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Economics of

International Trade
1
Midterm Examination Review
Whats on the Midterm Exam?
Content From Chapters 1 through 9 and
Possibly 10
Analysis of Midterm Exams from 2005 to
2009 Shows the Following Topics (see
2
2009 Shows the Following Topics (see
next slide):
Topics in Previous Midterm Exams:
Absolute Advantage Nontariff Barriers
Comparative Advantage
Acceptable and Unacceptable Arguments for
Trade Barriers
Ricardian Model New and Advanced Trade Theories
Heckscher-Ohlin Model Small Country Vs Large Country
General Equilibrium
3
General Equilibrium
Framework Nominal Rate of Protection
Standard Trade Model Effective Rate of Protection
Partial Equilibrium
Analysis Different Kinds of Trade Blocs
General Equilibrium
Analysis Customs Union
Tariffs; Seven effects of
a Tariff Import Substitution
What is the Exam Format?
3 Hours Long, 3 Sections A, B and C
Section A Short Answer, Choose One
Question from 4 or 5; 10% 0f the Grade
Section B Two Questions, You Must
4
Section B Two Questions, You Must
Answer Both of them; 30% of Grade
Section C Two Long Essay Questions
Two Questions, You Must Answer Both;
60% of Grade
Test Taking Strategy
Budget Your Time! Many students spend
too much time on one question in section
A or B and run out of time for Section C.
Be sure to write some kind of answer for
5
Be sure to write some kind of answer for
every question dont leave any question
blank
When you first open the exam, quickly
look through it for questions in A, B and C
that are similar topics.
IELTS Test Skills
The Midterm Exam is also a test of writing ability. If
you studied for the IELTS, Remember the writing
and time budgeting skills you may have learned.
Skills you learned for Writing Task 1 and Writing
Task 2 Questions are often useful for Section A
6
Task 2 Questions are often useful for Section A
and Section B questions on the exam:
Writing Task 1 Problems 150 Words in 20 Minutes
Writing Task 2 Problems 250 Words in 40 Minutes
Section C Questions require longer essay
answers
Answering Exam Questions
Follow the Pattern of Explain and Discuss.
First, Explain. Show that you know what
the question is about. For example if you
are writing about Customs Union, define
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are writing about Customs Union, define
what a Customs Union is.
Use Diagram or Simple Algebra Wherever
Possible to Answer Questions.
It is Possible to get a Passing Mark by
explaining well a model or theory.
Answering Exam Questions, Contd
Explain and Discuss Continued:
Discuss: After you have explained the basic
idea, write about:
The strengths and weaknesses the
8
The strengths and weaknesses the
good and bad points. Critical Evaluation.
Evaluation of the Assumptions.
How Realistic is the theory or model?
Try to Provide at least 3 supporting facts
or reasons, especially in Section C.
INTERNATIONAL TRADE
9
INTERNATIONAL TRADE
THEORY
What makes International
Economics different?
International Economics Consists Of
Issues Arise From Problems of Economic
Interaction between Sovereign States.
10
Its Relations Differ from Interregional
Economics (Different Parts of the Same
Nation) Requiring It to Use Different Tools
of Analysis and Justifying Its Existence as
a Distinct Branch of Economics.
Concerns of International
Economics
Trade and investment occur between independent
nations
Countrys policies/restrictions disrupt trade and limit
imports
Foreign exchange fluctuations affect the relative prices
11
Foreign exchange fluctuations affect the relative prices
of countries imports and exports
Also, international flows of goods, services and
resources give rise to payments and receipts in foreign
currencies, which change in value over time.
International flows may be hampered by differences in
languages, customs, and laws
CHAPTER 2: THE LAW OF
COMPARATIVE ADVANTAGE
Why do countries trade?
The Mercantilists Views on Trade 17
th
&
18
th
Centuries
Adam Smiths Absolute Advantage Trade
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Adam Smiths Absolute Advantage Trade
Theory 18th Century
Absolute Advantage is the greater efficiency
that one nation may have over another in the
production of a commodity
Refer to Transparency Table 2.1
David Ricardos Comparative
Advantage Trade Theory
Comparative Advantage is when a Nation 1 has
absolute advantage in both commodities but has
comparatively greater advantage in producing
good A over than good B. As long as Nation 2
comparative advantage is in the good B for which
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comparative advantage is in the good B for which
Nation 1 has comparative disadvantage, but
nations can still gain from specialisation and trade.
The concept of Absolute Advantage is
concerned with differences between actual
efficiency of production.
The concept of Comparative Advantage is
about the relative efficiency of production.
Ricardos Assumptions:
1. Two Nations and Two Commodities
2. Free trade
3. Perfect mobility of labour within each nation
but immobility between nations
4. Constant Costs of Production
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4. Constant Costs of Production
5. No transport costs
6. No technical change, and
7. The labour theory of value
See Table 2.2, Table 2.3
Comparative Advantage:
Opportunity Costs
Law of Comparative Cost
1939 by Haberler
Opportunity Costs
(Constant Cost) and Relative Prices
15
(Constant Cost) and Relative Prices
Comparative Advantage:
Opportunity Costs -Contd
Assumptions one to six can be easily relaxed
but assumption #7 (Labor Theory of Value) is
not valid and should not be used to explain
comparative advantage.
Production Possibility Frontier (PPF)
16
Production Possibility Frontier (PPF)
demonstrates the alternative
combinations of the two commodities that
a nation can produce by fully utilising all
of its resources with the best available
technology.
Comparative Advantage:
Opportunity Costs -Contd
MRT Opp cost
for
Wheat
Relative
price for
Wheat
Opp
Cost for
Cloth
Relative
price for
Cloth
17
Wheat Wheat Cloth Cloth
USA 120/180
=2/3
6/4 =
1.5
Pw/Pc =
2/3
4/6 =
2/3
Pc/Pw =
1.5
UK 120/60
= 2
1/2 Pw/Pc =
2/1=2
2/1 = 2 Pc/Pw =
1/2
Comparative Advantage:
Opportunity Costs CONTD
The difference in relative commodity prices between two
nations is a reflection of their comparative advantage and
provides the basis for mutually beneficial trade.
The equilibrium-relative commodity price with trade is the
common relative price in both nations at which trade is
balanced: Nation 1 Price = Nation 2 Price
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balanced: Nation 1 Price = Nation 2 Price
Figure 2.2: Trade Under Constant Cost
Figure 2.3: Equilibrium-Relative Commodity Prices with
Demand and Supply
Small-Country Case with Constant Costs
Empirical Tests of the Ricardian Model
Empirical Tests of the Ricardian Model by
MacDougall in 1951
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Figure 2.4 Relative Labor Productivities and Comparative Advantage
CHAPTER 3: THE STANDARD
THEORY OF INTERNATIONAL
TRADE
20
TRADE
The Production Frontier with
Increasing Costs
Increasing opportunity costs mean that the nation
must give up more and more of one commodity to
release just enough resources to produce each
additional unit of another commodity.
21
The marginal rate of transformation (MRT) of X for
Y refers to the amount of Y that a nation must give
up to produce each additional unit of X. since the
PPF is concave, it represents increase opportunity
cost as one more down the PPF.
Community Indifference Curves (3.3A)
The Indifference Curve represents all
combinations of market baskets that
provide a consumer with the same level
of satisfaction.
22
Equilibrium in Isolation (Autarky) and with
Trade
Figure 3.3: Equilibrium in Isolation
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 3-3 Equilibrium in Isolation.
Revealed (Real World)
Comparative Advantage (3.4B)
Case Study 3-1 shows the revealed
comparative advantage
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Gains from Trade with Increasing
Costs (3.5)
Figure 3.4: The Gain from Trade with
Increasing Costs
Differences between Constant Costs and
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Differences between Constant Costs and
Increasing Costs
Small-Country Case with Increasing
Costs(3.5D)
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 3-4 The Gains from Trade with Increasing Costs.
Gains from Exchange and from
Specialization
27
FIGURE 3-5 The Gains from Exchange and from Specialization.
Trade Based on the Differences
in Tastes (3.6A)
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FIGURE 3-6 Trade Based on Differences in Tastes.
CHAPTER 4: DEMAND AND
SUPPLY, OFFER CURVES, AND
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SUPPLY, OFFER CURVES, AND
THE TERMS OF TRADE
DEMAND AND SUPPLY, OFFER
CURVES, AND THE TERMS OF
TRADE
The Equilibrium-Relative Commodity Price
with Trade Partial Equilibrium Analysis
30
with Trade Partial Equilibrium Analysis
Figure 4.1: The Equilibrium-Relative
Commodity Price with Trade with Partial
Equilibrium Analysis
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade with Partial Equilibrium
Analysis.
The Offer Curve (4.3)
Offer Curve (reciprocal demand curve) shows
how much of its import commodity the nation
demands for it to be willing to supply various
amounts of its export commodity.
The Offer curve shows a nationss willingness
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The Offer curve shows a nationss willingness
to import and export at different commodity
prices.
The Offer Curve can also be derived from a
Nations PPF, its indifference maps, and the
various hypothetical commodity prices where
trade could take place.
Derivation of Offer Curves
Figures 4.3 & 4.4: Derivation of the Offer
Curves of Nations 1 & 2
The Equilibrium-Relative Commodity Price
with Trade General Equilibrium Analysis
33
with Trade General Equilibrium Analysis
Figure 4.5: Equilibrium-Relative
Commodity Price with Trade
Figure 4.6: Equilibrium-Relative
Commodity Price with Partial Equilibrium
Analysis
Derivation of Offer Curves
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 4-3 Derivation of the Offer Curve of Nation 1.
Derivation of Offer Curves
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 4-4 Derivation of the Offer Curve of Nation 2.
Equilibrium-Relative Commodity Price with Trade
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade.
Equilibrium-Relative Commodity Price with Partial
Equilibrium Analysis
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial Equilibrium Analysis.
The Terms of Trade (4.6)
In a world with two-nations and two commodities
situation, the Terms of Trade of a nation is defined as
the ratio of the price of its export commodity to the
price of its import commodity the relative trading
prices.
Generally with many nations and commodities, the
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Generally with many nations and commodities, the
terms of trade of a nation (commodity or net barter
terms of trade) are given by the ratio of the price index
of its exports to the price index of its imports multiplied
by 100 to express it as a percentage.
Case Study 4-3 Terms of Trade of the G-7 Nations
Case Study4-4 Terms of Trade of Industrial and
Developing Countries for selected years: 1972 0 2001.
CHAPTER 5: FACTOR
ENDOWMENTS AND THE
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ENDOWMENTS AND THE
HECKSCHER-OHLIN THEORY
Assumptions
We will extend the trade model in two
directions:
To identify the basis for what
determines- comparative advantage
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To examine the effect of international
trade has on the earnings of factors of
production in two trading nations earnings
of labour and cause for the international
differences in earnings.
11 Assumptions, (5.2A)
Factor Intensity, Factor Abundance, and
the Shape of the Production Frontier (5.3)
Factor Intensity (5.3A): commodity Y is
capital intensive if the capital-labour ratio
K/L used in the production of Y is greater
the K/L used in the production of X.
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the K/L used in the production of X.
For Examples:
To produce 1Y requires 2K & 2L (2/2 = 1)
To produce 1X requires 1K & 4L (1/4 = )
To produce 1X require 3K & 12L (3/12 = )
Factor Intensity
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Figure 5.1: Factor Intensity for Commodity
X and Y in Nations 1 2
FIGURE 5-1 Factor Intensities for Commodities X and Y
in Nations 1 and 2.
Factor Intensity
Nation 1 Nation 2
Commodity
Y (K/L)
1 4
43
Y (K/L)
Commodity
X (K/L)
1
Labour
Intensive
Capital
Intensive
What happen if the relative price
of capital falls?
K-Intensity refers to the ratio in terms of
the technology K/L used in the production
process.
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Factor Abundance (5.3B)
Two ways to define factor abundance
In terms of physical units overall amount
of capital and labour available in the
nation. This definition considers only
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nation. This definition considers only
the supply of factors.
Physical K-Abundance refers to the
physical amount of capital/labour ratio
used in the production process.
Factor Abundance (5.3B) Contd
In terms of relative factor prices
rental price of capital & price of labour time in
each nation.
46
This definition considers both the supply
and the demand of factors under perfect
competition. Also, the demand for a factor
of production is a derived demand from
the final commodity that requires it in the
production process.
Factor Abundance (5.3B) Contd
K-Abundance in terms of relative prices
refers to the ratio of capital/labour in terms
of costs (r/w) used in the production
process.
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process.
Factor Endowments and the
Shape of the PPF (5.3C)
Figure 5.2: The Shape of the Production
Frontier of Nation 1 & 2 (same as Fig 3.1)
Case Study 5-1: Relative Resource
Endowments of Various Countries and
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Endowments of Various Countries and
Regions
Case Study 5-2: Capital-Labour Ratios of
Selected Countries
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 5-2 The Shape of the Production Frontiers of
Nation 1 and Nation 2.
Factor Endowments and the
Heckscher-Ohlin Theory (5.4)
The Heckscher-Ohlin Theory can be
presented in the form of two theorems:
The Heckscher-Ohlin Theorem deals
with and predicts the pattern of trade
50
with and predicts the pattern of trade
Factor-Price Equalization Theorem deals
with the effect of international trade on
factor prices.
In addition, Theorem 2 holds only if 1
holds.
The Heckscher-Ohlin Theorem
(5.4A)
Figure 5.3: The General Equilibrium
Framework of the Heckscher-Ohlin Theory
Figure 5.4: The Heckscher-Ohlin Model
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Figure 5.4: The Heckscher-Ohlin Model
Now compare Fig. 5.4 with Fig. 3.4
Figures 5-4 and 3-4
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 5-4 The Heckscher-Ohlin
Model.
FIGURE 3-4 The Gains from Trade with
Increasing Costs.
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 5-3 General Equilibrium Framework of the
Heckscher-Ohlin Theory.
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 5-4 The Heckscher-Ohlin Model.
Principle of H-O theorem:
It requires that if tastes differ, they do not
differ sufficiently to neutralize the tendency
of different factor endowments and
production possibility in the two nations.
55
Case Study 5-3: examines the Pattern of
revealed Comparative Advantage and
disadvantage of Various Countries or
Regions.
Factor-Price Equilization and
Income Distribution (5.5)
Heckscher-Ohlin-Samuelson (H-O-S)
Proven by Paul Samuelson
56
The H-O-S Theorem
International trade will bring about
equalization in the relative and absolute
returns to homogeneous factors across
nations.
57
nations.
Thus, international trade is a substitute for
international mobility of factors.
Figure 5.5: The Relative Factor-Price
Equalization
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 5-5 Relative FactorPrice Equalization.
Absolute Factor-Prices
Equalization
Means that free international trade also
equalizes the real wages for the same
type of Labour and the real rate of interest
for same type of Capital in the two nations.
59
for same type of Capital in the two nations.
Absolute Factor-Prices
Equalization, Contd
Trade operates on the demand for factors
Factor mobility operates on the supply of
factors
International trade causes real
60
International trade causes real
wages/income of labour to fall in a capital-
abundant and labour-scarce nation (USA),
If So, Shouldnt U.S., the EU, and
Japan Restrict Trade?
If international trade causes real wages/income
of labour to fall in a capital-abundant and labour-
scarce nation (USA), shouldnt they have trade
restrictions?
61
No, because the loss that trade causes in those
countries is less than the gain received by
owners of capital. Appropriate taxes on owners
of capital and subsidies for labor can bring
benefit to both factors from international trade.
The Specific-Factors model
(5.5D)
Says that trade will:
Have an ambiguous effect on the nations
mobile factors.
Benefit the immobile factors specific to the
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Benefit the immobile factors specific to the
nations export commodities or sectors.
Harm the immobile specific factors to the
nations import-competing commodities or
sectors.
Empirical Relevance of Factor-Price
Equilibrium
Theorem- H-O-S
Has international trade equalized the
returns to homogeneous factors in
different nations in the real world?
63
different nations in the real world?
If it has not, why?
Because the many simplifying
assumptions of the model are true, do not
hold in the real world. Identical
technology, no transportation costs, etc.
Empirical Test of the Heckscher-
Ohlin Model - Leontief (1951)
Assumption: USA most K-abundant nation in the world

Expect to find that USA K/L estimates

Exported - K-intensive goods and


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Exported - K-intensive goods and
Imported - L-intensive good
Data used: Input-Output table for 1947

RESULT

Exports less K-intensive than Imports by 30%


LEONTIEF PARADOX
LEONTIEF PARADOX
Leontief Rationalization
Leontief attempted to explain the Paradox
by Saying that in 1947 USA was really an
L-Intensive country
65
L-Intensive country
This Explanation was Not Acceptable and
Leontief withdrew it
Factor-Intensity Reversal
Factor-intensive reversal (5.6C)
An exception to the H-O and Factor-Price
Equalization Theorem
is when a given commodity is L-intensive in the L-
abundant nation AND K-intensive in the K-
abundant nation.
66
abundant nation AND K-intensive in the K-
abundant nation.
This causes factor-price equalization theorem to
fail
Empirical evidence is that Factor-Intensity
Reversal does Happen But is Rare, Unusual.
Because it is a rare exception, the H-O theory can
is Not Invalidated.
CHAPTER 6: ECONOMIES OF
SCALE, IMPERFECT
COMPETITION, AND
67
COMPETITION, AND
INTERNATIONAL TRADE
The Heckscher-Ohlin Model and
New Trade Theories (6.2)
Relaxing Most of the Assumptions of the
H-O models does not affect its validity.
However 3 assumptions require more
68
However 3 assumptions require more
attention:
Constant economies of Scale
Perfect Competition
Technological change.
The Heckscher-Ohlin Model and New
Trade Theories - Contd
Complementary Theories for Constant
Economies of Scale and Perfect Competition
New trade models which take into account
69
New trade models which take into account
Economies of Scale and Imperfect
Competition can be seen as complementary
to, or extensions of, the H-O theory as they
explain something about international trade
that is not covered by the basic H-O theory.
The Heckscher-Ohlin Model and New
Trade Theories - Contd
Differences in Technology Between Nations
can be Accommodated by the H-O theory.
However, technological change not just
70
However, technological change not just
differences in technology requires new
theories such as the technological gap and
the product cycle models, and these are
covered in section 6.5
Economies of Scale and
International Trade (6.3)
Figure 6.1: Trade Based on Economies of
Scale
International economies of scale refer to
the reduction in the average costs of
production as the firms output expands
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production as the firms output expands
remaining internal to the firm.
External economies refer to the reduction
in each firms average costs of production
as the entire industry output expands
for reasons external to the firm.
Salvatore: International Economics, 8th
Edition 2004 John Wiley & Sons, Inc.
FIGURE 6-1 Trade Based on Economies of Scale.
Imperfect Competition and
International Trade (6.4)
Trade Based on Product Differentiation
(6.4A) Intra-Industry Trade Models by
Helpman, Krugman, Lancaster and others
in 1979
73
in 1979
Case Study 6-2: U.S. Intra-Industry Trade
in Automotive Products
Formal Model of Intra-Industry
trade (6.4C)
Figure 6.2: Production and Pricing Under
Monopolistic Competition - Firm Analysis
Monopolistic Competition
74
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 6-2 Production and Pricing Under Monopolistic Competition.
Relationship of the inter-industry
and intra-industry trade
Figure 6.3: Monopolistic Competition and
Intra-Industry Trade Industry Analysis
76
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 6-3 Monopolistic Competition and Intra-Industry Trade.
Trade Based on Dynamic
Technological Differences (6.5)
Note that Trade based on Differences in Technology Can Be
Seen to Fall within the H-O Model. The basic H-O model can
accommodate them. Changes in Technology Require new
Models:
Technological Gap and Product Cycle Models
According to the Technological Gap Model, trade among
industrialized nations is based on the introduction of new
78
industrialized nations is based on the introduction of new
products and new production processes emphasizing time
lag in the imitation process.
The Product Cycle Model is when a new product is introduced
which requires skilled labour to produce, as the product
matures and standardized, it can be produced by mass
production technique and less skilled labour emphasizing
the standardization process.
Illustration of the Product Cycle
Model (6.5B)
Figure 6.4: The Product Cycle Model
Technological diffusion, Standardization, and
Lower costs abroad bring an end to the
product life cycle. Diffusion lags of new
79
product life cycle. Diffusion lags of new
technologies in recent years are decreasing
compressing the product life cycle.
Solution: introduction of new innovative
products by the advanced nation.
Product Cycle Model (6.5B)
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 6-4 The Product Cycle Model.
Costs of Transportation,
Environmental Standards, and
International Trade (6.6)
Non-Trade Goods and Services.
Transport Costs are Much Higher for
Developing Countries
81
Developing Countries
Industries Classifications:
Resource Oriented
Market Oriented
Footloose Industries
Unit 2 INTERNATIONAL TRADE
82
Unit 2 INTERNATIONAL TRADE
POLICY
CHAPTER 8: TRADE
RESTRICTIONS: TARIFFS
Restrictions and regulations on the free
flow of trade or commerce are known as
trade or commercial policies.
83
Nominal Tariff on Imports of a Final
Commodity:
Partial Equilibrium Analysis of a
Tariff
Figure 8.1: Partial Equilibrium Effects of a
Tariff
Figure 8.2: Effect of a Tariff on Consumer
and Producer Surplus
84
and Producer Surplus
Figure 8.3: Partial Equilibrium Costs and
Benefits of a Tariff
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-1 Partial Equlibrium Effects of a Tariff.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.
Effects of a Tariff
Consumption Effect
Production Effect Trade/Import Studies 8-
1 and 8-2
Case Study 8-2: The Welfare Effect of
88
Case Study 8-2: The Welfare Effect of
Liberalizing Trade in Some U.S. Products
Case Study 8-3: The Welfare Effect of
Liberalizing Trade in Some E.U. Products
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-1 Partial Equlibrium Effects of a Tariff.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.
The Seven Effects of a Tariff
Consumer
Production Effect
Trade/Import Effect
Consumer Surplus
92
Consumer Surplus
Producer Surplus
Revenue Effect
Deadweight Loss/Protection Cost
Effects of a Tariff
Consump
tion
Effect
Product
ion
Effect
Trade/Im
port
Effect
Consu
mer
Surplu
s
Produ
cer
Surpl
us
Revenu
e Effect
Deadwei
ght loss
Partial
Equilibr
Reduce
from AB
Increas
e from
Reduce
from CB
Reduct
ion
Increa
se by
Collecti
on of
CJM +
BHN
93
Equilibr
ium
Effects
from AB
to GH
e from
AC to
GJ
from CB
to JH
ion
from
ARB to
GRH
se by
AGJC
on of
MJHN
BHN
Costs &
Benefits
Effects
-20X +10X -30X $60 $15 $30 $15
The Rate of Effective Protection
(8.3A)
When a Country Imports a material, which is the
input for another some final product with zero tariff
or a lower tariff than on the importation of the final
product.
Example: Import Tariff on Wool is zero but
importation of Cloth made from Wool has a Tariff ,
94
importation of Cloth made from Wool has a Tariff ,
of perhaps 5 %.
Cascading Tariffs
Domestic value added equals the price of the
final commodity minus the cost of the
imported inputs went into the production of
the commodity.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff Structure in Industrial Countries.
The Rate of Effective Protection
(8.3A)
Rate of effective protection is calculated
on the domestic value added or
processing, that takes place in the
96
processing, that takes place in the
nation exceed the nominal tariff rate.
Nominal Tariff Rate is calculated on the
value of the final commodity.
The Rate of Effective Protection
(8.3A) - Contd
The Rate of Effective Protection formula:
g = t aiti / 1 ai
Case Study 8-5: U.S. Rising Tariff Rates
with Degree of Domestic Processing
97
with Degree of Domestic Processing
Case Study 8-6: Structure of Tariffs on
Industrial Products in the United State, the
European Union, Japan and Canada
General Equilibrium Analysis of
a Tariff - Small Country (8.4)
Stolper-Samuelson Theorem states that
the increase in the relative price of a
commodity (tariff) raises the return or
earnings of the factor used intensively
98
earnings of the factor used intensively
in the production of the commodity.
General Equilibrium Analysis of
a Tariff - Large Country
Figure 8.6: General Equilibrium Effects of
a Tariff in a Large Country
Metzler Paradox: Cases when Px/Py falls
for individual producer and consumers
99
for individual producer and consumers
after a nation impose a tariff and w will fall.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 8-6 General Equilibrium Effects of a Tariff
in a Large Country.
The Optimum Tariff and
Retaliation
101
FIGURE 8-7 The Optimum Tariff and Retaliation
CHAPTER 9: NON-TARIFF
TRADE BARRIERS AND THE
NEW PROTECTIONISM
102
NEW PROTECTIONISM
NON-TARIFF TRADE BARRIERS
AND THE NEW PROTECTIONISM
Voluntary Export Restraints (VERs):
Technical, Administrative, and Other
Regulations:
103
Regulations:
International Cartels
Dumping
Export Subsidies
Comparison of an Import Quota
to an Import tariff
Quota is direct quantitative restrictions
on the amount of a commodity allow to
be imported or exported.
104
Figure 9.1: Partial Equilibrium Effects
of an Import Quota
Comparison of Import Quota to
Import Tariff
With a given import quota, an increase in
demand will result in a higher domestic
price and greater domestic production
than with an equivalent import tariff.
However, with a given import tariff, an
105
However, with a given import tariff, an
increase in demand will leave the
domestic price and domestic production
unchanged but will result in higher
consumption and imports than with an
equivalent import quota.
Comparison of Import Quota to
Import Tariff Contd
Quotas involve import licenses, and if the
government does not auction these off in a
competitive market, the companies that have
the licenses will receive monopoly profits.
106
Such choices may be made arbitrarily by
officials.
Companies participate in lobbying, and even
bribery to get the licenses, also known as
rent seeking activities.
Comparison of Import Quota to
Import Tariff Contd
Thus import quotas not only replace market
mechanism but also result in waste from the
point of view of the economy as a whole and
contain the seeds of corruption.
107
An import quota limits imports to the
specified level with certainty, while a tariffs
effect is uncertain. The reason is that the
elasticity of supply and demand often
unknown, making it difficult to estimate the
import tariff required to restrict imports to a
desired level.
Comparison of Import Quota to
Import Tariff Contd
Furthermore, foreign exporters may
absorb all or part of the tariff by increasing
their efficiency or accepting lower profits.
Exporters cannot do this with an import
quota since quantity of imports is clearly
108
quota since quantity of imports is clearly
specified. For this reason domestic
producers prefer quotas to tariffs.
However, since quotas more restrictive
than tariffs, society should resist these
efforts.
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 9-1 Partial Equilibrium Effects of an Import Quota.
Export Subsidies
110
FIGURE 9-2 Partial Equilibrium Effect of an Export Subsidy.
Voluntary Export Restraints
(VERs)
Economic Effects of a Quota
Except Revenue is captured by Foreign
Exporters
Case Study 9-2: Voluntary Export
111
Case Study 9-2: Voluntary Export
Restraints on Japanese Automobiles to
the United States
Technical Administrative and Other
Regulations
9.3C International Cartels: OPEC
OPEC had influence on the price of oil in
the 1970s but not so much anymore.
Cartels are Inherently Unstable and often
112
Cartels are Inherently Unstable and often
Collapse and Fail
Cartels
9.3C International Cartels: OPEC
Cartels are Inherently Unstable and often
Collapse and Fail
113
Technical Administrative and Other
Regulations
9.3C International Cartels: OPEC
Cartels are Inherently Unstable and often
Collapse and Fail
OPEC appeared to be able to control
114
OPEC appeared to be able to control
prices in the 1970s.
However during 1980s and 90s More
Countries Started Producing oil and
Petroleum Prices dropped.
Dumping
Export of a Commodity at Below Cost
Figure 9.5: International Price
Discrimination
115
Case Study 9-3: Antidumping Measures in
Force in 2004
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 9-5 International Price Discrimination.
Export Subsidies:
Refer to Figure 9.2: Partial Equilibrium
Effect of an Export Subsidy
Case Studies 9-3 and 9-4: Agriculture
117
Case Studies 9-3 and 9-4: Agriculture
Subsidies and Countervailing Duties
Salvatore: International
Economics, 8th Edition
2004 John Wiley & Sons, Inc.
FIGURE 9-2 Partial Equilibrium Effect of an Export Subsidy.
The Political Economy of
Protectionism: Arguments for
Protection
Fallacious:
Needed to Protect Domestic Labor Against
Cheap Foreign Labor.
Scientific Tariff
119
Scientific Tariff
Protection Reduces Domestic
Unemployment.
Protection is a Cure for Balance of Payments
Deficit.
Beggar-thy-Neighbor Arguments
Arguments for Protection II
Questionable Arguments for Protection:
Infant Industry
To be valid the return when the industry grows
up would have to high enough to offset the
120
up would have to high enough to offset the
higher prices paid by consumers during the
infant industry period.
Protection, Once Given, is Difficult to
Remove.
Difficult to choose which industry
Production Subsidy is a better solution
Arguments for Protection III
Acceptable Economic Arguments
Optimal Tariff (Discussed in Section 8.6)
If a Nation is Large Enough
However an Optimal Tariff Invites
121
However an Optimal Tariff Invites
Retaliation
Arguments for Protection II
Questionable Arguments for Protection:
Infant Industry
Protection, Once Given, is Difficult to
Remove
122
Remove
Arguments for Protection III
Acceptable Economic Arguments
Optimal Tariff (Discussed in Section 8.6)
If a Nation is Large Enough
However an Optimal Tariff Invites
123
However an Optimal Tariff Invites
Retaliation
Who Gets Protected?
The Well Organized and Politically
Represented.
Case Study 9-7: Economic Effects on the
U.S. Economy of Removing All Import
124
U.S. Economy of Removing All Import
Restraints
Strategic Trade and Industrial
Policies (9.5A)
Strategic Trade Policy:
A nation can create a comparative
advantage through temporary trade
protection, subsidies, tax benefits, and
125
protection, subsidies, tax benefits, and
cooperative government-industry
programs in fields such as
semiconductors, computers,
telecommunications and other industries
similar to infant-industry argument.
Game Theory (9.5B):
Airbus
Produce Dont Produce
Boeing Produce -10, -10
(million) *
100 million ***
126
Free trade may be sub-optimal In theory but it is optimal in
practice.
Dont Produce 100 million ** 0, 0 ****
The U.S. Response to Foreign
Industrial Targeting and
Strategic Trade Policies (9.5c)
Some Examples:
The United States has retaliated again
countries that adopted policies that were
127
countries that adopted policies that were
detrimental to US economics interests:
Sematech
The U.S. Response (9.5c) - II
The US has taken Unilateral Steps to force
Foreign Markets to Open to US exports,
and has retaliated with restrictions of its
own against nations that failed to respond:
128
own against nations that failed to respond:
1991 Semiconductor Agreement with
Japan
The U.S. Response (9.5c) - III
In 1998 and 1999 the US imposed Anti-
dumping Duties on Steel Imports from
Russia, Brazil, Japan and China which
the WTO ruled as Illegal. The US removed
129
the WTO ruled as Illegal. The US removed
the them in 2003.
US has demanded reduction of Subsidies
granted to Airbus by the Governments of
France, Germany, England and Spain.
The History of U.S. Commercial
Policy (9.6):
Smoot-Hawley Act of 1930
Increased Average Import Duty (Tariff) to 59%
Foreign Retaliation by more than 60
Countries
130
Countries
Trade Agreement Act of 1934
Tariffs reduced up to 50%
Introduced the Most Favored Nation
(MFN) Principle
The Uruguay Round and
Outstanding Trade Problems
Section 9.7:
Tariffs on Inustrial products to be reduce to
and average of 3%
Share of goods with zero tariff to increase
to 40 -45 %
131
to 40 -45 %
WTO to Replace GATT ( #10)
Collapse of the Doha Round
CHAPTER 10: ECONOMIC
INTEGRATION
132
INTEGRATION
CUSTOMS UNIONS AND FREE
TRADE AREAS
Trading Blocs
Lower
Tariffs
among
Members
Free Trade
among
Members
Common
External
Tariff
Free
Movement of
Factors of
Production
Harmonisati
on of
economic,
legal and
social policies
Organisation
s
Preference
Area
X Preference
Scheme
133
Free Trade
Area
X EFTA,
NAFTA)
Customs
Union
X X EU prior to
1992
Mercosur
Common
Market
X X X EU (1992)
and
Economic
Union
X X X X Objective of
the EU
Theory of the Second Best
Economic Integration refers to the commercial
policy of discriminatively reducing or eliminating
trade barriers only among the nations joining
together.
Are such trade arrangements preferable to free
134
Are such trade arrangements preferable to free
trade, or not?
The Theory of the Second Best says that if it is
not possible to achieve all the conditions for
optimality, and then the next best option is not
necessarily to achieve just some of them.
Trade Creation & Diversion
The static, partial equilibrium effects of customs
unions are measured in terms of trade creation and
trade diversion.
Trade Creation
Refer to Figure 10.1: A Trade-Creating Customs
135
Refer to Figure 10.1: A Trade-Creating Customs
Union
Trade Diversion
Refer to Figure 10.2: A Trade-Diverting Customs
Union
Refer to Transparency Figure 10.0: UK Market For
Imported Cars
Why Form a Customs Union ?
Conditions More Likely to Lead to
Increased Welfare with Customs Union
(10.4B)
136
(10.4B)
Dynamic Benefits & etc (10.50
Some History (10.6)

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