Econ Dept, UMR Presents Principles of Principles of International and International and Interregional Trade Interregional Trade Part I Part I
Starring Starring N The Importance of International Trade and N Comparative Advantage 7 With Linear PPF 7 With Concave PPF
Why Foreign Trade? Why Foreign Trade? N For the same reason we go to For the same reason we go to N WalMart WalMart N We get more of what we want for less We get more of what we want for less N N Trade involves exchanging something Trade involves exchanging something N we value less for something we value we value less for something we value more more N International Trade is the exchange of International Trade is the exchange of N exports (goods we value less) for exports (goods we value less) for imports (goods we value more) imports (goods we value more)
Export, Imports, and GDP Export, Imports, and GDP GDP, Gross Domestic Product, is N GDP, Gross Domestic Product, is N the market value of final goods the market value of final goods and services produced. In 1997, and services produced. In 1997, GDP was about $7,000 billion. GDP was about $7,000 billion. Exports, included in GDP, were Exports, included in GDP, were about $600 billion, and Imports, about $600 billion, and Imports, which are a subtraction from which are a subtraction from GDP, were about $800 billion. GDP, were about $800 billion.
Exports Exports 10% 1996 22% 1996 11% 41% 16% Agriculture Products Capital Goods Other Automobiles Industrial Supplies and Materials
Imports Imports 9% 17% 1996 1996 21% 17% 36% Petroleum and Products Capital Goods Other Automobiles Industrial Supplies and Materials
Foreign Trade Links Economic Report of the President Economic Report of the President Annual Report 1997, Ch. 7, has a broad discussion of the U.S. role in the global economy NAFTA And Fast Track A collection of articles on these issues from Policy.com U.S. Department of Commerce U.S. Department of Commerce Facts on international trade by country and trade sector
What Determines What We What Determines What We Sell and What We Buy? Sell and What We Buy? N David Ricardo English Economist, David Ricardo English Economist, N 1772- -1823 1823 1772 N Formulated the notion of Formulated the notion of N Comparative Advantage Comparative Advantage
Comparative Advantage Comparative Advantage N The ability to produce something The ability to produce something N desired at a lower opportunity cost desired at a lower opportunity cost than someone else than someone else N By specializing in activities where By specializing in activities where N you have a comparative advantage you have a comparative advantage and trading, you realize a higher and trading, you realize a higher standard of living standard of living
By Exercising Comparative By Exercising Comparative Advantage, We Gain From Advantage, We Gain From Trade Trade N Let’s go back to the Production Let’s go back to the Production N Possibilities Model Possibilities Model N And see how two countries win And see how two countries win N with trade with trade
A Simple PPF A Simple PPF N Constant Marginal Cost Constant Marginal Cost N N Two Countries: U.S. and Saudi Two Countries: U.S. and Saudi N Arabia Arabia N Two Goods: Oil and All Other Two Goods: Oil and All Other N Goods, AOG Goods, AOG
Production Possibilities Production Possibilities Remember, the Marginal Cost of the good on the horizontal axis is the slope. AOG/t 120 SA has the CA in Oil (MC oil = 1 AOG < U.S. MC oil U.S. = 4 AOGs) 60 Saudi Arabia 30 60 Oil/t
Should They Trade? Should They Trade? N Who can produce the most Oil? the Who can produce the most Oil? the N most AOG? most AOG? N Who has a comparative advantage Who has a comparative advantage N in Oil? in AOG? in Oil? in AOG? N Who should produce what? Who should produce what? N
Who Can Produce More Who Can Produce More Depends on Resources Depends on Resources Stock and Technology Stock and Technology N The U.S. can produce more AOG The U.S. can produce more AOG N N And Saudi Arabia more Oil And Saudi Arabia more Oil N N But this has little relevance for But this has little relevance for N answering the question who will answering the question who will trade what trade what
Comparative Advantage Comparative Advantage and Marginal Cost and Marginal Cost N Comparative Advantage depends Comparative Advantage depends N on opportunity cost on the margin, on opportunity cost on the margin, Marginal Cost Marginal Cost
Determining MC The slope of the PPF is the marginal cost of X. If the PPF AOG/t is concave, the marginal cost of X is the slope of a tangent to 3 the PPF. The inverse of the 1 slope of the tangent is the marginal cost of AOG, MC X = 3 AOGs, MC AOG = 1/3 X. X/t
Opportunity Cost (U.S.)- - Opportunity Cost (U.S.) Linear PPF Linear PPF AOG/t MC Oil = 4 AOGs 120 U.S. MC AOG = 1/4 Oil A A: U.S. Production 64 and Consumption Point 14 30 Oil/t
Opportunity Cost (Saudi Opportunity Cost (Saudi Arabia) Arabia) AOG/t MC Oil = 1 AOGs MC AOG = 1 Oil B 60 B: Saudi Arabia’s Production 40 and Consumption Point Saudi Arabia 20 60 Oil/t
Comparative Advantage Comparative Advantage N Saudi Arabia has a comparative Saudi Arabia has a comparative N advantage in Oil production in Oil production advantage N U.S. has a comparative advantage U.S. has a comparative advantage N in AOG production in AOG production N This is established by comparing This is established by comparing N MCs, e.g., MC Oil = 4 AOGs in U.S. MCs, e.g., MC Oil = 4 AOGs in U.S. > MC Oil = 1 AOG in SA > MC Oil = 1 AOG in SA N Each can gain if they specialize Each can gain if they specialize N
Specialization Specialization AOG/t In this simple model, there is complete 120 specialization U.S. 60 Saudi Arabia 30 60 Oil/t
Terms of Trade (ToT) Terms of Trade (ToT) N U.S. is willing to pay up to four units of U.S. is willing to pay up to four units of N AOGs for one unit of Oil (max WTP) AOGs for one unit of Oil (max WTP) N Saudi Arabia wants at least one AOG for a Saudi Arabia wants at least one AOG for a N unit of Oil (min WTA) unit of Oil (min WTA) N ToT must lie between max WTP and min ToT must lie between max WTP and min N WTA ( 1 AOG < ToT < 4 AOG) WTA ( 1 AOG < ToT < 4 AOG) N Let’s use 2 AOGs for 1 Oil Let’s use 2 AOGs for 1 Oil N
Consumption Possibilities Consumption Possibilities AOG/t ToT: 1 Oil for 2 AOGs 120 U.S. PPF Saudi Arabia PPF 60 30 60 Oil/t
U.S. Gains from Trade U.S. Gains from Trade N Increase in production mix from A to Increase in production mix from A to N 120 AOGs 120 AOGs N Exports 44 units of AOG for 22 units of Exports 44 units of AOG for 22 units of N Oil (ToT is 2 AOGs of 1 Oil) Oil (ToT is 2 AOGs of 1 Oil) N Consumption increases from 64 AOGs Consumption increases from 64 AOGs N and 14 Oil (A), to 76 AOG and 22 Oil and 14 Oil (A), to 76 AOG and 22 Oil (A’) (A’)
U.S. Gain From Trade U.S. Gain From Trade AOG/t ToT: 1 Oil for 2 AOGs 120 U.S. PPF A’ 76 U.S. Gain from trade: 64 A •12 AOGs • 8 units of Oil 14 30 60 Oil/t 22
Saudi Arabia Gains from Saudi Arabia Gains from Trade Trade N Increase in production mix from B Increase in production mix from B N to 60 units of Oil to 60 units of Oil N Exports 22 units of Oil for 44 AOGs Exports 22 units of Oil for 44 AOGs N (ToT is 2 AOGs of 1 Oil) (ToT is 2 AOGs of 1 Oil) N Consumption increases from 40 Consumption increases from 40 N AOGs and 20 Oil to 44 AOG and 38 AOGs and 20 Oil to 44 AOG and 38 Oil Oil
Saudi Arabia’s Gain From Saudi Arabia’s Gain From Trade Trade AOG/t 120 ToT: 1 Oil for 2 AOGs S.A. PPF 60 S.A. Gain from trade: B’ 44 40 • 4 AOGs B • 18 units of Oil 20 38 60 Oil/t
A More Complex Model A More Complex Model N Increasing Marginal Cost Increasing Marginal Cost N N As production of a good increases, As production of a good increases, N so does its MC (the PPF is concave) so does its MC (the PPF is concave) N Increased specialization, but not Increased specialization, but not N complete specialization complete specialization
First Determine Comparative Advantage AOG/t MC Oil, U.S. = 2 U.S.’s PPF 142 AOGs Assume that in SA the MC Oil,SA = 1/3 AOGs 100 A Saudi Arabia Saudi Arabia has CA in Oil, has CA in Oil, the U.S. in the U.S. in AOG AOG Oil/t 30 50 53 74 100
Second Determine the Terms of Second Determine the Terms of Trade (ToT) Trade (ToT) The terms of trade will lie between the importers’ maximum willingness to pay and the exporters’ minimum willingness to accept. Here, Saudi Arabia has the CA in Oil and must have at least 1/3 AOG for a unit of Oil. The U.S. would only be willing to pay SA what it costs to produce at home, 2 AOGs Min WTA = 1/3 ≤ ToT ≤ 2 = Max WTP Assume ToT is 1 AOG for 1 Oil
Third Increase Production in Good with Comparative Advantage U.S. increases 155 production of AOG 142 125 until cost of AOG B equals what SA 100 will pay for it, 1 Oil A At B, MC AOG AOG = 1 Oil = 1 Oil 30 50 53 74 100
Recommend
More recommend
