rule

government procurement

Requirement that the government must purchase from domestic producers.

—> Limits imports since governments are major purchasers of goods and services.

first- best world

there are no positive or negative externalities that are unaccounted:

• Private marginal benefits = Social marginal benefits.

• Private marginal costs = Social marginal costs.

—> If these conditions hold, the actions undertaken by an individual will maximize the wellbeing of the whole society. No need for government intervention.

second- best world

There are distortions (‘market failure’):

• Private marginal benefits>(<)Social marginal benefits: Over-consumption (underconsumption).

• Private marginal costs<(>)Social marginal costs: Over-production (under-production).

positive externalities

Activity generates higher returns for society than perceived by individuals (e.g. knowledge spillover) —> too little activity.

negative externalities

Activity generates lower benefits (or: higher costs) for society than perceived by individual actors (e.g. pollution) —> too much activity

specifity rule

Address the externality in the most direct is most efficient.

—> Direct production subsidy is more efficient —> increased production without reduction in consumer surplus.

—> Direct income transfers more efficient  can achieve the same income distribution without price distortions.

Production in the import-competing sector may have positive social benefits:

avoid unemployment, knowledge spillovers, retain worker skills, etc.

infant industry argument

(Temporary) protection from import competition gives domestic industry time to become more competitive.

—> E.g. due to increasing returns to scale (fixed costs), learning-by-doing

Import barriers bring benefits of more cost-effective production in the future, but welfare losses today.

Lack of government revenue can lead to:

inadequate supply of public goods (schooling, health, transport infrastructure, national defense, …)

—> Import tariffs may be a valid policy choice if tariffs are a crucial source of government revenue.

—> In developing countries, tariffs may be the only reliable source of revenue.

—> Benefits of better public goods provision may outweigh deadweight losses from tariffs.

political economy argument

Not all actors have the same influence on political decisions.

—> Number of people hurt by trade protection is typically large, but their per-capita losses are small.

—> Number of people who benefit from trade protection is typically small, but their stakes are high.

free- rider problem

Each individual has an incentives to contribute to a common cause and free-ride on others making their contribution.

U.S. based firms requiring inputs from China can respond to the tariffs in various ways:

• Switch to domestic suppliers.

• Switch to other foreign suppliers.

• In case of imports from firm’s own subsidiaries: Relocate production to other countries.

• Relocate U.S. production to other countries that don’t have import tariffs

—> This re-organization of supply chains is costly: transaction costs, fixed costs of building new production facilities, higher variable costs, lower quality of inputs, etc. —> When U.S. firms move abroad, jobs are lost.

week 6