Micro Ch09 Lecnotes 6e

PowerPoint Lecture Notes for Chapter 9: Application: International Trade Principles of Microeconomics 4th edition, by N.
Gregory Mankiw PowerPoint Slides by Ron Cronovich
Application: International Trade
PRINCIPLES OF
MICROECONOMICS
F OURT H E DITIO N
N. G R E G O R Y M A N K I W
PowerPoint Slides by Ron Cronovich
2006 Thomson South-Western, all rights reserved
This relatively short chapter has a few main objectives. Welfare analysis of free trade in a good that a country exports, relative to no trade. Welfare analysis of free trade in a good that the country imports, relative to no trade. Welfare analysis of a tariff, relative to free trade in a good the country imports. The most common arguments for restricting imports, and the economists response to each. I encourage you to bring to your students attention several interesting items in the book itself. Theres a new In the News box on the 2005 expiration of U.S. quotas on textile products from China. In another new In the News box, George Will addresses the outcry over Mankiws famously-misquoted statement about outsourcing. The chapters conclusion makes an effective point about international trade by comparing it to technological progress. In addition, one of the macro chapters of this textbook has a new In the News box that you should try to obtain for possible use with this chapter. In it, the Presidents of two African nations use sound economics to explain why the farm subsidies of rich countries are contributing to the impoverishment of millions of African farmers. The article is very well-written, effective, and impassioned. It appears in the chapter entitled Production and Growth, chapter 25 in the complete Principles of Economics textbook, and chapter 12 in the Principles of Macroeconomics split.
In this chapter, look for the answers to these questions: What determines how much of a good a country
will import or export?
Who benefits from trade? Who does trade harm?

Do the gains outweigh the losses?
If policymakers restrict imports, who benefits?

Who is harmed? Do the gains of the policy outweigh the losses?
What are some common arguments for restricting

trade? Do they have merit?
CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 1
Introduction Recall from Chapter 3:

A country has a comparative advantage in a good if it produces the good at lower opportunity cost than other countries. Countries can gain from trade if each exports the goods in which it has a comparative advantage.
Now we apply the tools of welfare economics

to see where these gains come from and who gets them.
CHAPTER 9
APPLICATION: INTERNATIONAL TRADE
The world price and comparative advantage
PW = the world price of a good,

the price that prevails in world markets
PD = domestic price without trade If PD < PW, country has comparative advantage in the good under free trade, country exports the good If PD > PW, country does not have comparative advantage under free trade, country imports the good
The small economy assumption

A small economy is a price taker in world markets:
Its actions have no affect on PW.
Not always true especially for the U.S. but

simplifies the analysis without changing its lessons.
When a small economy engages in free trade,

PW is the only relevant price:
No seller would accept less than PW, because she could sell the good for PW in world markets. No buyer would pay more than PW, because he could buy the good for PW in world markets.
APPLICATION: INTERNATIONAL TRADE 4
CHAPTER 9
A country that exports soybeans

Without trade, PD = $4 Q = 500 PW = $6 Under free trade, domestic consumers demand 300
$6 $4
P
Soybeans exports
S
domestic producers supply 750 exports = 450
300 500 750
CHAPTER 9
Fun soybean facts (all data from 2004): U.S. farmers grew 3.1 billion bushels of soybeans. The average price was $5.65/bushel, for a total of nearly $18 billion. The U.S. exported 1.1 billion bushels, comprising nearly half of international trade in soybeans. China purchased $2.3 billion worth of U.S. soybean exports, making China the U.S. soybean farmers biggest foreign customer. Japan was second with $1.0 billion in purchases. Source: American Soybean Association, http://www.soystats.com/ You might alert your students that, in just a moment, they will be asked to do some analysis very similar to this analysis. This will make them pay close attention. In this case, PD < PW, so this country will export soybeans. The quantity of exports is simply the difference between the domestic quantity supplied and the domestic quantity demanded at the world price.
A country that exports soybeans

Without trade, CS = A + B PS = C Total surplus =A+B+C With trade, CS = A PS = B + C + D Total surplus =A+B+C+D
CHAPTER 9
Trade benefits soybean producers, because they can sell at a higher price. Producer surplus rises by the area B + D. Trade makes domestic buyers worse off, because they have to pay a higher price. Consumer surplus falls by the area B. The gains to producers are greater than the losses to consumers, so trade increases total welfare: total surplus rises by the amount D.
6
Soybeans exports B D gains from trade

D Q S
A $6 $4 C
ACTIVE LEARNING
Analysis of trade
Without trade, PD = $3000, Q = 400 In world markets, PW = $1500 Under free trade, how many TVs will country import or export?
1:
P
Plasma TVs
S
The two preceding slides show students the analysis of trade when the country exports. The next step is to cover the analysis of trade when the country imports the good. Instead of lecturing on this material, I suggest you have students work on this exercise, which students to do this analysis themselves. Its an activity that breaks up the lecture and gives students a chance to apply the techniques youve just presented. I suggest you have students work on it in pairs. Give them about 5 minutes, then go over the answers on the following two slides. While students are working, circulate around the room and offer to assist any students that ask for help. This will also give you a sense of how well students are understanding the material. If you prefer to lecture on the material instead, replace these slides with the two hidden slides that immediately follow the CHAPTER SUMMARY. You will then have to unhide those slides by unselecting Hide Slide from the Slide Show drop-down menu.
$3000 $1500
D
Identify CS, PS, and total surplus without trade, and with trade.
200
400
600
ACTIVE LEARNING
Answers
1:
P
PD > PW, so this country will import plasma TV sets from abroad.
Plasma TVs
S
Under free trade,
domestic consumers demand 600 domestic producers supply 200 imports = 400
The quantity of imports is simply the difference between the quantity demanded by domestic consumers and the quantity supplied by domestic firms at the world price.
$3000 $1500 imports 200 600

D Q
ACTIVE LEARNING
Answers
1:
P
Without trade, CS = A PS = B + C Total surplus =A+B+C
Plasma TVs
S
A $3000 With trade, B $1500 CS = A + B + D C PS = C Total surplus =A+B+C+D
gains from trade D imports

D Q
Trade benefits consumers in this case, because it allows them to buy plasma TVs at lower prices, so more consumers can afford plasma TVs if imports are allowed. The gains to consumers appear on the graph as the area (B+D), which represents the increase in consumer surplus when the country allows trade. In this example, trade harms domestic producers, because they now must sell their plasma TVs at a lower price. As a result, they produce a smaller quantity, earn less revenue, and likely let go of some of their workers. These losses are represented on the graph by the area B , which represents the fall in producer surplus resulting from trade. As the graph shows, the gains to consumers outweigh the losses to producers: total surplus increases by the amount D, which represents the gains from trade in plasma TV sets.
Summary: the welfare effects of trade

PD < PW direction of trade consumer surplus producer surplus total surplus exports falls rises rises PD > PW imports rises falls rises
Whether a good is imported or exported, trade creates winners and losers. But the gains exceed the losses.
Other benefits of international trade consumers enjoy increased variety of goods producers sell to a larger market, may achieve
lower costs through economies of scale
competition from abroad may reduce market

power of some firms, which would increase total welfare
trade enhances the flow of ideas, facilitates the

spread of technology around the world
CHAPTER 9
11
Then why all the opposition to trade? Recall one of the Ten Principles:
Trade can make everyone better off.
The winners from trade could compensate the

losers and still be better off.
In December 2005, thousands of protestors gathered outside the meeting place of the World Trade Organization talks in Hong Kong. Some protests turned violent, and police made 900 arrests. Mankiw addresses the issue of opposition to trade very nicely in the Ask the Author video for Chapter 3. The Ask the Author videos are available at the Mankiw Xtra website. You may need a username and password; you can get them from your Thomson/South-Western sales rep. There is one Ask the Author video clip per chapter. Each video is about 2 minutes. In each, Mankiw addresses a question submitted by a student. I encourage you to check out these videos, and consider showing some of them in your class. The videos for Chapter 3 and Chapter 9 both go very nicely with the material in this PowerPoint.
Yet, such compensation rarely occurs. The losses are often highly concentrated among
a small group of people, who feel them acutely. The gains are often spread thinly over many people, who may not see how trade benefits them.
Hence, the losers have more incentive to organize

and lobby for restrictions on trade.
Tariff: an example of a trade restriction
Tariff: a tax on imports. Example: Cotton shirts

PW = $20 Tariff: T = $10/shirt Consumers must pay $30 for an imported shirt. So, domestic producers can charge $30 per shirt.
In general, the price facing domestic buyers &

sellers equals (PW + T ).
CHAPTER 9
13
Analysis of a tariff on cotton shirts

PW = $20 free trade: buyers demand 80 sellers supply 25 imports = 55 T = $10/shirt price rises to $30 buyers demand 70 sellers supply 40 imports = 30
CHAPTER 9
Cotton shirts
$30 $20 imports imports 25 40 70 80

D Q
14

free trade CS = A + B + C +D +E +F PS = G Total surplus = A + B +C +D +E +F+ G
P
Cotton shirts deadweight loss = D + F

S
The tariff benefits domestic producers, by allowing them to sell for a higher price. Producer surplus increases by C. The tariff makes consumers worse off, because they have to pay a higher price. Consumer surplus falls by C + D + E + F. The tariff generates revenue for the government equal to E.
D Q
15
A tariff CS = A + B $30 C D PS = C + G $20 G Revenue = E Total surplus = A + B 25 40 +C +E+G

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE
B E F
70 80
The losses from the tariff exceed the gains, so total welfare falls. The tariff reduces total surplus by (D + F).

D = deadweight loss from the overproduction of shirts F = deadweight loss from the underconsumption of shirts
P
Cotton shirts deadweight loss = D + F

S
A tariff is a tax. Like the taxes we studied in the preceding chapter, the tariff causes a deadweight loss because it distorts incentives. Here, the tariff causes the economy to devote more resources to a good that could be produced at lower opportunity cost in other countries. This causes a deadweight loss, represented on the graph by the area D.
D Q
16
A $30 $20 G 25 40 70 80 B C D E F
Also, the tariff gives consumers an incentive to purchase a smaller quantity. The result is a deadweight loss, area F on the graph.
CHAPTER 9
Import quotas: Another way to restrict trade
An import quota is a quantitative limit on imports

of a good.
The 4th edition of the textbook replaces the graphical analysis of a quota with an FYI box. This slide is based on that box.
Mostly, has the same effects as a tariff:
raises price, reduces quantity of imports reduces buyers welfare increases sellers welfare
A tariff creates revenue for the govt. A quota

creates profits for the foreign producers of the imported goods, who can sell at higher price.
Or, govt could auction licenses to import to

capture this profit as revenue. Usually it does not.
In the News: Textile Imports from China

On 12/31/2004, expiration of U.S. quotas on apparel & textile products. During Jan 2005: The U.S. textile industry & for labor U.S. unions importsfought of these new trade restrictions. products from China increased over 70%. The National Retail Federation opposed any loss of 12,000 jobs restrictions. in U.S. textile industry
CHAPTER 9
November 2005: Bush Administration agreed to limit growth in imports from China.
18
If you can spend a few extra minutes of class time on this, you might consider the following: Show the first bit of text, which states the expiration of the quotas. Then ask students to take a few moments and write down all of the different groups that would be affected by the expiration of the quotas. Ask which of these groups would be most likely to fight for reinstatement of the quotas. Better yet, have them work in pairs. After a couple minutes, ask for volunteers to share their answers. The typical responses would be: U.S. textile producers and workers would be hurt, would fight for new restrictions. U.S. consumers would benefit. Other possible responses: The U.S. retail sector (e.g. Gap stores) would benefit, and would oppose new restrictions. Senators and Congressmembers from states with significant textile production would likely argue for new restrictions on imports from China. The statistics on this slide came from: Free of Quota, China Textiles Flood the U.S. New York Times, 3/10/2005, pp.A1 and C6. A condensed version of this excellent article appears in the textbook itself as a new In the News box.
ARGUMENTS FOR RESTRICTING TRADE

1. The jobs argument
Trade destroys jobs in industries that compete with imports.
Economists response:
Look at the data to see whether rising imports cause rising unemployment
CHAPTER 9
19
U.S. imports & unemployment,

decade averages, 1956-2005
16% 14% 12% 10% 8% 6% 4% 2% 0%
By using decade averages, the short-term noise and fluctuations average out, which makes the long-term trends easier to see. In most periods, rising imports are accompanied by falling, not rising unemployment.
imports (% of GDP)
unemployment (% of labor force)
Note: This data does not appear in the textbook. I include it here because I think it is effective. But it is not supported in the Test Bank or Study Guide, so please feel free to omit this and the preceding slide if you wish. Data source: FRED database, St Louis Federal Reserve, http://research.stlouisfed.org/fred2/ and my calculations. (I constructed imports as a percentage of GDP from quarterly, nominal, seasonally adjusted data. Then I computed simple averages of the two series over each of the decades shown in the graph.)
1956 -65
1966 -75
1976 -85
1986 -95

1. The jobs argument
Trade destroys jobs in the industries that compete against imports.
Economists response: Total unemployment does not rise as imports rise, because job losses from imports are offset by job gains in export industries.
Even if all goods could be produced more cheaply abroad, the country need only have a comparative advantage to have a viable export industry and to gain from trade.

2. The national security argument An industry vital to national security should be protected from foreign competition, to prevent dependence on imports that could be disrupted during wartime. Economists response: Fine, as long as we base policy on true security needs. But producers may exaggerate their own importance to national security to obtain protection from foreign competition.
1996 -2005

3. The infant-industry argument A new industry argues for temporary protection until it is mature and can compete with foreign firms. Economists response: Difficult for govt to determine which industries will eventually be able to compete, and whether benefits of establishing these industries exceed cost to consumers of restricting imports. Besides, if a firm will be profitable in the long run, it should be willing to incur temporary losses.

4. The unfair-competition argument Producers argue their competitors in another country have an unfair advantage, e.g. due to govt subsidies. Economists response: Great! Then we can import extra-cheap product subsidized by the other countrys taxpayers. The gains to our consumers will exceed the losses to our producers.
CHAPTER 9
24

5. The protection-as-bargaining-chip argument Example: the U.S. can threaten to limit imports of French wine unless France lifts their quotas on American beef. Economists response: Suppose France refuses. Then the U.S. must choose between two bad options: A) Restrict imports from France, which reduces welfare in the U.S. B) Dont restrict imports, and suffer a loss of credibility.
Of course, this argument and response are meant to apply more generally than in the specific example described. But most noneconomics majors more easily learn a general concept if they start with a specific, graspable example than with the general concept itself.
Trade agreements
A country can liberalize trade with
The WTO website (http://www.wto.org) has useful information. Especially worthwhile for students is the section Common misunderstandings about the WTO.
unilateral reductions in trade restrictions multilateral agreements with other nations North American Free Trade Agreement (NAFTA), 1993 General Agreement on Tariffs and Trade (GATT), ongoing
Examples of trade agreements:
World Trade Organization (WTO) est. 1995,

enforces trade agreements, resolves disputes
CHAPTER SUMMARY A country will export a good if the world price of

the good is higher than the domestic price without trade. Trade raises producer surplus, reduces consumer surplus, and raises total surplus.
A country will import a good if the world price

is lower than the domestic price without trade. Trade lowers producer surplus, but raises consumer and total surplus.
A tariff benefits producers and generates revenue

for the govt, but the losses to consumers exceed these gains.
CHAPTER SUMMARY Common arguments for restricting trade include:

protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions. Some of these arguments have merit in some cases, but economists believe free trade is usually the better policy.
CHAPTER 9
28
A country that imports plasma TVs

Without trade, PD = $3000 Q = 400 PW = $1500 Under free trade, domestic consumers demand 600
$3000 $1500 imports 200 400 600
D Q P
Plasma TVs
S
This and the following slide cover the same material in Active Learning Exercise 1. I provide these slides in case you wish to lecture on this material instead of having students work the exercise. To do this, simply delete the three orange and yellow slides titled Active Learning 1 and replace them with this and the following slide. Then, unhide these slides by unselecting Hide Slide from the Slide Show dropdown menu.
29
domestic producers supply 200 imports = 400
CHAPTER 9
In this case, PD > PW, so this country will import plasma TV sets from abroad. The quantity of imports is simply the difference between the quantity demanded by domestic consumers and the quantity supplied by domestic firms at the world price.
A country that imports plasma TVs

Without trade, CS = A PS = B + C Total surplus =A+B+C
P
Plasma TVs
S
A D
gains from trade
Trade benefits consumers in this case, because it allows them to buy plasma TVs at lower prices, so more consumers can afford plasma TVs if imports are allowed. The gains to consumers appear on the graph as the area (B+D), which represents the increase in consumer surplus when the country allows trade. In this example, trade harms domestic producers, because they now must sell their plasma TVs at a lower price. As a result, they produce a smaller quantity, earn less revenue, and likely let go of some of their workers. These losses are represented on the graph by the area B , which represents the fall in producer surplus resulting from trade. As the graph shows, the gains to consumers outweigh the losses to producers, as total surplus increases by the amount D, which represents the gains from trade in plasma TV sets.
$3000 With trade, B CS = A + B + D $1500 C PS = C Total surplus =A+B+C+D

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE
imports
D Q
30

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PowerPoint Lecture Notes for Chapter 9: Application: International Trade Principles of Microeconomics 4th edition, by N.

Gregory Mankiw PowerPoint Slides by Ron Cronovich

Application: International Trade

Who benefits from trade? Who does trade harm?

If policymakers restrict imports, who benefits?

What are some common arguments for restricting

Introduction Recall from Chapter 3:

Now we apply the tools of welfare economics

APPLICATION: INTERNATIONAL TRADE

The world price and comparative advantage

PW = the world price of a good,

The small economy assumption

Not always true especially for the U.S. but

When a small economy engages in free trade,

A country that exports soybeans

domestic producers supply 750 exports = 450

300 500 750

APPLICATION: INTERNATIONAL TRADE

A country that exports soybeans

Soybeans exports B D gains from trade

APPLICATION: INTERNATIONAL TRADE

Under free trade,

$3000 $1500 imports 200 600

Without trade, CS = A PS = B + C Total surplus =A+B+C

A $3000 With trade, B $1500 CS = A + B + D C PS = C Total surplus =A+B+C+D

gains from trade D imports

Summary: the welfare effects of trade

competition from abroad may reduce market

trade enhances the flow of ideas, facilitates the

APPLICATION: INTERNATIONAL TRADE

The winners from trade could compensate the

Hence, the losers have more incentive to organize

Tariff: an example of a trade restriction

Tariff: a tax on imports. Example: Cotton shirts

In general, the price facing domestic buyers &

APPLICATION: INTERNATIONAL TRADE

Analysis of a tariff on cotton shirts

$30 $20 imports imports 25 40 70 80

APPLICATION: INTERNATIONAL TRADE

Analysis of a tariff on cotton shirts

Cotton shirts deadweight loss = D + F

A tariff CS = A + B $30 C D PS = C + G $20 G Revenue = E Total surplus = A + B 25 40 +C +E+G

Analysis of a tariff on cotton shirts

Cotton shirts deadweight loss = D + F

APPLICATION: INTERNATIONAL TRADE

Import quotas: Another way to restrict trade

An import quota is a quantitative limit on imports

Mostly, has the same effects as a tariff:

A tariff creates revenue for the govt. A quota

Or, govt could auction licenses to import to

In the News: Textile Imports from China

APPLICATION: INTERNATIONAL TRADE

ARGUMENTS FOR RESTRICTING TRADE

APPLICATION: INTERNATIONAL TRADE

U.S. imports & unemployment,

unemployment (% of labor force)

ARGUMENTS FOR RESTRICTING TRADE

ARGUMENTS FOR RESTRICTING TRADE

ARGUMENTS FOR RESTRICTING TRADE

ARGUMENTS FOR RESTRICTING TRADE

APPLICATION: INTERNATIONAL TRADE

ARGUMENTS FOR RESTRICTING TRADE

Examples of trade agreements:

World Trade Organization (WTO) est. 1995,