Terms:
Inputs/resources
gains from trade
Imports/exports
Specialization
Absolute and comparative advantage
Protectionism
Natural and acquired endowments.
Free trade/Protectionism
Infant industry argument
Tariff
Quota
Voluntary Export Restraints (VER)
Dumping
GATT – WTO
Useful for next class:
International Institutions
World Bank
IMF
Basic Economic model – PPC
Two outputs (product) graphed based on an
Assumptions of model – all resources (inputs) being used. Inputs are implicit to the model. What inputs are generally important to producing output? Labor, capital, land (which Stiglitz says is not so important. I disagree.)
Diminishing returns may prevail. (Some resources are better at producing one output than another.)
Why is this model useful?
Theoretical way of modeling:
full production/efficient resource use.
opportunity costs
the impact of technological change
the impact of unemployed resources
gains from trade (we’ll do this today.)
What other economic models look similar?
Budget constraint (graph).
Time constraint (graph).
These are all graphs with a negative slope.
What graphs are likely to have a positive slope?
What is trade?
The movement of goods and services between individuals/across borders.
Imports are goods leaving the country/Exports are goods entering the country.
Globalization has meant not only increasing movement of products, but also labor and capital.
How can the PPC provide us with a theoretical explanation of why trade is beneficial?
Generally trade also means specialization, which in turn means that resources can be used better.
Let's say you have two producers (or two countries) who/ich each have their resource endowment (land, labor, capital). They can each produce a certain amount of various different commodities, given their resources. Or they can specialize and then trade. Economic theory suggests that countries can improve by specializing and trading. Can be shown using the PPC.
Again let's look at the bread and shirts economy:
Assume that you have fixed hours of work (say 1 year) and fixed land and other resources.
You may produce shirts and or bread.
Country 1 Country2
Shirts Bread OC b/s Shirts Bread OC b/s
1000 0 7/5 1000 0 4/5
750 350 750 200
500 700 500 400
250 1050 250 600
0 1400 0 800
Pretrade
500 700 250 600
Combined Product of both countries: 750 Shirts 1300 Loaves of Bread
Which country is better at producing shirts?
Same. No one has the advantage.
Which country is better at producing bread? Country 1.
That means Country 1 has the absolute advantage at producing bread.
Overall Country 1 is more productive, but it is still worth trading between the two countries.
Which country should specialize in which good? To determine what form specialization should take, need to figure out opportunity cost, which in turn will tell you what each country's comparative advantage is. In order to do this, you need to figure out the relative cost of one good, in terms of the other good. In this case we calculated bread/shirts. In other words, you need to calculate a RATIO.
What is the opportunity cost of more shirts for country 1? Have to give up 350 loaves of bread to get 250 more shirts. (Constant because this time we have straight line PPC.) This translates into 7 loaves of bread for each 5 shirts.
What about for country 2? Only have to give up 200 loaves to get 250 shirts. (4/5) Where are shirts relatively cheaper?
Country 2. Notice that the ratio of bread/shirts is smaller for them. Country 2 has the relative or comparative advantage in producing shirts,since they only give up 200 loaves of bread to get 250 shirts. It is more costly for Country 1 to produce shirts.
This model suggests that countries can gain from trading and both be better off.
Post specialization production
0 1400 750 200
Combined Product 750 Shirts 1600 Loaves of Bread
Trade
+500 -600 -500 +600
Post trade consumption
500 800 250 800
Shirts Bread Shirts Bread
How does this simple model differ from real life?
Ignores how transition to trade will occur.
Ignores the fact that there are the winners and losers to free trade.
Ignores problems such as protection of environment and workers’ rights.
Ignores dependency problems that may result from specialization. Eg: Iraq faced sanctions.
What policies are often enacted around trade?
Although many economists advocate for free trade, some argue that free trade is not advantageous. Politically speaking it is difficult to achieve free trade.
Countries use various forms of protectionism to prevent free trade including:
Tariffs (taxes on imports)
Quotas (restricting the quantity of imports)
Voluntary Export Restraints (VER) (convincing other countries to voluntarily restrict their exports)
Ex: US/Japan – cars
Countries also use the Infant industry argument to justify restricting free trade.
This is the argument that a new industry can not be expected to be able to compete globally and will need protection until it matures.Removing such protection though often proves difficult.
Others use national defense, economic hardship, or food security as an excuse.
Special interest groups get protection. (Examples in the US– Sugar industry!)
Countries get into disputes about trade and in particular about restrictions on trade, as well as dumping, which is the process ofexporting goods below cost.
Previously the GATT and now the WTO are involved in settling these disputes as well as helping countries achieve freer trade.
Many economists feel that the WTO plays a positive role, but as we will see, some feel that this organization plays a very negative role.
Thought to end on: what issues concerning trade does the PPC not address?