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Globalization and International Trade Lecture 8 – academic year 2014/15 Introduction to Economics Fabio Landini What do we do today? • Lect. 8: the welfare effects of globalization • Lect. 8: is it convenient to impose a tax on Chinese shoes imported in Europe? If so, convenient for whom? 2 Question of the day Who made our shoes? 3 Globalization What’s “globalization”? Process of growing economic and financial, e.g. exchange of goods and financial activities (assets). We ask: • Which are the effects of globalization on welfare? • Who gain and who looses from the free trade among nations? 4 World exports of goods (Billions US $ x 1000) European Union (15) 08 20 05 20 03 20 00 20 90 19 80 19 70 19 60 19 19 48 18 16 14 12 10 8 6 4 2 0 World 5 Updating… the crisis Export of goods and service (source: OECD) 1800 1600 US Billion Dollar 1400 1200 1000 800 600 400 200 0 Germany Italy United States Equilibrium in the absence of international exchanges Economy without international exchanges (“closed”): the price adjusts so as to equalize internal demand and supply. 7 Equilibrium in the absence of exchanges Price of steel Consumer surplus Internal supply Equilibrium price Internal demand Producer surplus 0 Equilibrium quantity Quantity of steel 8 Equilibrium in the absence of exchanges EXAMPLE – Market for steel Hypotheses: •A country that is not in contact with the rest of the world and produces steel. •The market for steel consists of producers and consumers of that country. 9 Opening to international trade: questions If a country opens to international trade, what happens to exporters and importers of steel? Who gains and who looses from the opening of the market (= globalization)? Are the gains of some compensated by the losses of the others? 10 Opening to international trade Baseline hypothesis: the country is SMALL in the world market. Hence: it behaves like consumers and producers under perfect competition. Take the world price as a given. The country decides whether to sell or buy steel to/from the world market. 11 World price and comparative advantage If a country has a “comparative advantage” in the production of a good, then: internal price < global price – why? Price= opportunity cost In this case: the country becomes an exporter of that good 12 World price and comparative advantage If a country does not have a “comparative advantage”, then internal price > global price. In this case: the country becomes exporter of that good 13 International trade in an importing country If global p < internal p, “once the borders are opened”, the country becomes an importer of steel. Key question: who do the consumers want to buy from (given that they are free to choose) ? 14 International trade in an importing country Price of steel Internal supply Price in a closed economy World price Internal demand 0 Quantity of steel 15 International trade in an importing country Internal consumers want to buy steel at a lower price. – For small quantities, the most efficient among the internal producers can satisfy demand – For larger quantities, the internal producers are too inefficient compared to foreign competitors and imports 16 International trade in an importing country Price of steel Internal supply Price in a closed economy World price Internal demand Import 0 Internal quantity supplied Internal quantity demanded Quantity of steel 17 International trade in an importing country Import= Internal quantity demanded – internal quantity supplied, at the world price. Internal price until internal p = global p Internal consumption and internal production i.e., the country becomes an importer of steel. 18 International trade in an importing country Price of steel Consumer surplus in a closed economy Internal supply A Price in a closed economy World price Import Internal demand 0 Quantity of steel 19 International trade in an importing country Price of steel Consumer surplus in a closed economy Internal supply A Price in a closed economy B World price C Import Produce surplus in a closed economy 0 Internal demand Quantity of steel 20 International trade in an importing country Price of steel Consumer surplus in a open economy Internal supply A Price in a closed economy B D World price Import Internal demand 0 Quantity of steel 21 International trade in an importing country Price of steel Consumer surplus in a open economy Internal supply A Price in a closed economy B C D Import Produce surplus in a open economy 0 World price Internal demand Quantity of steel 22 International trade in an importing country Price of steel Consumer surplus in a open economy A Price in a closed economy Additional surplus in an open economy B C D World price Import Produce surplus in a open economy 0 Internal supply Internal demand Quantity of steel 23 Gains and losses from free trade When a country opens its frontiers to free trade becoming an importer, its consumers gain. They pay a lower price and can buy more. The national producers, instead, are damaged. They receive a lower price and sell less units. 24 Gains and losses from free trade Overall, international trade increases the total welfare of the country. The net variation of total welfare (surplus) is positive The gains of consumers are greater than the losses of producers. 25 The effects of a custom duty A custom duty is a tax on a good produced abroad and imported. A custom duty increases the global price proportionally. 26 The effects of a custom duty National producers take advantage of the duty, while consumers experience a loss. 27 The effects of a custom duty Price of steel Internal supply World price Price without duty Internal demand 0 QS1 QD1 Import without duty Quantity of steel 28 The effects of a custom duty Consumer surplus without duty Price of steel Internal supply World price Price without duty Producer surplus Without duty 0 QS1 Internal demand QD1 Import without duty Quantity of steel 29 The effects of a custom duty Price of steel Internal supply World price Price without duty Internal demand 0 QS1 QD1 Import without duty Quantity of steel 30 The effects of a custom duty Price of steel Internal supply Price with duty Duty World price Price without duty Internal demand 0 QS1 QS2 Import without duty QD2 QD1 Quantity of steel 31 The effects of a custom duty Price of steel Internal supply Price with duty Duty World price Price without duty 0 Import with duty Q QS2 Internal demand QD2 QD1 Quantity of steel 32 The effects of a custom duty Consumer surplus without duty Price of steel Internal supply Price with duty Duty World price Price without duty Internal demand Producer surplus with duty 0 Q QS2 QD2 QD1 Quantity of steel 33 The effects of a custom duty Consumer surplus without duty Price of steel Internal supply Public revenue Price with duty Duty World price Price without duty Internal demand Producer surplus with duty 0 Q QS2 QD2 QD1 Quantity of steel 34 The effects of a custom duty Consumer surplus without duty Price of steel Internal supply Public revenue Net loss due to the duty Price with duty Duty World price Price without duty Internal demand Producer surplus with duty 0 Q QS2 QD2 QD1 Quantity of steel 35 The effects of a custom duty As any other tax, a duty creates a distortion in incentives and affects the optimal allocation of resources 36 The argument in favour of restrictions to free trade • Employment • National security • Infant industry protection • Dumping • Protectionism as bargaining tool 37 Hence Through the comparison between internal price and world price one can identify which countries are exporters and which are importers of a particular good. 38 Globalization means: In exporting countries, producers gains, while consumers loose. In importing countries, consumers gain, while producers loose. In both cases gains are greater than losses. 39 Conclusion The custom duty. . . • Increases the national price of a good. • Reduces the welfare of internal consumers • Increases the welfare of internal producers • Creates a net loss in terms of welfare 40