Lecture 17 Chapter 2 7 Trade and Comparative Advantage 2017 Economics 101 CCC content Trade Terminology Canada and Trade Production Possibilities Frontier Comparative amp Absolute Advantage ID: 667029
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Economics 10 12017 September
Lecture 17Chapter 2, 7Trade, and Comparative Advantage
2017 Economics 101 CCCSlide2
content
Trade TerminologyCanada and Trade Production Possibilities FrontierComparative & Absolute Advantage
Markets with international trade
Gains from international trade
Winners and losersIf trade is beneficial, why oppose it?Protectionist, Quotas & Tariffs
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Trade terminology
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Trade Terminology
International trade: the exchange of goods, services, and resources between countriesAbsolute advantage (AA): the ability to produce a product by using fewer resources
Comparative advantage (CA)
: the ability to produce a product at a lower opportunity cost
A country will produce the product in which it has a lower opportunity cost (OC)
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Trade Terminology
Imports Goods and services bought domestically but produced in other countries.
Exports
Goods and services produced domestically but sold in other countries
Autarky Economic system of self-sufficiency and limited trade. A country is said to be in a complete state of autarky if it has a closed economy, which means that it does not engage in international trade with any other country.
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Trade Terminology
Protectionism: Position that a nation’s industries should be protected from free trade with other nations
Opportunity Cost (OC)
Next best alternative
Free TradeTrade between countries without (major) restrictions
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Trade Terminology
Globalizationterm used to describe growing interdependence of people around the world with regard to societal influence, economies, and cultural exchanges.
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Trade Terminology
Tariffs: Tax on imported goodsCan be a fixed dollar amount per physical unit or a percentage of good’s value
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Trade Terminology
QuotasGovernment decree limiting imports of a good to a specified maximum physical quantity
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US Canada Trade
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World Trade
global exports and imports were $23 trillion, which is a third of the value of global production.Canadian exports were $566 billion, which is about 27 percent of the value of Canadian production.
Canadian imports were $486 billion, which is about 23 percent of the value of Canadian production.
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Canada US Trade
Exports Canada was the United States' largest goods export market in 2015.
Top export categories (2-digit HS) in 2015 were: vehicles ($48 billion), machinery ($43 billion), electrical machinery ($25 billion), mineral fuels ($21 billion), and plastics ($13 billion).
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Canada US Trade
Imports: Canada was the United States' 2nd largest supplier of goods imports in 2015.
Top import categories (2-digit HS) in 2015 were: mineral fuels ($70 billion), vehicles ($55 billion), machinery ($20 billion), special other (returns) ($14 billion), and plastics ($11 billion).
https://ustr.gov/countries-regions/americas/canada
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Canada US Trade
https://ustr.gov/countries-regions/americas/canada
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Canada US Trade
North American Free Trade Agreement (NAFTA)Came into effect on January 1, 1994, creating the largest free trade region in the world, generating economic growth and helping to raise the standard of living for the people of all three member countries.
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Canada US Trade
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Production Possibility Frontier
Text: Chapter 2 page 32-34
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The Classic Example: guns versus butter
A country can produce two goods: guns OR butter Choice - how much of each good to produce?
More guns (military spending) means less butter (food), and vice versa.
How to model the relationship between a nation's investment in defense and civilian goods?
Use concepts of scarcity – choices – opportunity cost and cost/benefit
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Production Possibility Frontier (PPF)
PPF represents all possible choices of production for the economy. boundary between those combinations of goods and services that can be produced and those that cannot
implies that every choice has an opportunity cost
; you can get more of something only by giving up something else. (scarcity)
limits exist .. you cannot produce outside the curve unless there is an increase in productivity.
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PPF shows the following:
Production efficiency (max output)Scarcity
Choice
Opportunity Cost
Increasing Opportunity Cost
Economic growth
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Comparative and absolute advantage
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Absolute vs. Comparative Advantage
Absolute advantage - produce the product using fewer inputs than anyone else.Comparative advantage - produce the product at a lower opportunity cost than anyone else. Next best thing they have to do is lowest cost than anyone else..not the same as being the best at something
Why do we care?
Efficiency!
If two people, or two societies, specialize in producing the product in which they have a comparative advantage, they will increase the total value of available goods and services to those countries
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Absolute vs. Comparative Advantage
A person has an absolute advantage in a task over someone else if
That person takes fewer hours/input to perform a task than the other person
Refers to producing a good or service more efficiently – using fewer inputs – than anyone else.
A person has a comparative advantage in a task over another ifThat person’s own opportunity cost of performing the task is lower than the other person’s opportunity cost
Person is giving up less – than anyone else to get the same amount
Need to have someone to compare it to …
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Absolute vs. Comparative Advantage
Comparative advantage
produce the product at a
lower opportunity cost
than anyone else.
Use equation to define the
Opportunity Cost =
What you give up
What you get
Whoever has the lowest OC should make the product
Gain efficiency and products:
Total output is largest when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.
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4 step method for solving the comparative advantage problem
4 steps
1. Set up the table to organize values
2. Calculate the opportunity costs (OC)
3. Circle the lowest OC in the in each activity
4. Define who should produce using lowest OC
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Example of Comparative Advantage
Economic research papers per day
Medical Research papers per day
Laura
1
4
Kelsey
4
1
Opportunity Cost =
What you give up
What you get
Who should become the economist and who should become the medical Dr.? Why? Gains?
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How global markets work
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How Global Markets Work
What Drives International Trade?comparative advantage. divergent opportunity costs exist between countries and thus national comparative advantage exist
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Comparative Advantage as a Basis for Trade
Comparative advantage is a function of:ClimateNatural resources
Technology
Workers' levels of skill, training, and education
Culture
Why do we care about OC and CA
?
Economic Efficiency: If two countries specialize in producing the product in which they have a comparative advantage, they
will increase the total value of available goods and services to those countries
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How Global Markets Work: Example
Canada and China & Gain from Trade T-shirts-
opportunity cost of producing a T-shirt is lower in China than in Canada, so China has a comparative advantage in producing T-shirts.
Jets
- opportunity cost of producing a regional jet is lower in Canada than in China, so Canada has a comparative advantage in producing regional jets.countries can reap gains from trade by specializing in the production of the good at which they have a comparative advantage and then trading.
Result: Both countries are better off. Why?
Gains from trade!
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How Global Markets Work: Example
Autarky – Closed economy & no international trade
.
Given Canadian demand and Canadian supply
P
rice of a T-shirt at $8.
Qs & Qs are :
Canadian firms produce
4 million T-shirts a year and Canadian consumers buy 4 million T-shirts a year.Slide32
How Global Markets Work: Example
T-shirt World Demand & Supply
World price of a T-shirt
=
$5.
World price
is less
than $8, so the rest of the world has a comparative advantage in producing T-shirts.Slide33
How Global Markets Work: Example
Open the Borders in Canada- What happens
?
Price of a T-shirt in Canada falls to $5.
Canadian garment makers produce 2 million T-shirts a year.
Canadians buy 6 million T-shirts a year.
Canada imports 4 million
T-shirts a year.Slide34
How Global Markets Work: Example
Autarky – Closed economy & no international trade
.
Price of a jet at $100 million.
Bombardier produces
40 regional jets a year and Canadian airlines buy 40 a year.Slide35
World Demand & Supply
world price of a regional jet at $150 million.
The world price
exceeds
$100 million, so Canada has a comparative advantage in producing regional jets.
How Global Markets Work: ExampleSlide36
Open the Borders in Canada- What happens
?
price of a jet in Canada rises to $150 million.
Canadian airlines buy 20 jets a year.
Bombardier produces 70 regional jets a year.
Bombardier
exports 50 regional jets a year.
How Global Markets Work: Example
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Winners, Losers, and the NetGain from Trade
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Gains and Losses from
Imports
Without international trade
.
CS PS ES
Winners, Losers, and the Net
Gain from Trade Imports
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Gains and Losses from
Imports
With international trade.
CS PS ES
Consumer surplus expands from area
A
to the area
A
+
B
+
D
.
Producer surplus shrinks to the area
C
.
Area
D
is an increase in total surplus & net gain from imports.
Winners, Losers, and the Net
Gain from Trade
Imports
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Gains and Losses from Imports
Without international trade
.
CS PS ES
Winners, Losers, and the Net
Gain from Trade exports
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Gains and Losses from Imports
With international trade
.
CS PS ES
Consumer surplus shrinks
A
.
Producer surplus expands
C + B + D
.
The area
B
is transferred from consumers to producers.
Area
D
is an increase in total surplus & net gain from exports.
Winners, Losers, and the Net
Gain from Trade exports
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Domestic, Closed Economy
Price = 1400
The economy will tend to become a net importer of that good or service. The economic surplus is larger
with trade.
Open Economy
World Price = 1000
Scenario 1 When World Price LOWER than domestic price
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The economy will tend to become a net exporter of that good or service. The economic surplus is larger
with trade.
Domestic, Closed Economy
Price = 7
Open Economy
World Price = 10
Scenario 2 When World Price HIGHER than domestic price
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Who wins and who loses from free trade?
Domestic consumers of imported goods win from free trade because they can purchase the imported goods at lower prices than domestically produced goods.
Domestic
producers of import-competing products lose from free trade as the import captures a part of the domestic market.
Consumers
of exported goods tend to
lose
from free trade because the domestic price of the exported good rises to the world price.
Domestic
producers
of exported goods
win
from free trade because they can charge the higher world price for their products.
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If trade is beneficial, why oppose it?
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If trade is beneficial, why oppose it?
1. Winner and Losers from TradeEven if international trade does increase the total dollar value of all goods and services, there is no guarantee that everyone will benefit – in general, there are winners and losers from reducing trade barriers
Employees and Owners in protected industries will lose when trade barriers fall
Rational for them to oppose – if they will end up worse off
E.G. NAFTA. Even if Canadian consumers generally benefit from lower prices, are job – losers compensated for their losses ?
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If trade is beneficial, why oppose it?
2. Foreign Policy A superpower may use trade as an instrument of foreign policy e.g. US policy to Cuba; Russia, Iraq….
3. Foreign Ownership
If there is lots of foreign ownership, the benefits of trade may mostly flow to foreigners, rather than to the domestic population
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If trade is beneficial, why oppose it?
4 Trade may lock existing comparative advantages into place, forestalling developmentCanadians forever “Hewers of wood and drawers of water” How can hi-tech industries reach the critical mass for survival ?
“Learning by Doing” means that initial costs in hi-tech industries are high – but they fall over time
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If trade is beneficial, why oppose it?
5. National sovereignty ( big versus small nation)
6.
National security
– food ..airlines…technology..security..defense7. Politics
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Protectionist, Quotas & Tariffs
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Protectionist Policies
Tariff: A tax imposed on an imported good.
Quota: A
legal limit on the quantity of a good that may be imported.
Export Subsidy:
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Protectionist Policies: Tariffs
Tariff tax on an import that raises the price of the import in the domestic market.
also called duty or custom duties
Key elements:
Domestic producers sell their output at the price of the import plus the tariff,
Domestic consumers pay a higher price than they would have to pay in the absence of the tariff.
The government collects
duty
, or revenue from the tax, on the sales of imported products.
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Protectionist Policies: Tariff Example 1
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Protectionist Policies: Tariff Example 1
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The cost of producing a
T-shirt in Canada increases and creates a social loss shown by area
C
.
The decrease in the quantity of imported T-shirts creates a social loss shown by area
E
.
The tariff creates a social loss (deadweight loss) equal to area
C
+
E
.
Protectionist Policies: Tariff Example 2Slide56
Protectionist Policies: Tariff
Effect of Tariff:
Raises domestic prices to the world price plus the tariff.
Hurts domestic consumers. Reduces domestic consumption
Helps domestic producers. Increases domestic production
Raises government revenue.
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Protectionist Policies: Tariff:
Justification Infant industry argument Protection for young domestic industryEmployment argument
Protect domestic jobs
Terms of Trade argument
Tariffs improve terms of tradeDiversification and Industrialization argumentCollect revenue to help!
Cost of Tariffs
Interfere with comparative advantage
Reduced economic efficiency
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Protectionist Policies: Quotas
Quota
restricts the quantity of imports allowed into a country.
Key elements
Supply of imports reduced
Domestic producers then sell their output at a price above the world price for the product
Consumers pay a price higher than they otherwise would have to pay.
Unlike the situation of tariffs, the government collects no duty when a quota is imposed.
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Protectionist Policies: Quotas Example 1
BEFORE QUOTA
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AFTERQUOTA
Protectionist Policies:
Quotas Example 1
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Protectionist Policies: Quotas
Winners, Losers, and Social Loss from an Import QuotaWhen the Canadian government imposes an import tariff on imported T-shirts:
Canadian consumers of T-shirts lose.
Canadian producers of T-shirts gain.
Importers of T-shirts gain. Society loses: A deadweight loss arises.Figure 7.8 illustrates the winners and losers with an import quota.
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The import quota raises the price of a T-shirt to $7 and decreases imports.
Area
B
is transferred from consumer surplus to producer surplus.
Importers’ profit is the sum of the two areas
D
.
The area
C +
E
is the loss of total surplus—a deadweight loss created by the quota.
Protectionist Policies: Quotas Example 2Slide63
Protectionist Policies: Export Subsidies
Export SubsidiesAn export subsidy is a payment made by the government to a domestic producer of an exported good.
Export subsidies bring gains to domestic producers, but they result in overproduction in the domestic economy and underproduction in the rest of the world and so create a deadweight loss.
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Questions
Why do people exchange goods and services instead of doing all by themselves?How does trade or exchange result in more goods being produced?Why does Canada export grain and import textile?Someone needs paint the house .. who should paint the house .. Unemployed son or neurosurgeon mom?
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Questions
What exactly is gains from trade and how do you get this?Describe absolute advantage, comparative advantage, and implication of comparative advantage
Identify
sources
of comparative advantage and relation to efficiencyDefine PPF in terms of an one-country economy and identify attainable, unattainable, efficient, and inefficient points.Why do people specialize and trade?What give a person CA?How do PPF illustrate opportunity cost? Efficiency? Tradeoff? Scarcity?
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Questions
Understand benefits and costs of specialization.Understand benefits and costs of trade.
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questions
Does international trade always benefit everybody?Can a poor nation prosper by trade?
Does the same logic of individuals and specialization apply to countries for trade and specialization?
How does all these terms of comparative advantage, opportunity cost, scarcity and specialization come into play here?
What is free trade? Goods?/ Bad??
What about Autarky? Goods Bad?
How does free trade contribute to globalization?
Is their a role for protectionism?
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questions
How do economists assess gain from trade and why so they support openness and free trade?What is comparative advantage and why is it important in trade?
How can we protect a country in terms of trade? Close market? Quota? Subsidy? Tariff? Trade off , Description, Graphs?
Why do people want to do away with free trade?
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End of slides
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