Chapter 5: International Economics Notes

International Trade Overview

• Definition: International trade is the exchange of goods and services across borders.

• Importance:

  • More important for the U.S. than it used to be.

  • Essential for some countries more than others.

• Benefits:

  • Improves welfare for both producers and consumers (e.g., Chinese smartphone producers & American consumers).

• Key Concept: Hyperglobalization

  • A phenomenon characterized by extremely high levels of international trade.

Comparative Advantage & Trade

• Definition: A country has a comparative advantage in producing a good or service if the opportunity cost of production is lower for that country than for others.

• Ricardian Model: Trade follows this model, assuming constant opportunity costs.

• Key Assumptions:

  • Countries specialize in goods they can produce more cheaply.

  • Trade allows consumption beyond production capabilities.

• Autarky: A situation where a country does not trade.

  • Without trade, a country’s consumption is limited by its production.

• Comparative vs. Absolute Advantage:

  • Just because the U.S. can produce more of both goods doesn’t mean it’s better off without trade.

  • Opportunity costs determine trade benefits.

Production Possibilities & Specialization

• Trade-offs & Opportunity Costs:

  • Without trade, a country must choose a mix of two products.

• Specialization:

  • U.S. focuses on trucks; China focuses on phones → Total world production increases.

• Economies of Scale:

  • Firms grow → Average total cost (ATC) drops.

  • Some firms, like Toyota, expand globally to access larger markets.

  • Diseconomies of scale occur when costs increase beyond a certain point.

Sources of Comparative Advantage

1. Differences in Climate: (e.g., Bananas grow better in certain regions)

2. Factor Abundance:

   • Supply of production factors (land, labor, capital, entrepreneurship).

   • Example: A country rich in forests vs. one rich in machinery.

3. Factor Intensity:

   • The quantity of a factor used compared to others (e.g., labor vs. natural resources).

4. Technology Differences:

   • Some countries develop advanced technologies (e.g., Swiss watches, AI).

   • U.S. once had an advantage in manufacturing but shifted focus.

5. Changing Comparative Advantages:

   • Example: Hong Kong lost its advantage in garments as it specialized in higher-value industries.

Supply & Demand in International Trade

• Key Terms:

  • Domestic Demand Curve: Shows how the quantity demanded depends on price.

  • Domestic Supply Curve: Shows how the quantity supplied depends on price.

  • World Price: The global market price for a good.

• Without Trade:

  • Equilibrium price & quantity depend only on domestic supply and demand.

• With Trade:

  • If world price (Pw) < domestic price (Pa) → Imports increase, domestic price drops.

  • If world price (Pw) > domestic price (Pa) → Exports increase, domestic price rises.

• Effects of Trade on Surplus:

  • Imports lower domestic prices, benefiting consumers.

  • Exports raise domestic prices, benefiting producers.

Trade Barriers & Their Effects

• Types of Trade Protection:

  • Tariffs (Taxes on Imports)

    • Increase domestic production but reduce domestic consumption.

    • Raise prices → Decrease consumer surplus, increase producer surplus.

    • Government earns revenue, but deadweight loss occurs.

  • Import Quotas (Limits on Imports)

    • Same effects as tariffs but with revenue going to quota holders instead of the government.

• Historical Context:

  • Smoot-Hawley Tariff (1930s): Increased tariffs, worsened the Great Depression.

  • Bretton Woods Agreement (Post-WWII): Established international economic cooperation (IMF & World Bank).

Arguments for & Against Trade Protection

• Arguments for Protection:

  • National Security: Essential industries (oil, steel, defense, food) must be protected.

  • Domestic Employment: Globalization may cause job losses in some industries.

  • Infant Industry Argument: New industries need protection to develop.

  • Using Tariffs as a Bargaining Tool: Tariffs can be used to negotiate better trade deals.

• Critiques of Protectionism:

  • Hard for governments to predict which industries will succeed.

  • Protection discourages competitiveness.

  • Political influence often determines which industries receive protection.

International Trade Agreements

• NAFTA (Now USMCA): U.S., Canada, and Mexico trade agreement.

• EU (European Union): Customs union among 28 European nations.

• WTO (World Trade Organization): Oversees trade agreements and disputes.

• Impact of Trade Agreements:

  • Reduce tariffs, promote economic growth.

  • Encourage specialization and efficiency.

Trade & Income Distribution

• Exporting Industries: Sell goods abroad.

• Import-Competing Industries: Compete with imported goods.

• Wage Effects of Trade:

  • U.S. exports skill-intensive products & imports labor-intensive goods.

  • Can widen the wage gap between highly educated and less educated workers.

• Offshore Outsourcing:

  • Hiring foreign workers for certain tasks.

  • Still a smaller portion of trade compared to physical goods.

Inflation & Trade

• Consumer Price Index (CPI): Measures inflation, released monthly.

• Inflation Terms:

  • Inflation: Rising price levels.

  • Deflation: Falling price levels.

  • Disinflation: Slowing inflation rate.

• Tariffs & Inflation: Tariffs increase prices and contribute to inflation.

• Controlling Inflation:

  • Governments raise interest rates to slow the economy.

  • Politicians often avoid drastic economic slowdowns due to electoral risks.