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A Lecture Presentation
in PowerPoint
to accompany
Essentials of Economics
by Robert L. Sexton
Copyright © 2003 Thomson Learning, Inc.
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Printed in the United States of America
ISBN 0030342333
Copyright © 2003 by Thomson Learning, Inc.
Chapter 19
International Trade
Copyright © 2003 by Thomson Learning, Inc.
19.1 The Growth in World Trade


In a typical year, about 15 percent of the
world's output is traded in international
markets.
While the importance of the
international sector varies enormously
from place to place, the volume of
international trade has increased
substantially.
Copyright © 2003 by Thomson Learning, Inc.
Major U.S. Trading Partners
Top Five Trading Partners
Exports of Goods in 2000
Rank
1
2
3
4
5
Country
Percent of Total
Canada
Mexico
Japan
United Kingdom
Germany
SOURCE: CIA, The World Factbook 2001.
Copyright © 2003 by Thomson Learning, Inc.
23
14
8
5
4
Top Five Trading Partners
Imports of Goods in 2000
Rank
1
2
3
4
5
Country
Canada
Japan
Mexico
China
Germany
SOURCE: CIA, The World Factbook 2001.
Percent of Total
19
11
11
8
5
19.2 Comparative Advantage and
Gains from Trade



The very existence of trade suggests
that trade is economically beneficial.
Because almost all trade is voluntary, it
would seem that trade occurs because
the participants feel that they are better
off because of the trade.
Both participants of an exchange of
goods and services anticipate an
improvement in their economic welfare.
Copyright © 2003 by Thomson Learning, Inc.
19.2 Comparative Advantage and
Gains from Trade

The classical economist David
Ricardo's theory that explains how trade
can be beneficial to both parties centers
on the concept of comparative
advantage.


A person, a region, or a country can gain
from trade if it produces a good or service
at a lower opportunity cost than others.
An area should specialize in producing and
selling those items in which it has a
comparative advantage.
Copyright © 2003 by Thomson Learning, Inc.
19.2 Comparative Advantage and
Gains from Trade

What is important for mutually beneficial
specialization and trade is comparative
advantage, not absolute advantage.
Copyright © 2003 by Thomson Learning, Inc.
19.2 Comparative Advantage and
Gains from Trade


The gains from comparative
advantage—specialization in what one
is a lower opportunity cost producer
of—can be illustrated with a production
possibility curve.
The differences in opportunity costs
provide an incentive to gain from
specialization and trade.
Copyright © 2003 by Thomson Learning, Inc.
Specialization and Trade
B
Food (pounds)
30
Total
production with
specialization
Wendy’s
PPC
C
15
10
7.5
Calvin’s
PPC
A
7.5 10 15
Cloth (yards)
Copyright © 2003 by Thomson Learning, Inc.
30
19.3 Supply and Demand in
International Trade

Consumer surplus


difference between the most a consumer
would be willing and able to pay for a
quantity of a good and what a consumer
actually has to pay
Producer surplus

difference between the least a supplier is
willing and able to supply a quantity of a
good or service for and the revenues a
supplier actually receives for selling it
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade

With the tools of consumer and
producer surplus, we can better analyze
the impact of trade.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade

The demand curve represents a
collection of maximum prices that
consumers are willing and able to pay
for different quantities of a good or
service while the supply curve
represents a collection of minimum
prices that suppliers require to be willing
to supply different quantities of that
good or service.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade


Trading at the market equilibrium price
generates both consumer surplus and
producer surplus.
Once the equilibrium output is reached
at the equilibrium price, all of the
mutually beneficial opportunities from
trade between suppliers and demanders
will have taken place; the sum of
consumer surplus and producer surplus
is maximized.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade


The total gains to the economy from
trade is the sum of consumer and
producer surplus.
That is, consumers benefit from
additional amounts of consumer surplus
and producers benefit from additional
amounts of producer surplus.
Copyright © 2003 by Thomson Learning, Inc.
Consumer and Producer Surplus
$8
S
7
Price
6
5
CS
CS
CS
4
3
2
PS
PS
PS
D
1
1
2
3
Quantity
Copyright © 2003 by Thomson Learning, Inc.
4
19.3 Supply and Demand in
International Trade

When the domestic economy has a
comparative advantage in a good
because it can produce it at a lower
relative price than the rest of the world,
international trade raises the domestic
market price to the world price,
benefiting domestic producers but
harming domestic consumers.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade

While this redistributes income from
consumers to producers, there are net
benefits from allowing free trade
because producer surplus increases
more than consumer surplus decreases.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade


While domestic consumers lose from
the free trade, those negative effects
are more than offset by the positive
gains captured by producers.
In net, export trade increases domestic
wealth.
Copyright © 2003 by Thomson Learning, Inc.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade


When a country does not produce a
good relatively as well as other
countries, international trade will lower
the domestic price to the world price,
with the difference between what is
domestically supplied and what is
domestically demanded supplied by
imports.
Domestic consumers benefit from
paying a lower price for the good,
increasing their consumer surplus.
Copyright © 2003 by Thomson Learning, Inc.
19.3 Supply and Demand in
International Trade


But domestic producers lose because
they are now selling at the lower world
price.
While this redistributes income from
producers to consumers, there is a net
increase in domestic wealth from free
trade and imports because the
consumer surplus increases more than
producer surplus decreases.
Copyright © 2003 by Thomson Learning, Inc.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

Tariffs



a tax on imported goods
usually relatively small revenue producers
that retard the expansion of trade
bring about
higher prices and revenues to domestic
producers,
 lower sales and revenues to foreign producers,
and
 higher prices to domestic consumers


The gains to producers are more than
offset by the losses to consumers.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


With import tariffs, the domestic price of
goods is greater than the world price.
At the new price, the domestic quantity
demanded is lower and the quantity
supplied domestically is greater,
reducing the quantity of imported goods.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

While domestic producers do gain more
sales and producer surplus at the
expense of foreign producers, and the
government gains from tariff revenue,
consumers lose more in consumer
surplus than producers and the
government gain from the tariff.
Copyright © 2003 by Thomson Learning, Inc.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


One argument for tariffs is that tariff
protection is necessary temporarily to
allow a new industry to more quickly
reach a scale of operation at which
economies of scale and production
efficiencies can be realized.
This argument has many problems.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


How do you identify "infant industries"
that genuinely have potential economies
of scale and will become quickly
efficient with protection?
Would it not be wise to make massive
loans to the industry in such a case,
allowing it to instantly begin large-scale
production rather than slowly and at the
expense of consumers with a protective
tariff?
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

The history of infant industry tariffs
suggests that the tariffs often linger long
after the industry is mature and no
longer in “need” of protection.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


Tariffs can lead to increased output and
employment and reduced
unemployment in domestic industries
where tariffs were imposed.
Yet the overall employment effects of a
tariff imposition are not likely to be
positive.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

Not only might the imposition of a tariff
lead to retaliatory tariffs by other
countries, but domestic employment
would likely suffer outside the industry
gaining the tariff protection.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


If new tariffs lead to restrictions on
imports, fewer dollars will be flowing
overseas in payment for imports, which
means that foreigners will have fewer
dollars available to buy our exports.
Other things equal, this will tend to
reduce our exports, thus creating
unemployment in the export industries.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


Sometimes it is argued that tariffs are a
means of preventing a nation from
becoming too dependent on foreign
suppliers of goods vital to national
security, but the national security
argument is usually not valid.
If a nation's own resources are
depletable, tariff-imposed reliance on
domestic supplies will hasten depletion
of domestic reserves.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

From a defense standpoint, it makes
more sense to use foreign supplies in
peacetime and perhaps stockpile
“insurance” supplies so that large
domestic supplies would be available
during wars.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies



An import quota gives producers from
another country a maximum number of
units of the good in question that can be
imported within any given time span.
The case for quotas is probably even
weaker than the case for tariffs.
Like tariffs, quotas directly restrict
imports, leading to reductions in trade
and thus preventing nations from fully
realizing their comparative advantage.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


Tariffs at least use the price system as
the basis of restricting trade, while
quotas do not.
Unlike with a tariff, the U.S. government
does not collect any revenue as a result
of the import quota.
Copyright © 2003 by Thomson Learning, Inc.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

Nations have also devised still other,
more subtle means to restrict
international trade.

Product standards ostensibly designed to
protect consumers against inferior, unsafe,
dangerous or polluting merchandise,
which, in effect, are sometimes a means to
restrict foreign competition.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


Except in rather unusual circumstances,
the arguments for tariffs and import
quotas are rather suspect.
They exist because of producers’
lobbying efforts to gain profits from
government protection, called rent
seeking.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies

Because these resources could have
produced something instead of being
spent on lobbying efforts, the measured
deadweight loss from tariffs and quotas
will likely understate the true
deadweight loss to society.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies



Working in the opposite direction,
governments sometimes try to
encourage exports by subsidizing
producers.
With a subsidy, revenue is given to
producers for each exported unit of
output, stimulating exports.
While not a barrier to trade like tariffs
and quotas, subsidies can also distort
trade patterns, leading to ones that are
inefficient.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies


With subsidies, producers export goods
not because their costs are lower than
that of a foreign competitor, but because
their costs have been artificially reduced
by government action transferring
income from taxpayers to the exporter.
The actual costs of production are not
reduced by the subsidy—society has
the same opportunity costs as before.
Copyright © 2003 by Thomson Learning, Inc.
19.4 Tariffs, Import Quotas, and
Subsidies



A nation's taxpayers end up subsidizing
the output of producers who, relative to
producers in other countries, are
inefficient.
The nation, then, exports products in
which it does not have a comparative
advantage.
Gains from trade in terms of world
output are eliminated or reduced by
such subsidies.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


The record of all of the international
financial transactions of a nation over a
year is called the balance of
payments.
It records all the exchanges those in a
nation engaged in that required an
outflow of funds to other nations or an
inflow of funds from other nations, and
provides information about a nation’s
world trade position.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments

The balance of payments is divided into
three main sections:




the current account,
the capital account, and
official reserve assets.
The current account is a record of a
country’s imports and exports of goods
and services, net investment income ,
and net transfers.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments

Because the U.S. gains claims over
foreign buyers by obtaining foreign
currency in exchange for the dollars
needed to buy U.S. exports, all exports
of U.S. goods abroad are considered a
credit or plus item in the U.S. balance of
payments.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


When a U.S. consumer buys an
imported item, the reverse is true.
U.S. imports are considered a debit item
in the balance of payment because the
dollars sold to buy the necessary
foreign currency add to foreign claims
against U.S. buyers.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments



Our imports provide the means by
which foreigners can buy our exports.
Nations import and export services,
such as tourism, as well as the largest
component of the balance of payments,
merchandise (goods).
Private and government grants and gifts
to foreigners also count as a debit item
in a country’s balance of payments, and
grants and gifts from foreigners count
as a credit item.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


The balance on current account is the
net amount of debits or credits after
adding up all transactions of goods,
services, and fund transfers.
If the sum of credits exceeds the sum of
debits, a nation is said to have a
balance of payments surplus on current
account.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


If debits exceed credits, it is running a
balance of payments deficit on current
account.
The merchandise import/export
relationship is often called the balance
of trade, which is different from the
balance on current account.
Copyright © 2003 by Thomson Learning, Inc.
U.S. Balance of Payments (Billions of $)
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


A deficit on current account is settled by
movements of financial, or capital,
assets.
Therefore, a current account deficit
would be financed by a capital account
surplus, and a current account surplus
would be financed by a capital account
deficit.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


Capital account transactions include
income from U.S. financial investments
in other countries and other foreign
income from investments in the U.S.,
which can be viewed as compensation
for the use of capital services.
Income from U.S. investments overseas
are a credit item in the U.S. balance of
payments, and income from foreign
investments in the U.S. are a debit item.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


Due to the reciprocal aspect of trade,
the balance of payments must balance
so that credits and debits are equal.
However, errors and omissions mean
the official measures do not come out
equal.
The statistical discrepancy is included
so that the official balance of payments
do balance.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


A useful analogy from personal financial
transactions can be made to the
balance of payments.
People earn income by exporting their
labor services, or receiving investment
income, and they import consumption
goods.
Copyright © 2003 by Thomson Learning, Inc.
19.5 The Balance of Payments


Both loans and fund transfers are
sometimes made.
Any deficit must be financed by
borrowing or selling assets; surpluses
allow new investment or additions to
reserves.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates


U.S. consumers must first exchange
U.S. dollars for the seller’s currency in
order to pay for imported goods.
Similarly, foreigners buying U.S. goods
must sell their currencies to obtain U.S.
dollars in order to pay for exported
goods.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates

The price of one unit of a country’s
currency in terms of another country’s
currency is called the exchange rate.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates


Prices of goods in their own currencies
combine with exchange rates to
determine the domestic price of foreign
goods.
For instance, an increase in the eurodollar exchange rate from $1 per euro to
$2 per euro would increase the U.S.
price of German goods, reducing the
number of German goods that would be
demanded in the United States.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates



The demand for foreign currencies is a
derived demand because it derives
directly from the demand for foreign
goods and services or for foreign
capital.
The more foreign goods demanded, the
more of that foreign currency that will be
needed to pay for those goods.
Such an increased demand for the
currency will push up the exchange
value of that currency relative to other
currencies.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates


Similarly, the supply of foreign currency
is provide by foreigners who want to buy
the exports of a particular nation.
The more foreigners demand U.S.
products, the more of their currencies
they will supply in exchange for U.S.
dollars, which they use to buy our
products.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates

Just as in the product market, the
supply of and demand for a foreign
currency determine the equilibrium price
(exchange rate) of that currency.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates


The demand for a foreign currency is
downward sloping because, as the price
of the euro falls relative to the dollar,
European products become relatively
more inexpensive to U.S. consumers,
who therefore buy more European
goods.
To do so, the quantity of euros
demanded by U.S. consumers will
increase to buy more European goods
as the price of the euro falls.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates


The supply curve of a foreign currency
is upward sloping because, as the price,
or value, of the euro increases relative
to the dollar, American products become
relatively more inexpensive to European
buyers and the quantity of dollars they
will demand will increase.
Europeans will, therefore, increase the
quantity of euros supplied to the U.S. by
buying more U.S. products (assuming
the European demand for U.S. products
is price elastic).
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates


Equilibrium in the foreign exchange
market is reached where the demand
and supply curves for a given currency
intersect.
If the dollar price of euros is higher than
the equilibrium price, there will be an
excess quantity of euros supplied at that
price (a surplus of euros), and
competition among euro sellers will
push the price of euros down toward
equilibrium.
Copyright © 2003 by Thomson Learning, Inc.
19.6 Exchange Rates

If the dollar price of euros is lower than
the equilibrium price, there will be an
excess quantity of euros demanded at
that price (a shortage of euros), and
competition among euro buyers will
push the price of euros up toward
equilibrium.
Copyright © 2003 by Thomson Learning, Inc.
Dollar Price of Euros
Equilibrium in the Foreign Exchange Market
Excess supply
for euros
$1.40
Supply for euros
(U.S. sales
of goods
and services
to Europeans)
$1.20
$1.00
Excess demand
for euros
0
Copyright © 2003 by Thomson Learning, Inc.
Demand for euros
(U.S. purchase of
European goods
and services)
Quantity of Euros
19.7 Equilibrium Changes in the
Foreign Exchange Market


Any force that shifts either the demand
for or supply of a currency will shift the
equilibrium in the foreign exchange
market, leading to a new exchange rate.
An increased demand for euros will
result in a higher equilibrium price
(exchange value) for euros, while a
decreased demand for euros will result
in a lower equilibrium price (exchange
value) for euros.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market

Changes in a currency’s exchange rate
can be caused by





changes in tastes for goods,
changes in income,
changes in relative real interest rates,
changes in relative inflation rates, and
speculation.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market

Demand for foreign currencies is
derived from demand for foreign goods
so shifts in the foreign goods demand
curve will shift the foreign currency
demand curve in the same direction.


U.S. taste for European goods increases,
the demand for euros increases, increasing
the equilibrium price of euros
U.S. taste for European goods decreases,
the demand for euros decreases,
decreasing the equilibrium price of euros.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market


An increase in U.S. incomes would
increase the amount of European imports
purchased by Americans, which would
increase the demand for euros, resulting in
a higher exchange rate for euros.
A decrease in U.S. incomes would
decrease the amount of European imports
purchased by Americans, which would
decrease the demand for euros, resulting
in a lower exchange rate for euros.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market

A decrease in U.S. tariffs on European
goods would tend to have the same
effect as an increase in U.S. incomes,
by making imports more affordable,
increasing the U.S. demand for
European goods and increasing the
exchange rate for euros.
Copyright © 2003 by Thomson Learning, Inc.
Dollar Price of Euros
Impact of U.S. Taste or Income Increase, of Tariff
Decrease, in the Foreign Exchange Market
E1
$1.50
$1.00
E0
D1
D0
0
Quantity of Euros
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market

If European incomes rose, European
tariffs on U.S. goods increased, or their
tastes for American goods increased,
Europeans would demand more U.S.
goods, leading them to increase their
supply of euros to obtain the added
dollars necessary to make those
purchases, leading to a new lower
exchange rate for euros.
Copyright © 2003 by Thomson Learning, Inc.
Impact of European Taste of Income, or Tariff
Decrease, on the Foreign Exchange Market
Dollar Price of Euros
S0
S1
E0
$1.50
$1.00
E1
D
0
Quantity of Euros
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market


If U.S. interest rates were to increase
relative to European interest rates, other
things equal, the rate of return on U.S.
investments would increase relative to
that on European investments,
increasing European’s demand for U.S.
investments.
It would increase the supply of euros to
obtain the added dollars to buy added
U.S. investments.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market


At the same time, U.S. investors would
also shift their investments away from
Europe, decreasing their demand for
euros.
The combination of the increased
supply of euros and the decreased
demand for euros will lead to a new
lower exchange rate for euros.
Copyright © 2003 by Thomson Learning, Inc.
Impact of U.S. Interest Rate Increase on the
Foreign Exchange Market
Dollar Price of Euros
S0
S1
$1.90
E0
$1.50
E1
D0
D1
0
Quantity of Euros
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market

If Europe experienced a higher inflation
rate than the United States,



European products would become more
expensive to U.S. consumers,
decreasing the quantity of European
goods demanded by Americans, and
decreasing the demand for euros.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market


U.S. products would become less
expensive to European consumers,
increasing the quantity of U.S. goods
demanded by Europeans, and,
therefore, increasing the supply of
Euros.
The combination of the increased
supply of euros and the decreased
demand for euros will lead to a new
lower exchange rate for euros.
Copyright © 2003 by Thomson Learning, Inc.
19.7 Equilibrium Changes in the
Foreign Exchange Market

If currency speculators believe that the
United States was going to experience
more rapid inflation in the future than
Japan, they will believe that the value of
the dollar will soon be falling as a result.
That will increase the demand for yen,
so the yen will appreciate relative to the
dollar. The opposite will occur if
speculators expect less rapid inflation in
the United States.
Copyright © 2003 by Thomson Learning, Inc.
The Impact of European Inflation Rate Increase on
the Foreign Exchange Market
Dollar Price of Euros
S0
S1
$1.90
E0
$1.00
E1
D0
D1
0
Quantity of Euros
Copyright © 2003 by Thomson Learning, Inc.