Economics: Principles and Policy PDF

Economics: Principles and Policy William J. Baumol, Alan S. Blinder, John L. Solow 14th edition Powerpoint Slides prepared by: Philip Heap, James Madison University Baumol, Blinder and Solow, Economics: Princ...

Economics: Principles and Policy William J. Baumol, Alan S. Blinder, John L. Solow 14th edition Powerpoint Slides prepared by: Philip Heap, James Madison University Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © 2000 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Part 6 The United States in the World Economy Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 21 International Trade and Comparative Advantage Baumol, Blinder and Solow, Economics: Principles and Policy, 14 th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  An Opening Quote No nation was ever ruined by trade. Benjamin Franklin Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Next Three Chapters So far have largely ignored international issues Now want to consider globalization or a closer knitting together of the world’s national economies Key topics What are the factors that affect international trade? How are exchange rates determined? How do we integrate these two to build an international model? Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Can America Compete with Cheap Labor? Does cheap foreign labor take away American jobs, and force firms to reduce American wages? Lost manufacturing jobs, off-shoring etc. Facts do not support criticisms Over the last 40-50 years, wages in most countries that export to the U.S. have risen faster than wages in the U.S. Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table 1 Labor Costs in Industrialized Countries as a Percentage of U.S. Labor Costs Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Can America Compete with Cheap Labor? Does cheap foreign labor take away American jobs, and force firms to reduce American wages? Lost manufacturing jobs, off-shoring etc. Facts do not support criticisms Wages in most countries that export to the U.S. have risen in the last 40–50 years faster than wages in the U.S. Only workers in Canada and Mexico have lost ground Yet imports to the U.S. increased Need a different story Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Why Trade? Some reasons for trade Some countries lack key resources that they can only get through trade Each country’s climate, labor force, and other endowments differ Relatively efficient producer of some goods, relatively inefficient producer of others Main reason is specialization A country devotes its energies and resources to only a small proportion of the world’s productive activities Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Why Trade? Mutual gains from trade Old view: one country gains at the expense of another How would Adam Smith respond? Both countries must gain from voluntary exchange Otherwise, what’s the point of trading Trade allows each party to get goods better suited to their tastes Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Ideas For Beyond The Final Exam Trade is a Win-Win Situation Both parties must expect to gain from any voluntary exchange Trade allows the parties to consume a more preferred mix of goods than they did before This principle applies to two people on an island as well as nations Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  International versus Intranational Trade Trade between two countries is no different from trade among different states Michigan trades cars to California for computers Canada trades lumber to United States for cars In both case, trade improves standard of living Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  International versus Intranational Trade Three reasons for studying international trade as a separate subject 1. Political factors Governments more concerned with welfare of own people Problems with protectionist policies 2. Many currencies Need to deal with variability of exchange rates 3. Impediments to the mobility of labor and capital Immigration quotas, laws restricting hiring foreign workers Laws limiting foreign ownership of capital Political risks related to foreign investment Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Principle of Comparative Advantage If a country is more efficient at producing all goods, how can they gain from trade? Two trade concepts 1. Absolute advantage The ability of one country to produce a good using smaller quantities of resources than another country 2. Comparative advantage The ability of one country to produce a good relative to other goods less inefficiently than another country The ability of one country to produce a good at a lower opportunity cost than another country Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Ideas For Beyond The Final Exam The surprising principle of comparative advantage A country may have an absolute disadvantage relative to another country in the production of every good But if it has a comparative advantage in making a good, that country can gain from trade Comparative advantage determines the most efficient patterns of production A country can gain by importing a good even if that it can produce it more efficiently Such imports enable the country to specialize in producing goods at which it is even more efficient Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Arithmetic of Comparative Advantage A simple example Trade between the U.S. and Japan Computers and televisions Labor is the only input We want to show how the both countries can gain from trade Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table 2 Alternative Outputs from One Year of Labor Which country has the absolute advantage in which good? The U.S. in both computers and televisions Which country has the comparative advantage in which good? The U.S. in computers 5 times as efficient as Japan in making computers Japan in televisions Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Table 3 Example of the Gains from Trade Both countries will now devote more labor to the good in which they have a comparative advantage U.S. transfers 500 years of labor from televisions to computers 500 x 50 = + 25,000 and -500 x 50 = -25,000 Japan transfers 1,000 years of labor from computers to televisions -1,000 x 10 = -10,000 and 1,000 x 40 = 40,000 Now we have more computers and more televisions Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Arithmetic of Comparative Advantage What we have shown There was a change in the production arrangements Japan’s inefficient computer production is taken over by more efficient U.S. producers U.S.’s inefficient TV production is taken over by more efficient Japanese TV producers World productivity has increased: more TVs and computers Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Graphics of Comparative Advantage We can show the same principle using a production possibility frontier diagram We want to plot the production numbers from Table 2 Assume a million person years of labor Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 1 Production Possibilities Frontiers for Two Countries (per million person-years of labor) 60 Since the US has an absolute advantage in U both goods, its PPF is above Japan’s. 50 Television sets (millions) U.S. PPF 40 J The slope of the PPF indicates which country has a comparative advantage in each good 30 Japans 20 PPF 10 N S 0 10 20 30 40 50 60 Computers (millions) Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table 2 Alternative Outputs from One Year of Labor What is each country’s opportunity cost for 1 computer? 1 television in the U.S. 4 televisions in Japan What is each country’s opportunity cost for 1 television? 1 computer in the U.S. 1/4 a computer in Japan Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 1 Production Possibilities Frontiers for Two Countries (per million person-years of labor) 60 The slope of the PPF for the U S = 50/50 = 1, U which is the opportunity cost of one computer 50 Television sets (millions) in the U.S. U.S. PPF 40 J The slope of the PPF for Japan = 40/10 = 4, which is the opportunity cost of one computer in 30 Japan Japans 20 PPF 10 N S 0 10 20 30 40 50 60 Computers (millions) Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Graphics of Comparative Advantage What we’ve shown U.S has an absolute advantage in both goods U.S. has a comparative advantage in computers The OC of 1 computer = 1 television (4 in Japan) Japan has a comparative advantage in televisions The OC of 1 television = ¼ computer (1 in U.S.) Therefore, the U.S. should specialize in computers, Japan in TVs Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Graphics of Comparative Advantage How can we show the gains from trade? Rate of exchange In the US, the cost of 1 computer is 1 TV US will want more than 1 TV from Japan for a computer to gain from trade In Japan, the cost of 1 computer is 4 TVs Japan will want to give less than 4 TVs for a computer to gain from trade For both countries to gain from trade, the price of a computer should be between 1 and 4 TVs 1 computer trades for 2 TVs Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Figure 2 The Gains from Trade U.S. production 60 60 possibilities U 50 50 U.S. consumption Japanese production possibilities J A 40 possibilities 40 Television sets Television sets 30 30 Japanese consumption possibilities 20 20 10 10 N P S 0 10 20 30 40 0 10 20 30 40 50 60 Computers Computers (a) Japan (b) United states Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Principle of Comparative Advantage Summarizing the main points When every country does what it can do best, all countries can benefit because more of every commodity can be produced without increasing the amounts of resources used On a PPF diagram Absolute advantage shown by its having a higher PPF Comparative advantage is shown by the slope of the PPF Two very similar countries may gain little from trading with one another Each countries opportunity costs must be different Gains from trade arise from differences across countries Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The Principle of Comparative Advantage Summarizing the main points If two countries trade two goods, the price of one good must fall in between the opportunity cost of that good in each country Specialization will not be complete Some countries too small to provide the world’s entire output Production possibilities frontiers are curved As a country produces more and more of one good, the opportunity cost gets larger and larger Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Tariffs, Quotas, and Other Interferences with Trade Mercantilism Doctrine that holds that exports are good for a country, whereas imports are harmful Trade policy in the U.S. 1930s – Smoot-Hawley Act U.S. free trade actions Success with NAFTA, Uruguay Round U.S.-Mexico-Canada trade agreement in 2018 TPP in 2016, and out in 2017 Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Tariffs, Quotas, and Other Interferences with Trade Three main ways governments control trade Tariffs - Tax on imports Benefits domestic producers and raises tax revenue for the government Quotas - Legal limit on imports Export subsidies Government payment to exporter so they can lower prices and compete in foreign markets Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Tariffs, Quotas, and Other Interferences with Trade Tariffs vs. Quotas Both reduce international trade and increase prices Quotas Higher price benefits both foreign and domestic sellers Import licenses awarded in proportion to past sales or based on political favoritism Tariffs Some of the profits earned from higher prices end up as tax revenue Allow more efficient foreign firms to serve the domestic market Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Why Inhibit Trade? 1. Gaining a price advantage Tariff forces exporters to cut the prices of their goods Tariffs and quotas benefit particular domestic industries But if lead to retaliation, every country likely to lose in long run Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Why Inhibit Trade? 2. Protecting particular industries Preserve employment in the protected industry Rescue firms too inefficient to compete with foreign exporters Cost to consumers and the economy Sugar: Each job saved costs U.S. consumers $600,000 Trump tariffs: save 26,000 steel jobs, lose 428,000 jobs elsewhere How to help workers who lose their jobs Trade adjustment assistance ▶ Special unemployment benefits, loans, retraining programs, and other aid to workers and firms harmed by foreign competition Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Why Inhibit Trade? 3. National defense and other non-economic reasons Produce own national defense equipment True in some cases, but can lead to some unreasonable claims for protection: e.g. watchmakers Political grounds: Cuba, Iran Endangered species: seals 4. Infant-industry argument New industries need protection from foreign competition until they develop and flourish Stands up only if the prospective future gains are sufficient to repay the up-front costs of protectionism But, then why doesn’t private capital take advantage Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Why Inhibit Trade? 5. Strategic trade policy A nation may sometimes have to threaten protectionism to induce other countries to drop their own protectionist measures U.S. versus Europe Luxury goods and bananas Tariffs and tax provisions Is their a risk? Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Can Cheap Imports Hurt a Country Should we worry about dumping Selling goods in a foreign market at lower prices than those charged in the home market Isn’t this good? Yes, we gain from lower prices No, lower prices of imports hurt domestic firms and workers Politics of protectionism Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Appendix Supply, Demand and Pricing in World Trade Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Supply, Demand, and Pricing in World Trade How do we model a demand and supply model with trade? Three complications There are two demand curves There are two supply curves Equilibrium does not take place at the intersection point of either pair of supply demand curves Under free trade, the equilibrium price must satisfy two requirements The quantity exported by one country must equal the quantity imported by the other country Price must be the same in both countries Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Figure 3 Supply-Demand Equilibrium in the International Wheat Trade Importing country’s Exporting Exporting supply country’s country’s demand supply Price of wheat per bushel Price of wheat per bushel G $3.25 H E F A B 2.50 C D Imports Exports Importing country’s demand Quantity of Wheat Quantity of Wheat (a) Exporting country (b) Importing country Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  How Tariffs and Quotas Work Import quotas Reduce the volume of that product traded Raises the price in the importing country Reduces the price in the exporting country Tariffs A tariff can accomplish exactly the same restriction of trade Quantity exported by one country must equal the quantity imported by the other country Price paid (consumers, importing country) = Tariff + price received (suppliers, exporting country) Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Figure 4 Quotas and Tariffs in International Trade Importing Price of wheat Price of wheat country’s per bushel per bushel Exporting supply country’s Exporting demand country’s supply Q T $3.25 A B C D $2.50 2.50 Importing R S country’s 2.00 demand 80 85 115 125 50 57.5 87.5 95 Quantity of Wheat Quantity of Wheat (a) Exporting country (b) Importing country Baumol, Blinder and Solow, Economics: Principles and Policy, 14th Edition. © Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.