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Econ 2301 Dr. Jacobson Mr. Stuckey Week 4 Chapters 4 & 5 Chapter 4 Price Controls and Quotas: Modeling With Markets Governmental Policies Effect Us All. Whether It Be a For Profit or Non-Profit Businesses, An Organization, or Simply as Individuals. Controls on Prices Price Ceilings Price Floors Taxes Price Ceiling A legal Maximum On The Price At Which a Good Can Be Sold. In Chapter 3 We Looked at Supply and Demand Combined and We Discussed The Point Called Equilibrium. We Looked at What Occurred Above and Below The Equilibrium Point in Terms of Supply and Demand. In Simplest Terms On Any Given Graph of Supply and Demand One of Three Situations Exist In Simplest Terms On Any Given Graph of Supply and Demand One of Three Situations Can Exist: 1. There Can Be Equilibrium. A Price Where The Buyers Can Buy All They Want and The Sellers Can Sell All They Want. 2. There Can Be a Shortage. A Price Where The Buyers Want to Buy More Than The Sellers Are Willing to Sell. 3. There Can Be a Surplus. A Price Where Sellers Are Willing To Sell More Than Buyers Want to Buy. Important Note: Whether The Price of a Good or Service Is Above or Below The Equilibrium Point Determines If There Is a Surplus or Shortage. Equilibrium $3.00 Supply S1 P Surplus 2.50 Equilibrium Price 2.00 1.50 1.00 Demand .50 D1 Shortage 0 1 2 3 4 5 6 7 Quantity 8 9 10 Q Shortage Is a Situation In Which The Quantity Demanded Is Greater Than The Quantity Supplied At a Given Price. Shortage $3.00 Supply S1 P 2.50 Equilibrium ----------------------------- ----------------------------------------------- 1.00 Quantity .50 Supplied 0 1 2 3 4 5 Shortage 6 ---------------------- 1.50 ---------------------- Price 2.00 --------------------------------------- Demand Quantity Demanded D1 7 Quantity 8 9 10 Q What Then Are The Effects of A Price Ceiling in Relation To The Price of Goods or Services? Price Ceiling $3.00 S1 P Supply Price Ceiling Not Binding 2.50 Equilibrium ----------------------------- 1.50 1.00 Shortage Quantity .50 Supplied 0 1 2 3 4 5 6 7 Quantity 8 ---------------------- ----------------------------------------------- ---------------------- Price 2.00 --------------------------------------- Demand Quantity D1 Demanded 9 10 Q Price Ceiling $3.00 S1 P Supply Price Ceiling Is Binding 2.50 Equilibrium ----------------------------- 1.50 1.00 Shortage Quantity .50 Supplied 0 1 2 3 4 5 6 7 Quantity 8 ---------------------- ----------------------------------------------- ---------------------- Price 2.00 --------------------------------------- Demand Quantity D1 Demanded 9 10 Q Therefore a Binding Price Ceiling Causes A Shortage. Therefore When the Government Imposes a Binding Price Ceiling On a Competitive Market, A Shortage of The Good Arises, and Sellers Must Ration The Scarce Goods Among The Large Number Of Potential Buyers. Why and Where Would The Government Want To Impose a Price Ceiling? Places for Price Ceilings Gasoline (1973) Rent Control Flu Shots Medicines Interest Rates Taxes Now Let Us Look At The Other Side of The Spectrum, Surplus. Surplus Is a Situation In Which Quantity Supplied is Greater Than Quantity Demanded at a Given Price. Equilibrium Supply $3.00 S1 P Surplus 1.50 1.00 ----------------------------- Price 2.00 --------------------------------------- Quantity .50 Supplied 0 1 2 3 4 5 6 7 Quantity ------------------------------------- ------------------------------------- 2.50 ----------------------------------------------- 8 Equilibrium Demand Quantity D1 Demanded 9 10 Q Price Floor A Legal Minimum On The Price At Which a Good Can Be Sold. The Government May Also Impose a Legal Minimum On The Price of Goods or Services. Because The Price Cannot Fall Below This Level, The Legislated Minimum Is Called a Price Floor. What Then Are The Effects of A Price Floor in Relation To The Price of Goods or Services? Price Floor Supply $3.00 S1 P Surplus 1.50 1.00 .50 0 1 2 3 4 5 ----------------------------- Price 2.00 --------------------------------------- 6 7 Quantity ------------------------------------- ------------------------------------- 2.50 ----------------------------------------------- 8 9 Equilibrium Price Floor Not Binding Demand D1 10 Q Price Floor Supply $3.00 S1 P Price Floor That Is Binding Surplus 2.50 ----------------------------------------------- Equilibrium ----------------------------- Price 2.00 --------------------------------------1.50 1.00 .50 0 1 2 3 4 5 6 7 Quantity Demand D1 8 9 10 Q Therefore a Binding Price Floor Causes a Surplus Therefore When the Government Imposes a Binding Price Floor On a Competitive Market, A Surplus of the Good Arises, and The Buyers Must Decide Which Goods to Buy, Among The Large Number Of Goods or Potential Sellers. Why and Where Would The Government Want To Impose a Price Floor? Places for Price Floors Minimum Wage Legal Services Certain Occupations (Youth, Seniors) Farm Products Tariffs Taxes Minimum Alternative Tax Wage and Price Controls In 1971 Under President Nixon the Government Instituted A Mandatory Wage and Price Freeze In Order To Combat Inflation. Subsidies Housing Help Pay Portion of Rent. Wage Pay Portion of a Persons Salary. Earned Income Tax Credit On-The-Job Training Education ( Student Loans) Government Policy As It Relates To Taxes. TAXES AND EFFICIENCY Policymakers have two objectives in designing a tax system... Efficiency Equity TAXES AND EFFICIENCY One tax system is more efficient than another if it raises the same amount of revenue at a smaller cost to taxpayers. An efficient tax system is one that imposes small deadweight losses and small administrative burdens. TAXES AND EFFICIENCY The Cost of Taxes to Taxpayers The tax payment itself Deadweight losses Administrative burdens Deadweight Losses Because taxes distort incentives, they entail deadweight losses. The deadweight loss of a tax is the reduction of the economic wellbeing of taxpayers in excess of the amount of revenue raised by the government. Administrative Burdens Complying with tax laws creates additional deadweight losses. Taxpayers lose additional time and money documenting, computing, and avoiding taxes over and above the actual taxes they pay. The administrative burden of any tax system is part of the inefficiency it creates. Taxes Are Used To Raise Revenue For Public Projects, Such as Roads, Schools, and National Defense. Tax Incidence Is The Manner In Which The Burden of Tax Is Shared Among Participants In a Market. Tax Incidence Refers to The Distribution Of The Tax Burden. The Question The Government Must Answer, Is Who (and How) They Are Going To Tax and How Much? This Question Has As Much Impact On The Individuals and Companies Within a Nation As It Does On The Government. Let Us Look at The Government Tax Policies In Terms of Supply and Demand. Let Us Say a That The Government Places a $1 Tax on Movie Tickets. Who Pays The Tax? Step #1 The Initial Impact of The Tax Is on The Demand For Movie Tickets. The Supply Curve is Not Affected Because Sellers Have The Same Incentive To Sell Movie Tickets. Therefore, Initially The Buyers Have to Pay The Tax To The Government As Well As The Price to The Sellers. This Causes a Shift In The Demand Curve. Step #2 We Need To Determine The Direction of The Shift. The Tax Makes Movie Going Less Attractive, Therefore The Demand Curve Shifts Downward By The Amount of The Tax. Equilibrium Price Buyers Pay Price Without Tax $3.00 S1 P 2.50 Equilibrium 2.00 Without Tax Tax Shifts Demand Curve By Size Of Tax 1.50 1.00 Price Supply Equilibrium With Tax Demand .50 D1 D2 0 30 90 100 Quantity Q Step #3 The Effect of The Tax Can Be Seen In Comparing The Old Equilibrium ($2.00) With The New Equilibrium ($1.50). What We See Is That Because of The Tax, The Movie Theater Has Lost Patrons. Because Movie Theater’s Also Make Revenue on Concessions They May Want to Pay Some of The Tax. Therefore, If The Movie Theater Wants Recover Some of Its Lost Patrons (Essentially Return to The Original Demand Schedule) It Needs To Share In The Cost of The Tax. Equilibrium Price Buyers Pay Price Price Without Tax Price Sellers Receive $3.00 Supply S1 P 2.50 Equilibrium 2.00 Without Tax Tax Shifts Demand Curve By Size Of Tax 1.50 1.00 Equilibrium With Tax Demand .50 D1 D2 0 90 100 Quantity Q We See From This Example That In A Situation Where The Tax Could Be Picked Up Entirely By the Buyer The Seller Also Has A Stake In The Overall Effect Of The Tax. Let Us Look At Another Example Where The Government May Place a Tax Directly On Employers For Each Item They Sell. Again Let Us Consider That The Tax Imposed By The Government Is $1.00 For Each Ticket Sold. What Are The Effects Of This Law? Step #1 In This Case The Tax Is Imposed On The Sellers Therefore The Demand Curve Does Not Change, But The Tax Makes The Movie Tickets Less Profitable At Any Price. Therefore We Have A Shift In The Supply Curve. Equilibrium S2 Price Buyers Pay Price Price Without Tax Price Sellers Receive $3.00 S1 Tax Shifts Supply Curve By Size Of Tax P Equilibrium With Tax 2.50 Supply Equilibrium Without Tax 2.00 1.50 1.00 Demand .50 D1 0 90 100 Quantity Q Step #2 Because The Tax Raises The Sellers Cost, It Reduces The Quantity Supplied At Every Price, So The Supply Curve Shifts To The Left In The Amount of The Tax. Step #3 After The Shift of The Supply Curve We Again See That The Initial Equilibrium Has Changed From $2.00 To $2.50. Equilibrium Price Buyers Pay Price Price Without Tax Price Sellers Receive $3.00 Supply S1 P 2.50 Equilibrium 2.00 Without Tax Tax Shifts Demand Curve By Size Of Tax 1.50 1.00 Equilibrium With Tax Demand .50 D1 D2 0 90 100 Quantity Q Again The Buyers and The Sellers End Up Sharing The Cost of The Tax. The Tax Reduces The Size of The Market. In Both Cases The Tax Changes The Equilibrium Point Either Through A Shift In The Demand or Supply Curve. The Results In Either Case Are The Same. Elasticity and Tax Incidence In The Last Chapter We Examined Elasticity As It Applied To Both The Demand and Supply Curves. When A Good Is Taxed, Buyers And Sellers Share The Tax Burden. Only Rarely Is It Shared Equally, So How Then Is The Tax Burden Really Divided? Remember That Elasticity of Either Supply or Demand Is Measured By the Willingness of Either Buyers (Demand Elasticity) or Sellers (Supply Elasticity) To Leave The Market When Conditions Become Unfavorable. A Tax Burden Falls More Heavily On The Side Of The Market That Is Less Elastic This Makes Sense As The More Elastic, The More Willing The Buyer Or Seller Is To Move Away From or To Produce The Product Due To Price Increases or Decreases. Elastic Supply, Inelastic Demand Price Buyers Pay Price Price Without Tax Price Sellers Receive P Supply S1 TAX Tax Incidence on Sellers Quantity The Incidence of Tax Falls More Heavily On Consumers Demand D1 Q Inelastic Supply, Elastic Supply Demand S1 Price Buyers Pay Price Price Without Tax Price Sellers Receive P The Incidence of Tax On Consumers TAX Demand D1 Tax Incidence Falls More Heavily on Sellers Q Quantity The Law of Supply and Demand Describes The Way Markets Allocate Scarce Resources. In Short, We Have Looked At What Is, Rather Than What Should Be. We Know That The Prices of Toys During The Holidays Adjusts To Ensure That The Quantity of Toys Supplied Equals The Quantity of Toys Demanded. But At This Equilibrium Is That Quantity Produced and Consumed Too Large, Too Small or Just Right? That Takes Us To The Topic of Welfare Economics Welfare Economics Is The Study Of How The Allocation of Resources Affects Economic Well-Being. Imagine That You Have Just Developed A New Product and Are About To Take It To Market. You Ask 10 People What They Are Willing To Pay For The Product and They All Give You (As Expected) Different Answers. From The Information Given You By These Ten People Can You Develop A Strategy For Pricing Your Product? Let Us Explore This Question From Several Different Approaches. Willingness To Pay Is The Maximum Amount That A Buyer Will Pay For a Good. But What If, In Our Example, A Person Has Told You They Will Be Willing To Pay $50 For Your Product But, Actually They Would Be Willing To Pay $75. Product Demand Curve Price A $75 $65 $55 $45 $35 $25 $15 $5 1 2 3 4 5 Quantity Consumer Surplus Is The Amount A Buyer Is Willing To Pay For a Good Minus The Amount The Buyer Actually Pays For It. Consumer Surplus Consumer Surplus = Amount A Buyer Is Willing to Pay Amount They Paid Consumer Surplus Consumer Surplus = $75 $50 = $25 Now Let Us Assume That Your Product Is A Painting and You Have Made Two Copies. This Time Instead of Asking People What They Will Pay For Them, You Decide Auction Them Off. We Conduct The Auction Until Two Bidders Are Left and The Price Is At $45. Let Us Again Say That One Of The Two Persons Would Have Been Willing to Pay $75 For the Painting, But the Other Person Would Only Have Paid $50. Using Our Formula for Finding Consumer Surplus We Find That The First Person Has A Consumer Surplus of $30 and The Second Person A Consumer Surplus of $5 For The Same Item. Consumer Surplus Consumer Surplus = Amount A Buyer Is Willing to Pay Amount They Paid Consumer Surplus st For 1 Person Consumer Surplus = $75 $45 = $30 Consumer Surplus nd For 2 Person Consumer Surplus = $50 $45 = $5 Product Demand Curve Price Person A’s Consumer Surplus A $75 Person B’s Consumer Surplus $65 B $55 Price Actually Paid $45 $35 $25 $15 $5 1 2 3 4 5 Quantity Consumer Surplus Is Closely Related To The Demand Curve. The Area Below The Demand Curve and Above The Price Measures The Consumer Surplus In The Market. The Area Below The Demand Curve and Above The Price Measures The Consumer Surplus In The Market. The Reason Is That The Height of The Demand Curve Measures The Value Buyers Place On The Good, As Measured By Their Willingness To Pay For It. The Difference Between This Willingness To Pay and The Market Price Is Each Buyer’s Consumer Surplus. Therefore, The Total Area Below The Demand Curve and Above The Price Is The Sum Of The Consumer Surplus Of All Buyers In The Market For A Good or Service. Product Demand Curve Price Person A’s Consumer Surplus A $75 Person B’s Consumer Surplus $65 B $55 Price Actually Paid $45 $35 $25 $15 $5 1 2 3 4 5 Quantity Product Demand Curve Price Person A’s Consumer Surplus A $75 Person B’s Consumer Surplus $65 B $55 Price Actually Paid $45 $35 Total Of The Consumer Surplus Of All Buyers $25 $15 $5 1 2 3 4 5 Quantity Buyers Always Want To Pay Less and Paying Less Makes The Buyer Better Off. But How Much Does a Buyers Well-Being Rise In Response To a Lower Price? Consumer Surplus Measures The Benefit That Buyers Receive From A Good As The Buyers Themselves Perceive It. This Is Because Buyers Have Determined What They Would Have Paid For The Good Or Service. Government Policy Makers However, May Or May Not Care About What Creates Consumer Surplus. Example of A Drug Addict Being Able To Purchase Drugs Cheaper Therefore Creating Consumer Surplus. In This Case Consumer Surplus is Not A Good Measure of Well-Being, As The Drug Addict is Not Looking After Their Own Best Interests. However, In Most Markets, Consumer Surplus Does Reflect Economic WellBeing. Rational People Do The Best They Can To Achieve Their Objectives, Given Their Opportunities. Consumer Surplus Consumer Surplus = Amount A Buyer Is Willing to Pay Amount They Paid Now Lets Look At It From The Other Side and Discuss Producer Surplus. Let Us Assume That You Are Going To Have Your Taxes Done and You Contact 4 CPA’s That You Know Are Capable of Doing The Work and Ask Them For A Price For Them To Do Your Taxes. Each CPA Will Determine Their Costs In Order To Determine A Price. The Term “ Cost” is Really The Opportunity Cost, That Includes Materials, Overhead, Time to Do the Work and Expected Profit. Cost & Producer Surplus Cost The Value of Everything A Seller Must Give Up To Produce a Good. Producer Surplus The Amount A Seller Is Paid For A Good Minus The Seller’s Cost Of Producing or Providing It. Producers Surplus Measures The Benefit To Sellers of Participating In A Market. Producer Surplus Producer Surplus = Amount That a Seller Is Paid Sellers Cost Note: Because We Have Set Up a Bidding Situation In Our Example, The CPA With The Lowest Cost Should Win The Bid. Now Let Us Use The Supply Curve To Measure Producer Surplus. Let Us Say That All 4 CPA’s Submitted Bids As Follows: CPA CPA CPA CPA A B C D = = = = $10,000 $12,000 $14,000 $16,000 Let Us Now Plot A Supply Schedule For Preparing Taxes. The Supply Curve Shows The Cost of The Marginal Seller, The Seller Who Would Leave The Market First If The Price Were Any Lower Price Product Supply Curve $18 T h o u s a n d s D $16 C $14 $12 $10 B A $8 $6 $4 $2 0 1 2 3 4 # of Suppliers 5 Quantity Producer Surplus Producer Surplus = Amount A Seller Is Paid For a Good or Service Cost of Providing The Good or Service Therefore Any Amount Above The Suppliers Cost Would Be Producers Surplus. In Our Example The Area Below The Price and Above The Supply Curve Measures The Producer Surplus In A Market. However, Producers Always Want To Receive a Higher Price For Their Goods and Services That They Sell. Market Efficiency Consumer Surplus and Producer Surplus Are The Basic Tools Economists Use To Study The Welfare Of Buyers and Sellers In a Market. If We Want To Maximize The Economic Well-Being Of Everyone In a Society. We Must First Decide How We Are Going to Measure The Economic Well-Being Of a Society. One Possible Measure Is The Sum of Consumer Surplus and Producer Surplus, Which We Call Total Surplus. Remember That Consumer Surplus Is The Benefit That Buyers Receive From Participating In The Market and Producer Surplus Is The Benefit That Sellers Receive From Participating In The Market. Remember Also, That The Formulas For Each Are As Follows: Consumer Surplus Consumer Surplus = Amount A Buyer Is Willing to Pay Amount They Paid Or = Value To Buyers - Amount Paid By Buyers Producer Surplus Producer Surplus = Amount That a Seller Is Paid Sellers Cost Or = Amount Received By Sellers – Cost To Sellers Total Surplus Then Becomes: Total Surplus = Value To Buyer - Amount Paid By Buyers + Amount Received By Sellers – Cost To Sellers. Or Because The Amount Paid By Buyers Equals The Amount Received By Sellers The Equation Can Be Rewritten As: Total Surplus = Value To Buyers – Cost To Sellers If An Allocation of Resources Maximizes Total Surplus, We Say That The Allocation Exhibits Efficiency. If An Allocation Is Inefficient, Then Some Of The Gains Among Buyers and Sellers Are Not Being Realized. i.e. Not Taking The Minimum Bid. Efficiency The Property Of A Resource Allocation Of Maximizing The Total Surplus Received By All Members Of Society. Thus, Moving Production From a High-Cost Producer To a Low-Cost Producer Will Lower The Total Cost To Sellers and Raise Total Surplus. Also An Allocation Is Inefficient If A Good Is Not Being Consumed By The Buyers Who Value It Most Highly. Therefore, Moving Consumption Of The Good From A Buyer With A Low Valuation To A Buyer With A High Valuation Will Raise Total Surplus. Equity The Fairness Of The Distribution of WellBeing Among The Members of Society. While Efficiency Can Be Measured and Judged On Performance, Equity Involves Normative Judgments That Enter Into The Area of Political Philosophy. Putting The Supply Curve and Demand Curve Together and Finding Equilibrium. Remember That Consumer Surplus Equals The Area Above The Price and Under The Demand Curve and Producer Surplus Equals The Area Below The Price and Above The Supply Curve. Therefore, The Total Area Under Between The Supply Curve and The Demand Curves Up To The Point of Equilibrium Represents The Total Surplus. Observations: 1. Free Markets Allocate The Supply Of Goods To The Buyers Who Value Them Most Highly, As Measured By Their Willingness To Pay. Observations: 2. Free Markets Allocate The Demand For Goods To The Sellers Who Can Produce Them At Least Cost. Observations: 3. Free Markets Produce The Quantity of Goods That Maximizes The Sum Of Consumer and Producer Surplus. Consumer and Producer Surplus In Market Equilibrium Price A Equilibrium Price Consumer Surplus E D Supply Producer Surplus B C Equilibrium Quantity Demand Quantity The Next Figure Shows That At Quantities Less Than The Equilibrium Quantity Such As Q1, The Value To The Buyers Exceeds The Cost To The Sellers. At Quantities Greater Than The Equilibrium Quantity Such As Q2, The Cost To The Sellers Exceeds The Value To The Buyers. Therefore The Market Equilibrium Maximizes The Sum Of Producer and Consumer Surplus. The Efficiency of the Equilibrium Quantity Price Value to Buyers Is Greater Than Cost To Sellers Value to Buyers Is Less Than Cost To Sellers Value To Buyers Supply Cost To Sellers Value Cost To Buyers To Sellers Q1 Demand Equilibrium Q2 Quantity Quantity Questions ? Chapter 5 International Trade Adam Smith’s Dos and Don’ts Do Protect society from the violence and invasion of other countries Establish an exact administration of justice Erect and maintain certain public works and institutions where private enterprise could not profit from doing so Don’t do anything else Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 7-51 Figure 1 The Internationalization of the U.S. Economy Percent of GDP 15 Imports 10 Exports 5 0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Table 1 International Flows of Goods and Capital: Summary Government Intervention Protection Allocation Benefit One of The Nine Principles of Economics (From Chapter 1) Is That Trade Makes Everybody Better Off. Comparative Advantage and Trade Gains From Specialization and Trade Are Not Based on Absolute Advantage, But on Comparative Advantage. When Each Person Specializes in Producing the Good For which They Have a Comparative Advantage, Total Production in the Economy Rises an Everyone is Better Off. However, There Can Be Other Factors Including the Price of the Goods and How the Gains Are Shared Among the Trading Partners. Applications of Comparative Advantage Should Tiger Woods Mow His Own Lawn or Play Golf? The Principle of Comparative Advantage Holds That a Country Can Benefit From Trade Even If it is Absolutely More Efficient (or Absolutely Less Efficient) Than Every Other Country in the Production of Every Good. Therefore, Trade According to Comparative Advantage Provides Mutual Benefits to All Countries. In Addition- The Principle of Comparative Advantage Holds That Each Country Will Benefit If it Specializes in the Production and Export of Those Goods That it Can Produce at Relatively Low Cost. Conversely, Each Country Will Benefit If it Imports Those Goods Which it Produces at a Relatively High Cost. Trade Among Countries- Imports- Are Goods Produced Abroad and Sold Domestically. Exports- Are Goods Produced Domestically and Sold Abroad. Nations Also Can Enjoy a Comparative Advantage, However That Does Not Necessarily Mean It Will or Will Not Produce a Good. The United States Has A Comparative Advantage in Certain Items Involving the Military and Warfare. However, This Does Not Mean That it is in The U.S.’s Best Interest to Sell these Items. International Trade Can Make Some Individuals Worse Off, Even as it Make the Country as a whole Better Off. What Does It Matter? We buy much more from foreigners than they buy from us In effect, they lend or give us the money to make up the difference between our imports and our exports We are essentially selling them a piece of the (American) rock consisting of corporate stock, real estate, corporate and government bonds and other debt instruments Should this continue for another three or four decades, foreign investors will own most of America 32-9 Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Four Main Arguments for Protection The National Security Argument The Infant Industry Argument The Low-Wage Argument The Employment Argument Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-23 The National Security Argument Our dependence on foreign suppliers could make us vulnerable in time of war It is possible that we need to maintain certain defense-related industries What if we depended on foreign suppliers for critical components of entire weapons systems? The continued spread of nuclear arms technology may soon make the national security argument much more relevant Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-24 The Infant Industry Argument American products are no longer produced by infant industries being swamped by foreign giants About the best that can be said is that some of our infant industries never matured while others have evolved into senility Textiles, steel, clothing, and automobiles may be in the senile category Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-25 The Low-wage Argument How can American workers compete with foreigners who are paid sweatshop wages in labor intensive industries? There is no reason for American firms to compete with foreign firms in these industries We should import labor-intensive goods and produce goods and services in which we can excel and compete We should use the proceeds to buy the goods and services produced by people who are forced to work for very low wages Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-26 The Employment Argument The flood of imports throw millions of Americans out of work But if we restrict imports, the governments of our foreign competitors will restrict our exports By curbing imports, we will be depriving other nations of the earnings they need to buy our exports If we restrict our imports, our exports will go down as well We would just lose the jobs connected with these lost exports Which would be best? Lose the jobs of workers who work for companies who can’t or won’t compete or lose the jobs of workers who work for companies who can compete but can’t export their products because of restrictions we ourselves caused? Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-27 Tariffs or Quotas A tariff is a tax on imports The government gets the resulting revenue A tariff affects all foreign sellers equally. Efficient foreign producers will be able to pay a uniform tariff. Less efficient producers will not A quota is a limit on the import of certain goods Import quotas produce no federal revenues Imports quotas are directed against particular sellers on an arbitrary basis Arbitrary quotas may allow relatively inefficient producers in and keep out more efficient producers Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-28 Tariffs or Quotas A tariff, like any other excise tax, causes a decrease in supply Both tariffs and quotas raise the price that consumers in the importing countries must pay Tariffs are better than quotas But free trade is best Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-29 A Tariff Lowers the Supply Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-30 Conclusion Economics is all about the efficient allocation of scarce resources There is no reason why this efficient allocation of resources should not be applied beyond national boundaries International trade helps every country To the degree that we can remove the tariffs, import quotas, and other impediments to free trade, we will all be better off The economics profession nearly unanimously backs free trade Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-31 Our Balance of Trade Our balance of trade compares the dollar value of merchandise and services we buy from foreigners with the dollar value of the merchandise and services they buy from us Our balance of trade is our country’s record of all transactions between its residents and the residents of all foreign nations Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-32 What Are the Causes of Our Trade Imbalance “We are consuming more than we are producing, borrowing more than we are saving, and spending more than we are earning.” – Murray Weidenbaum Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-33 What Are the Causes of Our Trade Imbalance We have become a nation of consumption junkies We are borrowing about $2 billion a day to finance our consumption habit. Most Americans believe that somehow we’re entitled to all of these goods and services, even if we need to borrow to pay for them. Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-34 What Are the Causes of Our Trade Imbalance Our Low Saving Rate Americans are notoriously poor savers. In 2005 we managed to spend 100.5 percent of our disposable income If you don’t save, you can’t invest If you don’t invest, you don’t grow Foreign savers have been picking up the slack This will not continue indefinitely Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-35 What Are the Causes of Our Trade Imbalance Huge Oil Imports We import two-thirds of our oil We pay just a fraction of what citizens in other industrial countries pay for gasoline Our dependency on oil imports will keep growing In 2005, the cost of oil reached a record high of $252 billion High Defense Spending Today the United States spends more on defense than the rest of the world put together Stretching our armed forces around the world comes at an extremely high price Can we afford to do this? 31-36 Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. U.S. Trade Deficit With Japan and China, 1995-2005 Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-40 Japanese Trading Practices Japanese compete on the basis of price and quality This is driving out American competitors The fundamental difference between ourselves and the Japanese is quality Better quality also means lower prices We sell Japan agricultural products and buy manufactured products from them This is a colonial relationship The Japanese picks winners and then makes sure they win Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-41 Japanese Trading Practices The Japanese consumer has long accepted a lower standard of living because it was necessary for the greater economic good They are willing to pay more for goods they produce when they could have them cheaper if they imported the same good Can you imagine Americans being willing to make that kind of sacrifice Americans would not stand for restricting Japanese imports because they are addicted to Japanese goods Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-42 Our Trade Deficit with China We began trading with China in the mid-1970s Although exports to China have grown rapidly, our exports are only about one-sixth of our imports We import so much from China because U.S. retailers are seeking the cheapest goods available and are finding them in China The Chinese are making unauthorized copies of American movies, CDs, and computer software Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-43 Trading with China and Japan There are more differences than similarities Our trading position with Japan is much like a colony and a colonial power We send airplanes, computers, movies, compact disk, cars, cigarettes, powergenerating equipment, and computer software to China in exchange for toys, clothing, shoes, and low-end consumer electronics Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-44 Trading With China and Japan Japan has never been open to foreign trade China has been open to trade Japanese gains in production have led directly to the loss of millions of well-paying American jobs Chinese exports so far have generally not translated into job losses in the United States In 2005 we ran a $202 billion trade deficit with China and one of $83 billion with Japan 31-45 Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Trading with China and Japan The Chinese and the Japanese both insist on licensing agreements and large-scale transfer of technology as the price for agreeing to imports These agreements, of course, lead to eventual elimination of imports from the United States Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-46 Final Word Reducing Our Overall Trade Deficit We need to maintain our high rate of productivity growth and keep improving the quality of American goods and services We need to lower our dependence on oil imports by raising the tax on gasoline We must, somehow, reduce our trade deficit with Japan We need to do something about our rapidly rising trade deficit with China We need to face up to the fact that we are a nation of consumption junkies We need to reduce our trade deficit with the rapidly expanding internet which make it much easier to provide services of all types Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-47 Current Issue: Buy American? Are we as a nation becoming more inclined to “buy American?” The bottom line is that Americans are consumers first, while paying just lip service to economic nationalism Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 31-48 Questions ? Quick WriteWhat Kind of Absolute Advantage or Comparative Advantage Do You Think You Have Over Other Students and How Can This be Used to Your Advantage When You Graduate?