Paul Krugman and Robin Wells. Microeconomics. Third Edition. Chapter 8 International Trade. Copyright 2013 by Worth Publishers

1. A few fast facts: A. Relative to 1960, trade with other countries has become a much bigger part of the U.S. economy: Figure (a) B. However, relative to other countries, trade is a much smaller part of the U.S. economy: Figure (b) 1. Taxes: overview Figure 8.1 The Growing Importance of International Trade Krugman and Wells: Microeconomics, Third Edition Copyright 2013 by Worth Publishers

2. Trade and comparative advantage: a quick review comparative advantage = low opportunity cost of production a country with a comparative advantage in producing something * will tend to specialize in producing it, and * will trade with other countries for other things at which it does not have a comparative advantage e.g., US has comparative advantage producing planes, Mexico has comparative advantage producing auto parts US: opp. cost of 1 auto parts = 2 planes, Mexico: opp. cost of 1 auto parts = 0.5 planes, opp. cost of 1 plane = 0.50 auto parts opp. cost of 1 plane = 2 auto parts So US has lower opportunity cost of producing planes, Mexico has lower opportunity cost of producing auto parts

3. So Mexico will offer auto parts in exchange for planes from the US, the US will offer planes in exchange for auto parts from Mexico. Rate of exchange of parts for planes (and vice-versa) has to be advantageous to both parties in the transaction: to give up one plane, US will want to get more than 0.5 parts, to give up one parts, Mexico will want to get more than 0.5 plane An example (not the only possible outcome!): suppose we trade planes for parts on a one-for-one basis? By getting 1 parts from Mexico for each of its planes, US does better than it could by itself (= 0.5 parts) By getting 1 plane from the US for each of its parts, Mexico does better than it could by itself (= 0.5 plane)

4. Autarky = without trade Columns with trade assume that trade occurs at the rate of one plane for each one bundle of auto parts. With trade, US makes 2000 planes, keeps 1250, and sells the remaining 750 to Mexico for 750 parts. So US is able to consume 750 parts and 1250 planes. With trade, Mexico makes 2000 parts, keeps 1250, and sells the remaining 750 parts to Mexico for 750 planes. So Mexico can consume 1250 parts and 750 planes. As a result, both US and Mexico can go beyond their production-possibility frontiers!

5. Now we use the familiar consumers/producers surplus concept to analyze trade and the impact of restrictions on trade. A. First, a quick review:

B. Now for a few preliminaries: autarky price = the domestic price in the absence of trade if the world price > domestic price, US producers EXPORT if the world price < domestic price, US consumers IMPORT Note: the world price assumed to be independent of US consumption/production: thus, line for world price is a horizontal straight line (thus, assumes that no matter how much we import or export, it won t affect the world price) 6. When the world price < domestic price, US consumers IMPORT: important implications for the supply curve: if the world price is below the domestic price (leading to imports), then the supply curve facing US consumers will be the vertical minimum or lowest-price minimum of (a) the supply curve of US producers (b) the world supply curve (= the world price line)

Equilibrium with imports: P W < P A when world P < domestic ( autarky ) P, US consumers buy from abroad they import so supply to US consumers rises, US price falls to the world level since the US price falls, domestic production falls US consumers gain, US producers lose gain for US consumers is larger than the US loss for producers, so there is a net gain from trade (increase in national surplus) But note (a) US producers won t be happy with this, and (b) US producers includes workers as well as capitalists e.g., not just management, but also labor In principle, because there is a net gain from trade for US as a whole, the gainers should be able to compensate the losers and still have something left over but that rarely if ever happens

supply curve facing US consumers: before trade = STAU, after trade = STVW U T V W S

7. Equilibrium with exports: P W > P A when world P > domestic ( autarky ) P, US producers raise output and sell more abroad they export important implications for the demand curve: if the world price is above the domestic price (leading to exports), then the demand curve facing US producers will be the vertical maximum or highest-price maximum of (a) the demand curve of US consumers (b) the world demand curve (= the world price line) So supply to US consumers falls, US price rises to the world level since the US price rises, domestic consumption falls US producers sell more output (export) to the rest of the world US consumers lose, US producers gain gain for US producers is larger than the loss for US consumers, so there is a net gain from trade but US consumers won t be happy with this In principle, since there is a net gain for the US as a whole, the US gainers should be able to compensate the US losers and still have something left over but that rarely if ever happens

D demand curve facing US producers: before trade = DEAB, after trade = DEFG E F G B Figure 8.8 The Domestic Market with Exports Krugman and Wells: Microeconomics, Third Edition Copyright 2013 by Worth Publishers

8. Tariffs A. A tariff is a tax imposed exclusively on imported goods (an import quota is an upper limit on the amount of goods that can be imported -- its effects are very similar, but not identical, to the effects of a tariff: see below) B. A tariff is like any other tax: it raises the cost to US consumers, and raises the price of imports above the world level, to something closer to the pre-trade ( autarky ) level so its effects are the reverse of the effects of allowing imports: US price rises, US producers produce more, US consumers buy less, less gains from trade however, US government does collect some revenue equal to the tariff per unit the post-tariff number of imports C. Since tariff reduces imports, it also reduces gains from trade -- US consumers' surplus shrinks, US producers' surplus rises gain for US producers is less than loss for US consumers thus, total surplus falls

9. Import quotas A. An import quota sets an upper limit on the quantity of imports thus, reduces amount of imports thus, effects are very similar to effects of a tariff: raises US price, reduces US consumption, raises US production, reduces US consumers' surplus, raises US producers surplus B. HOWEVER: in contrast with a tariff, the US government collects no revenue from a quota but foreign producers do get a higher price! C. possible exception: the government can require foreign producers to buy a license, allowing them to import under the quota at least theoretically, such a license can collect just as much revenue as a tariff (!) in this case, a quota will be virtually identical to a tariff!

*Note: If the US government does NOT charge a fee or require a license to import under the quota, then the government gets nothing. In this case, the amount E +E goes to foreign producers, not to the US government, US consumers, or US producers. surplus before quota after quota change Consumer A+B+C+D+E +E +F A + B -(D+D+E +E +F) Producer G C + G +C Government* none E +E (?) E +E (?) Total A+B+C+D+E +E +F+G A+B+C+G -(D+F) +(E +E ) (?) -(E +E ) (?)

10. Should we restrict trade? A. examples: making US Olympic team s uniforms in China, shipping US jobs to China, etc. etc. vs. foreign athletes trained in the US vs. foreign graduate students trained in the US vs. US entertainers abroad B. why restrict trade? 1. protect US jobs/firms? (ignore benefits to US consumers?) 2. protect industries that are vital to national security? (like the watch industry?) 3. protect infant industries? (but do we remove restrictions when they grow up?) 4. use as a bargaining chip? (might not work) C. big problem: there are gainers as well as losers from trade; and there are losers as well as gainers from trade (e.g., in the Mexico-US comparative advantage story, when the US and Mexico trade, US makers of planes gain, but US makers of parts lose)

Example: quota on sugar imports, price floor for domestic output results: high price of sugar/sugar products for US consumers, and for other producers who need sugar as an input (refiners, candy) environmental damage due to US overproduction the Law of the Few : a small number of US sugar producers lobby, contribute $, dictate policy because they are focused like lasers (while consumers aren t)

11. Is globalization good or bad? A. Export-industry wages in developing exporting countries are low and working conditions are often very bad, BUT are nevertheless much better than in non-export industries B. People flock to export industries, which are more attractive than other industries or the countryside C. What s the alternative? Raising wages could cut off exports and destroy jobs D. Joan Robinson: It s better to be exploited by somebody than by nobody at all.