MicroEcon Chapter 9

Recall Comparative Advantage

• Produce what they are relatively good at.

Tasks where they have a lower opportunity cost than others.

• Buy what they are relatively bad at.

Tasks where you have a higher opportunity cost than someone else.

Result →The economic pie gets bigger and there are gains from trade that leave the exchanging parties both better off! We can produce more together than we can apart!

Comparative Advantage and International Trade

• Geographic borders are irrelevant when it comes to comparative advantage!

• Comparative advantage is what drives international trade

Import

To buy goods or services from “foreign” sellers.

Export

To sell goods or services to “foreign” buyers

Example of importing and exporting

Singapore example:

• Singapore imports all its beef from Brazil, Australia, the United States, and New Zealand.

  • Singapore is a small island country, only 281.3 square miles(not a lot of space to raise cattle).

• Singapore’s biggest export is integrated circuits

Trade costs

The extra costs incurred as a result of buying or selling internationally, rather than domestically

Trade costs determine whether it’s worth buying or selling internationally

Scenarios of Trade Costs

• Shipping costs and potential delays

• Taxes paid to the U.S. government on imports

• Taxes paid to the foreign government on exports

• Hassle of language barriers

• Hassle of different time zones

• Dealing with foreign laws

Trade Cost Example

Shopping online for a new phone case:

You see a case you like being sold by a Chinese vendor.

You consider both the price and the trade costs as part of the marginal cost to determine whether the phone case is worth it.

The trade costs you consider include the following:

• Shipping costs

• Potential shipping delays

• Extra taxes you will have to pay to both the United and Chinese governments

The equation for determining whether to IMPORT good

Foreign price + trade costs < domestic price

• The foreign price needs to be far enough below the domestic prices that the foreign price is still cheaper even after trade costs are brought into consideration

Example on determining whether to import a good

Foreign price ($15) + trade costs ($7) < domestic price ($30)

The equation for determining whether to EXPORT good

Foreign price− trade costs > domestic price

The foreign price needs to be far enough above the domestic prices that the foreign price is still higher even after export-related trade costs are brought into consideration

Example on determining whether to export a good

Foreign price ($100) − trade costs ($30) > domestic price ($65)

High trade costs

High trade costs: Importing and exporting are more costly.

Result: International trade is less likely to be worthwhile than it would be if the buyer and seller were in the same country

Low trade costs

Importing and exporting are less costly.

Result: International trade is more likely to be worthwhile

Takeaway of Trade Costs within International Trade

Trade costs are the major determinant of the volume of international trade.

Examples:

• Music now has very low trade costs (thank you, internet!), so there is a huge amount of international trade in music.

• You likely don’t get your dental work done in another country because the associated trade costs are large (flying to another country, booking a hotel, taking multiple days off work, etc.)

Sources of comparative advantage

1. Abundant inputs

2. Specialized skills

3. Mass production

Abundant inputs

Take advantage of what you have, to get what you want

• Sell what you have a lot of and buy what you don’t have much of

What are Abundant input determined by?

Geography, climate, and natural resources:

• Canada has ample forests → export wood.

• Saudi Arabia has ample oil → export gasoline.

• People, businesses, and strategic investments:

  • America’s investment in higher education created an abundance of highly educated and skilled workers → export of new medicines, software, and planes.

Specialized skills

Unique skills, production methods, or expertise can lower your opportunity costs.

• Even if two countries have similar inputs (land, labor, and capital), better production techniques in one country will lead to a comparative advantage

Examples of Specialized skills

• Switzerland has great watchmakers.

• France (and Wisconsin!) produces great cheese.

• Americans make good movies

Mass production

Benefits of mass production (sometimes called economies of scale):

• Incredibly specialized production lines

• Bargaining power

Examples of Mass production

Ikea Example:

• Ikea created highly specialized production lines—robots that can work 24 hours a day, 7 days a week.

• One of the world’s largest purchasers of wood.Uses this bargaining power to negotiate cheaper wood prices, further lowering its input costs.

World supply

The total quantity of a good supplied by all manufacturers around the world, at each price

World demand

The total quantity of a good demand by all buyers around the world, at each price

World price

The price that a product sells for in the global market.

World supply Example

The Domestic Market

How to evaluate the effects of trade (Import and Export)

1. Figure out the new price

2. Determine the quantities demanded and supplied by the domestic buyers at this new price

3. Assess the quantity that will be traded

Example of evaluating the effects of Imports on the market

How to Analyzing the consequences of imports

1. No trade: What are consumer and producer surplus?

2. Free trade: What are the new consumer and producer surplus?

3. Evaluate the difference.

Visual representation of how imports raise economic surplus: No trade

Visual representation of how imports raise economic surplus: Free trade

Visual representation of how imports raise economic surplus: Evaluate the difference

Example of evaluating the effects of Exports on the market

Visual representation of how Exports raise economic surplus: No trade

Visual representation of how Exports raise economic surplus: Free trade

Visual representation of how Exports raise economic surplus: Evaluate the difference

Consequences of trade on Domestic price

Effects of Imports

decreases (to the world price)

Effects of Exports

Increases (to the world price)

The consequences of trade and the effects on Quantity supplied (domestically)

Effect of Imports

Decreases (since it follows that law of supply)

Effect of Exports

Increases (since it follows that law of supply)

The consequences of trade and the effects on Consumers surplus

Effect of Imports

Bigger gain

Effect of Exports

Smaller fall

The consequences of trade and the effects on Producer surplus

Effect of Imports

Smaller fall

Effect of Exports

Bigger gain

Economic surplus

Effect of Imports

Increase overall

Effect of Exports

Increase overall

Five arguments for International trade

1. National Security Concerns

2. Protection for Infant Industries

3. Unfair Competition and Dumping

4. Enforcing Minimum Standards

5. Restrict Trade to Save Domestic Jobs

Argument FOR National Security Concerns

National security requires that we produce strategically important goods ourselves.

• Health and safety: Make our own masks and vaccines.

• Food security: Produce our own supply of certain food items.

• National security: Develop our own weapons and security systems.

It may be critical to our health and safety that certain goods are produced in the country our trading partners cannot limit our access

Argument AGAINST National Security Concerns

Enemies rarely control the global market for any good. Even during the pandemic, food supply remained largely reliable.

• As long as we are not cut off from all countries, we will have ways of getting what we need.

Argument FOR Protection for Infant Industries

Governments can help create new industries by shielding fledgling businesses from international competition.

• Example: Brazil banned imports of computers to help Brazilian computer makers

Argument AGAINST Protection for Infant Industries

Infant industries often fail to grow as efficient as the competition.

Difficult for governments to identify which industries are likely to mature well protected.

Political pressure on governments to keep renewing the temporary protection

Argument FOR Unfair Competition and Dumping

Anti-dumping laws prevent unfair competition.

Dumping: Rival businesses temporarily charge extremely low prices, essentially dumping their good into the U.S. market.

• Later, raise prices back up once their competition has been driven out of business

Counterargument Unfair Competition and Dumping

Difficult to distinguish “dumping” from an efficient producer.

• Artificially low prices, or are low prices the result of a strong comparative advantage?

• Truly able to produce at lower costs?

Argument FOR Enforcing Minimum Standards

Americans have agreed on certain minimum standards:

• No child labor

• Minimum wage

• Safety and environmental standards

Trade can undermine these standards when we purchase foreign goods made in sweatshops (or with child labor, or in unsafe environments, etc.)

Counterargument for Enforcing Minimum Standards

Restricting trade with low-income countries will create even more poverty.

• Working a low-paid job beats having no job

Argument FOR Restrict Trade to Save Domestic Jobs

Domestic workers employed in industries that compete with imported goods will lose their jobs.

• Concerns that these workers will not be re-employed in another job

Counterargument Restrict Trade to Save Domestic Jobs

Restraining trade will destroy jobs in businesses that rely on imported inputs.

Example: U.S. restrictions on sugar imports preserve jobs in the domestic sugar industry, but...

• The high price of sugar in the United States pushed candy manufacturing to other countries.

Trade causes export-oriented sectors to expand, creating new jobs.

• Trade changes what workers do, not how many people work

How do your evaluate how international policies affect the market

Start by understanding the impact of tariffs!

• Tariff: A tax on imported products.

  • Tariffs increase trade costs

How to evaluating the effects of an import tariff

1. Find the new price

2. Determine the quantities demanded and supplied by domestic buyers and sellers at this new price

3. Evaluate the quantity that will be traded

Step 1 to evaluating The effect of an important tariff

Find the new price

Step 2 to Evaluating the effect of an important tariff

Determine the quantities demanded and supplied by domestic buyers and sellers at this new price

Step 3 to Evaluating the effect of an important tariff

Evaluate the quantity that will be traded

Tools of Trade Policy

Tariffs: Reduce international trade, and raise revenue for domestic government.

Red tape: Reduces international trade but does not raise revenue for the domestic government.

Import quotas: Reduce international trade just as tariffs do (exact same price and quantity outcomes) but do not raise government revenue.

• Import quota: A limit on the quantity of a good that can be imported.

Exchange rate manipulation: A country can use this tool to increase its exports and reduce its imports

Globalization

The increasing economic, political, and cultural integration of different countries

The Rise of Globalization

Declining trade costs are a driving force of globalization:

Lower trade barriers

Closer political integration

Improved telecommunications

Electronic banking

Internet

Improved rail, sea, and air transportation

RECALL the interdependence principle—your economic life depends on the decisions made by others, including people all around the world

Effect of Globalization on U.S. Wages

American and Chinese laborers don’t directly compete(different national labor markets)...

• But their labor does compete in the form of the goods and services that are traded between countries

Productivity determines wages, and the productivity of U.S. workers is much higher than elsewhere

Effect of Globalization on Income Inequality in the United States

International trade likely may explain some of the rising income inequality in the United States

• U.S. exports skill-intensive goods

• U.S. imports low skill-intensive goods

U.S. exports skill-intensive goods

Lower trade costs...

• Increase foreign demand for these goods...

• which increases domestic demand for highly educated workers...

• thus, raising the incomes of highly educated workers

U.S. imports low skill-intensive goods

Lower trade costs...

• Increase U.S. demand for these goods...

  • which decreases domestic demand for these types of goods...

  • which decreases domestic demand for low-skilled workers...

  • thus, decreasing the wages of these lower-skilled workers.

    • The magnitude of this effect is estimated to be small, but it is an ongoing area of research