Ch 17 International Trade

U.S. TRADE PATTERNS

Imports and Exports

Imports are goods and services purchased from foreign sources.

Exports are goods and services sold to foreign buyers.

Imports

The U.S. imports over $1 trillion worth of goods and services.

Total imports represent 12% of total GDP.

Exports

Exports were just under $700 billion in 2000.

Exports account for about 11% of total output.

Exports in Relation to GDP

Trade Balances

Imports and exports are seldom equal.

The trade balance is the difference between exports and imports.

Trade balance = exports – imports

Trade deficit — the amount by which the value of imports exceeds the value of exports in a given time period.

Trade surplus — the amount by which the value of exports exceeds the value of imports in a given time period.

Any imbalance in trade in the world must be offset by reverse balances elsewhere in the world.

The U.S. typically has merchandise deficit, a services surplus, and an overall trade deficit.

Bilateral Trade Balances
Top Deficit Countries

Top Surplus Countries

MOTIVATION TO TRADE

Specialization increases total world output.

Gains From Trade

Increased world output.

A higher standard of living in both countries.

Production and Consumption Without Trade

The gains from trade may be illustrated using a production possibilities curve.

The production-possibilities curve defines the limits to what a country can produce.

In the absence of trade, a country cannot consume more than it produces.

Consumption Possibilities

Without trade, a country’s consumption possibilities equals its production possibilities.

Consumption possibilities are the alternative combinations of goods and services that a country could consume in a given time period.

Consumption Possibilities Without Trade

Production and Consumption With Trade

Changing the mix of output results in a higher total level of output.

International trade allows each country to focus on what it does best.

Trade Possibilities

When a country engages in international trade, its consumption possibilities exceed its production possibilities.

Consumption Combination Before Trade

Gains from Specialization

COMPARATIVE ADVANTAGE

The ability of a country to produce a specific good or service at a lower opportunity cost than its trading partners.

Opportunity cost is the most desired goods or services that are forgone in order to obtain something else.

A country should specialize in what it is relatively efficient at producing.

That is, goods for which it has the lowest opportunity costs.

Comparative advantage refers to the relative (opportunity) cost of producing particular goods.

World output and, thus, the potential gains from trade are maximized when each country pursues comparative advantage.

Absolute Costs Don’t Count

Absolute Advantage

The ability of a country to produce a specific good with fewer resources (per unit of output) than other countries.

It is not the absolute monetary cost of production that determines a nation’s comparative advantage.

TERMS OF TRADE

The rate at which goods are exchanged

The amount of good A given up for good B in trade.

Limits to Terms of Trade

A country will not trade unless terms of trade are superior to domestic opportunity costs.

The terms of trade between any two countries will lie somewhere between their respective opportunity costs in production.

The Market Mechanism

Import/export decisions are left up to the market decisions of consumers and producers.

Market participants tend to focus on prices.

The terms of trade depend on the willingness of market participants to buy or sell at various prices.

PROTECTIONIST PRESSURES

Not everyone supports free trade.

Microeconomic Losers

Workers and producers who work in import-competing industries have an economic interest in restricting trade.

Trade redistributes income from import-competing industries to export industries.

Trade not only alters the mix of output but also redistributes income from competing industries to export industries.

The Net Gain

Microeconomic gains from trade are greater than the microeconomic losses.

Trade restrictions designed to protect special microeconomic interests reduce the total gain from trade.

BARRIERS TO TRADE

The microeconomic losses caused by imports give rise to a constant clamor for trade restrictions.

Tariff

A tax (duty) imposed on imported goods.

Quota

A limit on the quantity of a good that may be imported in a given time period.

Nontariff Barrier

Protectionist measures designed to restrict trade.

Tariffs

50% of all U.S. imports – over 9,000 different products – are subject to tariffs.

Although individual tariffs vary widely, average tariff is 4%.

A tariff on imported goods makes them more expensive to domestic consumers.

It makes them less competitive with domestically produced goods.

Tariffs raise domestic prices and reduce quantity sold.

Quotas

Like all trade barriers, they reduce world efficiency and invite retaliatory action.

Quotas put an absolute limit on imported sales – gives domestic producers opportunity to raise market price.

Quotas are a much greater threat to competition than tariffs because they preclude additional imports at any price.

Impact of Trade Restrictions

Nontariff Barriers

U.S. uses nontariff barriers to restrict roughly 15% of its imports.

Examples include product standards, licensing restrictions, and restrictive procurement practices.

In 1999-2000, the European Union banned imports of U.S. beef, arguing that the use of hormones on U.S. ranches created a health hazard for European consumers.

Japan uses these to restrict nearly 30% of its imports.

EXCHANGE RATES

Every trade will require two different currencies as long as each nation has its own currency.

The exchange rate is the price of one country’s currency expressed in terms of another country’s currency.

The Euro Market

Global Pricing

The cost of a good depends on:

Appreciation/Depreciation

Global prices of all imports and exports change whenever exchange rates change.

Currency Appreciation

An increase in the value of one currency relative to another.

If the value of a nation’s currency appreciates:

Its exports become more expensive.

Its imports become cheaper.

Currency Depreciation

A decrease in the value of one currency relative to another.

If the value of a nation’s currency declines:

Its exports become cheaper.

Its imports become more expensive.

Foreign Exchange Markets

Exchange rates change when either the supply or demand for a currency shift.

Currency Appreciation

Policing World Trade

Trade policy is a continuing conflict between the benefits of comparative advantage and protectionism.

GATT — General Agreement on Tariffs and Trade (1948)

Purpose:

Pursue free trade policies.

Extend equal access – most favored nation status – to domestic markets for all GATT members.

Tariff rates in developed countries averaged 40 percent when GATT was first signed.

First seven GATT rounds lowered tariffs to an average of 6.3 percent.

The Uruguay Round (1994) lowered tariffs to 3.9 percent.

WTO — World Trade Organization

Created to replace GATT.

The WTO is empowered to cite nations that violate trade agreements and to impose remedial action when violations persist.

WTO Protest

Some believe freer trade is a mixed blessing.

Environmentalists

Question the desirability of economic growth.

Worry about depletion of resources, congestion and pollution, and social friction that growth often promotes.

Are concerned about “exporting pollution”

Labor organizations worry that global competition will depress wages and working conditions.

Many third-world nations are concerned about playing by trade rules that seem to benefit rich nations.

E.g., agricultural subsidies, intellectual property rights.