International tradePreviously, we talked about…Today: More on international tradeReview of comparative advantageComparative advantage: Same numbers, different namesComparative advantageRecall increasing opportunity costProduction possibilities curveSlide 9The world marketConsumption possibilities curveWhich consumption possibility curve is best?Optimal production in an open economySlide 14Supply and demand analysis of tradeMarket for cars, w/o tradeSlide 17Market for cars, with tradeSlide 19Surplus with tradeWithout imports (left) With imports (right)Net gainA similar exercise can be done for a country that is a net exporterTariffs, quotas, and bailoutsWhat happens when we impose a tariff?Slide 26Slide 27Slide 28Total surplus and tariff money collectedSlide 30Total surplus and tariff money collectedVoluntary export restraints (VERs)VERsQuotasWhat else is different with quotas?The U.S. automaker bailout“Outsourcing”Slide 38How to make sure your job does not get outsourcedFinal thoughts about “outsourcing”SummaryUpcoming attractionsEnd of Unit 3International tradeToday: Winners and losers of various international trade policiesPreviously, we talked about…How trade can benefit peopleComparative advantage being the core of beneficial tradeAn introduction of international tradeToday:More on international tradeReview of comparative advantageExamining consumption possibilitiesWithout tradeWith tradeSupply and demand analysis of tradeTariffs and Quotas“Outsourcing”Review of comparative advantageRecall the principle of comparative advantage“Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.” (F/B p. 39)Today, we will apply this concept on a countrywide scaleComparative advantage: Same numbers, different names Productivity in pizza productionProductivity in salad productionUnited States20 pizzas cooked per hour10 salads made per hourChile 16 pizzas cooked per hour4 salads made per hourComparative advantageRecall: To find comparative advantage for each person, find the lowest number in each columnOpportunity cost of cooking a pizzaOpportunity cost of making a saladU.S. ½ salad 2 pizzasChile ¼ salad 4 pizzasRecall increasing opportunity costOpportunity cost increases as production increases within each countryEach country uses its best pizza maker to make its first pizzasThen, the next best pizza maker is used, etc.The same applies to saladsProduction possibilities curveRecall from last lecture that all of the points along PGQ are the efficient points of the production possibilities curveRecall that this shape occurs due to increasing opportunity costs as more is producedProduction possibilities curveWithout trade, only points along arc PGQ (or points between this arc and the origin) can be consumedWe will see that gains can be made by tradeThe world marketIn the world market, there is an equilibrium price (based on world supply and world demand)Any one country that enters or exits the market usually does not change the market price muchFor ease of discussion, assume that entry or exit by any one country does not change the world priceConsumption possibilities curveIf we produce at point G, we can trade goods at the given market priceProduction at G (with trade)  Consumption anywhere along FGHWhich consumption possibility curve is best?We could produce at one of the red dots before we start tradingHowever, note that there are fewer consumption sets possible than producing at GOptimal production in an open economySince the red line is suboptimal, we will not utilize itSimilarly, any point except G will produce a similar result to the red lineSuboptimal consumption possibilities for any production except GOptimal production in an open economySolutionProduce such that the “line of trade possibilities” is tangent to the production possibilities curveIn this case, point G is tangent to line FGHSupply and demand analysis of tradeAs we just analyzed, we saw that total surplus goes up when world trade is possibleHowever, we will see that there are winners and losers to tradeNote that the winners’ gain is larger than the losers’ lossMarket for cars, w/o tradeSuppose that without trade, 40,000 cars are sold at a price of $14,000Market for cars, w/o tradeConsumer surplus is blue shaded areaProducer surplus is red shaded areaMarket for cars, with tradeNotice that the world price for cars is $10,000At this price, notice that 20,000 cars will be supplied and 60,000 cars will be demanded in this marketMarket for cars, with tradeWhat will happen?This is unlike the case of rent control, since the shortage is picked up by the world market20,000 domestic cars will be purchased40,000 foreign cars will be purchased ImportsSurplus with tradeConsumer surplus increases substantiallyProducer surplus decreases, but does not change as much as consumer surplus does ImportsWithout imports (left)With imports (right) ImportsNet gain ImportsA similar exercise can be done for a country that is a net exporterWhen a country is a net exporter, the world price is above what it would be if trade was not possibleConsumer surplus decreases when trade occursProducer surplus increases when trade occursOverall, total surplus increasesTariffs, quotas, and bailoutsEven when trade is not prohibited, countries use other devices to control the amount of a particular good importedTariffTax that must be paid for each unit of the good importedQuotaA binding limit set on the amount of a good that can be importedBailouts: An example with U.S. automakersSubsidized loansSee additional reading on class websiteWhat happens when we impose a tariff?In this case, the tariff imposed is $1000 per ton of sugar importedWe will see that some potential economic surplus is lost when the tariff is imposedWhat happens when we impose a tariff?Total surplus without tariffsShaded areaWhat happens when we impose a tariff?With a tariff, the price paid by consumers is the world price plus the amount of the tariffThink of a tariff just like a taxThis increases the quantity supplied domestically and decreases the amount importedWhat happens when we impose a tariff?Quantity supplied domestically increasesImports decreaseBefore, 100 tons