Transcript Chapter 2
GSIAS – North American Economy Intra- National Trade and International Trade in North America How and Why Lesson Overview • Current Trade Statistics • Basics of why people / countries trade Opportunity Cost and Comparative Advantage Intl. Trade through Comparative Advantage • Basic Trade Models Gravity Model Heckschire-Ohlin Model Economies of Scale • Barriers to Trade • Developing Country Model (Mexico) • Pros / Cons to Free Trade • Application to N.American Economy 2-2 Trade in North America USA Canada Mexico GDP $48,000 $40,200 $14,400 Current Acct. Bal. -$568.8 billion $12.82 billion -$13.45 billion Export $ $1.377 trillion $461.8 billion $294 billion Export Products capital goods 49.0%, indust supplies 26.8% consumer goods 15.0% motor vehicles/parts, industrial machinery, aircraft, tele equip.; chemicals, plastics, fertilizers; wood pulp, timber, crude petroleum, natural gas, alum. manufactured goods, oil and oil products, silver, fruits, vegetables, coffee, cotton Export Partners Can. 21.4%, Mex 11.7% China 5.6%, Japan 5.4% US 78.9%, UK 2.8%, China 2.1% US 82.2%, Canada 2.4%, Germany 1.5% Import $ $2.19 trillion $436.7 billion $305.9 billion Import Products Indust supplies 32.9% (crude oil 8.2%), capital goods 30.4%, consumer goods 31.8% machinery and equipment, motor vehicles and parts, crude oil, chemicals, electricity, durable consumer goods metalworking machines, steel mill products, agricultural machinery, electrical equipment, car parts for assembly, repair parts for motor vehicles, aircraft, and aircraft parts Import Partners China 16.9%, Can.15.7%, Mexico 10.6% US 54.1%, China 9.4%, Mexico 4.2% US 49.6%, China 10.5%, Japan 5.8%, South Korea 4.5% Current Acct Balance: records a country's net trade in goods and services, plus net earnings from rents, interest, profits, and dividends, and net transfer payments (such as pension funds and worker remittances) to and from the rest of the world during the period specified. Trade Basics: A PARABLE FOR THE MODERN ECONOMY Imagine an economic system with only two goods, potatoes and meat and only two people, a potato farmer and a cattle rancher What should each person produce? Why should these people trade? What can the Farmer and Rancher produce? Reference: 1 ounce = 28.35 grams Production Possibilities • Suppose the farmer and rancher decide not to engage in trade: Each consumes only what he or she can produce alone. The production possibilities frontier is also the consumption possibilities frontier. Without trade, economic gains are diminished. • Suppose instead the farmer and the rancher decide to specialize and trade… Both would be better off if they specialize in producing the product they are more suited to produce, and then trade with each other. Figure 2 How Trade Expands the Set of Consumption Opportunities (a) The Farmer ’s Production and Consumption Meat (ounces) 8 Farmer's consumption with trade A* 5 4 Farmer's production and consumption without trade A Farmer's production with trade 0 32 16 Potatoes (ounces) 17 Copyright©2003 Southwestern/Thomson Learning Figure 2 How Trade Expands the Set of Consumption Opportunities (b) The Rancher ’s Production and Consumption Meat (ounces) Rancher's production with trade 24 Rancher's consumption with trade 18 13 B* B 12 0 12 24 27 Rancher's production and consumption without trade 48 Potatoes (ounces) Copyright © 2004 South-Western COMPARATIVE ADVANTAGE • Differences in the costs of production determine the following: Who should produce what? How much should be traded for each product? • Two ways to measure differences in costs of production: The number of hours required to produce a unit of output (for example, one pound of potatoes). The opportunity cost of sacrificing one good for another. Opportunity Cost and Comparative Advantage • Compares producers of a good according to their opportunity cost, that is, what must be given up to obtain some item • The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. Who has the comparative advantage in the production of each good? ? ? Comparative Advantage and Trade • Potato costs… The Rancher’s opportunity cost of an ounce of potatoes is ½ an ounce of meat. The Farmer’s opportunity cost of an ounce of potatoes is ¼ an ounce of meat. • Meat costs… The Rancher’s opportunity cost of a pound of meat is only 2 ounces of potatoes. The Farmer’s opportunity cost of an ounce of meat is only 4 ounces of potatoes... Comparative Advantage and Trade …so, the Rancher has a comparative advantage in the production of meat but the Farmer has a comparative advantage in the production of potatoes. APPLICATIONS OF COMPARATIVE ADVANTAGE • Should Tiger Woods Mow His Own Lawn? ? ? ? ? Intl. Trade through Comparative Adv. Basic Trade Model •Countries will trade based on their particular comparative advantage. Below, no trade equilibrium point. Price of Steel Domestic supply Consumer surplus Equilibrium price Producer surplus Domestic demand 0 Equilibrium quantity Quantity of Steel The World Price and Comparative Advantage • The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good. • If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporter of the good. • If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good. International Trade in an Exporting Country Price of Steel Price after trade Consumer surplus surplus Consumer after trade before trade Exports A BB Price before trade World price D CC Producer surplus after before trade trade 0 Domestic supply Domestic demand Quantity of Steel THE WINNERS AND LOSERS FROM TRADE • The analysis of an exporting country yields two conclusions: Domestic producers of the good are better off, and domestic consumers of the good are worse off. Trade raises the economic well-being of the nation as a whole. The Gains and Losses of an Importing Country • International Trade in an Importing Country If the world price of steel is lower than the domestic price, • the country will be an importer of steel when trade is permitted. • domestic consumers will want to buy steel at the lower world price. • domestic producers of steel will have to lower their output because the domestic price moves to the world price. International Trade in an Importing Country Price of Steel Consumer surplus before trade Domestic supply A Price before trade Price after trade B C D Imports Producer surplus before trade 0 World price Domestic demand Quantity of Steel Figure 3 International Trade in an Importing Country Price of Steel Consumer surplus after trade Domestic supply A Price before trade Price after trade 0 BB C D Imports Producer surplus after trade World price Domestic demand Quantity of Steel The Gains and Losses of an Importing Country • How Free Trade Affects Welfare in an Importing Country The analysis of an importing country yields two conclusions: • Domestic producers of the good are worse off, and domestic consumers of the good are better off. • Trade raises the economic well-being of the nation as a whole because the gains of consumers exceed the losses of producers. Basic Trade Models • There are a variety of models today that describe why regions and countries trade. We will take a look at a few of the primary ones. Gravity Model Heckschire-Ohlin Model Economies of Scale • One note regarding these trade models: These models can be applicable whether we are talking about intra-national or international trade. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 2-22 Size Matters: The Gravity Model • Which countries do the US, Mexico and Canada primarily trade with? Why? • The Gravity Model can help explain. Newton‘s law of gravity states that the gravitational attraction between any two objects is proportional to the product of their masses and diminishes with distance. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 2-23 Size Matters: The Gravity Model (cont.) The Gravity Model Determinants of Trade: 1. Size of the potential trading partners economy. The more money a country has, the more they can spend on your products! 2. Distance between markets influences transportation costs and therefore the cost of imports and exports. Distance may also influence personal contact and communication, which may influence trade. 2. Cultural affinity: if two countries have cultural ties, it is likely that they also have strong economic ties. 3. Geography: ocean harbors and a lack of mountain barriers make transportation and trade easier. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 2-25 The Gravity Model (cont.) 4. Multinational corporations: corporations spread across different nations import and export many goods between their divisions. 5. Borders: crossing borders involves formalities that take time and perhaps monetary costs like tariffs. These implicit and explicit costs reduce trade. The existence of borders may also indicate the existence of different languages (see 2) or different currencies, either of which may impede trade more. 6. Trade Pacts Distance and Borders (cont.) Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 2-27 Heckscher-Ohlin Trade Model • While trade is partly explained by differences in labor productivity (ie. Ricardo model), it also can be explained by differences in resources across countries. • The Heckscher-Ohlin theory argues that international differences in labor, labor skills, physical capital or land (factors of production) create productive differences that explain why trade occurs. Countries have relative abundance (or scarcity) of factors of production. ie. land to people. Production processes use factors of production with relative intensity. ie. Farming is land intensive. Making cloth is labor intensive. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-28 Production and Prices (cont.) Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-29 Trade in the Heckscher-Ohlin Model • Suppose that the domestic country has an abundant amount of labor relative to the amount of land. The domestic country is abundant in labor and the foreign country is abundant in land: L/T > L*/ T* Likewise, the domestic country is scarce in land and the foreign country is scarce in labor. However, the countries are assumed to have the same technology and same consumer tastes. Does this matter? • Because the domestic country is abundant in labor, it will be relatively efficient at producing cloth because cloth is labor intensive. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-30 Trade in the Heckscher-Ohlin Model (cont.) • Like the Ricardian model, the Heckscher-Ohlin model predicts a convergence of relative prices with trade. • With trade, the relative price of cloth will rise in the domestic country and fall in the foreign country. In the domestic country, the rise in the relative price of cloth leads to a rise in the relative production of cloth and a fall in relative consumption of cloth; the domestic country becomes an exporter of cloth and an importer of food. The decline in the relative price of cloth in the foreign country leads it to become an importer of cloth and an exporter of food. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-31 Economies of Scale • The Heckscher-Ohlin model and many other models assume constant returns to scale: If all factors of production are doubled then output will also double. • But a firm or industry may have increasing returns to scale or economies of scale: If all factors of production are doubled, then output will more than double. Larger is more efficient: the cost per unit of output falls as a firm or industry increases output. • Also…when economies of scale exist, large firms may be more efficient than small firms, and the industry may consist of a monopoly or a few large firms. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-32 Types of Economies of Scale • Economies of scale could mean either that larger firms or that a larger industry (e.g., one made of more firms) is more efficient. • External economies of scale occur when cost per unit of output depends on the size of the industry. Ie. Hollywood example • Internal economies of scale occur when the cost per unit of output depends on the size of a firm. Ie. Auto industry example Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-33 Economies of Scale - Who • Do economies of scale exist in N.Am.? • Name some examples for each type of economies of scale for this region. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-34 Barriers to Trade • Tariffs • Import quotas • Export subsidies • Voluntary export restraints • Local content requirements Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 8-35 The Effects of a Tariff • A tariff is a tax on goods produced abroad and sold domestically. • Tariffs raise the price of imported goods above the world price by the amount of the tariff. Figure 4 The Effects of a Tariff Price of Steel Consumer surplus Producer surplus Domestic supply A Deadweight Loss B Price with tariff Price without tariff 0 C D E G Tariff F Imports with tariff Q S Q S Domestic demand Q Imports without tariff D Q D World price Quantity of Steel The Effects of a Tariff • A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. • With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss. Import Quotas: Another Way to Restrict Trade • The Effects of an Import Quota An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically. Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off. License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price. The Effects of an Import Quota Price of Steel Consumer surplus after quota Surplus for firms with licenses Domestic supply Equilibrium without trade Domestic supply + Import supply Quota A Isolandian price with quota Price World without = price quota 0 Producer surplus after quota B C E' D G Equilibrium with quota F E" Imports with quota Q S Q S Domestic demand Q Imports without quota D Q D World price Quantity of Steel CASE STUDY: KORUS FTA • Opening up the Korean Beef Market to US Imports (for approx. the same qty and quality meat) • Korean Beef Price at Lotte Mart = 31,500/kilo • Aust. Beef Price at Lotte Mart = 21,000/kilo CASE STUDY: KORUS FTA • Opening up the Korean Beef Market to USA Imports (for approx. the same qty and quality meat) • Safeway (US grocery store chain) retail price in Seattle, WA (doesn’t account for shipping and any added expenses) = 7,500/kilo CASE STUDY: KORUS FTA • 305,000 metric tons consumed (2006) • Total Spending (only Korean Beef): 19.2 Quad. • Total Spending (only Austr. Beef): 12.8 Quad. • Total Spending (only US Beef): 4.58 Quad. (Approx. spending assuming above assumptions and US Beef xfer pricing similar to what is found in USA) • What is the Korean consumer surplus? • What is Korean producer surplus? Voluntary Export Restraint • A voluntary export restraint works like an import quota, except that the quota is imposed by the exporting country rather than the importing country. • However, these restraints are usually requested by the importing country. • The profits or rents from this policy are earned by foreign governments or foreign producers. Foreigners sell a restricted quantity at an increased price. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 8-44 Local Content Requirement • A local content requirement is a regulation that requires a specified fraction of a final good to be produced domestically. • It may be specified in value terms, by requiring that some minimum share of the value of a good represent domestic valued added, or in physical units. • provides protection in the same way that an import quota would. • provides neither government revenue (as a tariff would) nor quota rents. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 8-45 The Cases for and against Free Trade • For Efficient allocation of resources with no govt. involvement economies of scale. competition and opportunities for innovation. • Against Optimal Tariff Jobs Argument National-Security Argument Infant-Industry Argument Unfair-Competition Argument Protection-as-a-Bargaining-Chip Argument Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-46 Developing Country Models • Import substituting industrialization • Export oriented industrialization Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-47 Import Substituting Industrialization • Import substituting industrialization was a trade policy adopted by many low and middle income countries before the 1980s. • The policy aimed to encourage domestic industries by limiting competing imports. • It was often accompanied with the belief that poor countries would be exploited by rich countries through international financial markets and trade. • Primary basis was on the infant industry argument. 10-48 Export Oriented Industrialization • Instead of import substituting industrialization, several countries in East Asia adopted trade policies that promoted exports in targeted industries. Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand, Indonesia and China are countries that have experienced rapid growth in various export sectors and rapid economic growth in general. These economies or a subset of them are sometimes called “high performance Asian economies”. • These days, Mexico is trying to orient their economy towards this model. 10-49 Application to N.American Economy • See handout. 10-50