Brian David Butler Miami Campus Facilitator International Economics & Trade (Prof. Grosse) Email: [email_address] home: 305-396-6116 Connect: Facebook Linkedin GloboTrends blog Session #5

Brian David Butler

Miami Campus Facilitator

International Economics & Trade (Prof. Grosse)

Email: [email_address]

home: 305-396-6116

Connect:

Facebook

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GloboTrends blog

Why study trade? Class outline Today Future class Trade theory trade barriers Why trade? Economics of tariffs Comparative advantage Compare this class vs. finance class?

Class outline

Today Future class

Trade theory trade barriers

Why trade? Economics of tariffs

Comparative advantage

Compare this class vs. finance class?

Perspectives: Whats the difference: How economist sees trade? How marketing sees trade? - Goals / objectives

Whats the difference:

How economist sees trade?

How marketing sees trade?

- Goals / objectives

For initial discussion… “ free trade is mutually beneficial for both countries” i.e. both countries are better off “ the freer the trade, the more both countries benefit” Agree? disagree? Limitations? what are the benefits of free trade? Negatives?

“ free trade is mutually beneficial for both countries” i.e. both countries are better off

“ the freer the trade, the more both countries benefit”

Agree? disagree? Limitations?

what are the benefits of free trade?

Negatives?

benefits? Greater diversity of products Economies of scale (from specialization ) bigger market, drives costs down) Greater efficiency in large plants (autos, example) Advantage to specialize in fewer products, and trade Don’t need factory in each country…less cost… 3. Competition = innovation Kills off lazy & stupid 4. Avoid inefficient costs of protectionism Tariffs, quotas, export su bsidies, etc…

Greater diversity of products

Economies of scale (from specialization )

bigger market, drives costs down)

Greater efficiency in large plants (autos, example)

Advantage to specialize in fewer products, and trade

Don’t need factory in each country…less cost…

3. Competition = innovation

Kills off lazy & stupid

4. Avoid inefficient costs of protectionism

Tariffs, quotas, export su bsidies, etc…

why controversial? Local industry harmed? Unfair competition /imperfect competition Dumping State enterprise vs. private enterprise 2. Unfair Income distribution Convergence of relative prices…leads to effects on relative earnings of land & labor…leads to … Trade tend to make low skilled workers in the US worse off, while making high-skilled workers better off.

Local industry harmed?

Unfair competition /imperfect competition

Dumping

State enterprise vs. private enterprise

2. Unfair Income distribution

Convergence of relative prices…leads to effects on relative earnings of land & labor…leads to …

Trade tend to make low skilled workers in the US worse off, while making high-skilled workers better off.

why controversial? Special interests Pain is localized, benefit is generalized Motivation of few vs. many Protect income of certain interest groups Political process Buy votes with protectionism

Special interests

Pain is localized, benefit is generalized

Motivation of few vs. many

Protect income of certain interest groups

Political process

Buy votes with protectionism

History: Adam Smith (1776) – Absolute cost advantage Theory England absolute = Machinery France absolute = Wine Should each specialize + Trade …obvious! Trade: Absolute Advantage:

History:

Adam Smith (1776) – Absolute cost advantage Theory

England absolute = Machinery

France absolute = Wine

Should each specialize + Trade …obvious!

History: David Ricardo (1817) – Relative cost advantage But, this time… Portugal is Absolute in BOTH Trade … not obvious! Trade: Comparative Advantage:

History:

David Ricardo (1817) – Relative cost advantage

But, this time… Portugal is Absolute in BOTH

Trade … not obvious!

Portugal has 120/80 = 1.5x advantage in wine Portugal has 100/90 = 1.1x advantage in cloth … .so, they have a comparative better advantage in wine Trade recommendation: specialize + trade for cloth Comparative Advantage cont’d:

Portugal has 120/80 = 1.5x advantage in wine

Portugal has 100/90 = 1.1x advantage in cloth

… .so, they have a comparative better advantage in wine

Trade recommendation: specialize + trade for cloth

Gains from Trade Gains from free trade – depend on “ Specialization ” More production if you specialize, and everyone can be better off

Gains from free trade – depend on

“ Specialization ”

More production if you specialize, and everyone can be better off

Insight: “ Trade between two countries can benefit BOTH countries if each country exports the goods in which it has a comparative advantage” If you learn one economic principle in this class, it should be this one! Trade: Comparative Advantage:

Insight:

“ Trade between two countries can benefit BOTH countries if each country exports the goods in which it has a comparative advantage”

If you learn one economic principle in this class, it should be this one!

example: Airplanes apples France 18 241 USA 12 198 The numbers in the table refer to the number of airplanes, and millions of bushels with complete specialization. Which country has: Absolute advantage? Comparative advantage?

Airplanes apples

France 18 241

USA 12 198

The numbers in the table refer to the number of airplanes, and millions of bushels with complete specialization.

Which country has:

Absolute advantage?

Comparative advantage?

example: Airplanes apples France 18 241 USA 12 198 Comparative: =18/12 = 241/198 = 1.5 = 1.22 Absolute advantage? France in both Comparative? France has comparative advantage in Airplanes, USA in apples

Airplanes apples

France 18 241

USA 12 198

Comparative: =18/12 = 241/198

= 1.5 = 1.22

Absolute advantage? France in both

Comparative? France has comparative advantage in Airplanes, USA in apples

What exchange rates will produce 2way trade, assuming these prices: Airplanes apples France* price € 100m €7.47 USA* price $90 m $5.4 Note: if you are given Airplane prices, you should be able to derive apple prices!

What exchange rates will produce 2way trade, assuming these prices:

Airplanes apples France* price € 100m €7.47 USA* price $90 m $5.4 USD / Euro = $90 / 100 =7.47/5.45 Trade range= US$ 0.90 < x < US$0.73 If USD weaken to $1 / euro…it would limit French airplane exports to USA. If USD strengthens to $0.5 /euro…it would limit US exports of apples

Airplanes apples

France* price € 100m €7.47

USA* price $90 m $5.4

USD / Euro = $90 / 100 =7.47/5.45

Trade range= US$ 0.90 < x < US$0.73

If USD weaken to $1 / euro…it would limit French airplane exports to USA.

If USD strengthens to $0.5 /euro…it would limit US exports of apples

Comp. Adv. Assumptions Products are identical Quality / characteristics Frictionless trade (negligible transport, etc.) No gov’t interference Tariff Subsidy Etc.. Assume prices relate to costs…. (marketing guys will disagree!!!)

Products are identical

Quality / characteristics

Frictionless trade (negligible transport, etc.)

No gov’t interference

Tariff

Subsidy

Etc..

Assume prices relate to costs….

(marketing guys will disagree!!!)

Barriers to gains? Limitations on comparative advantage: Trade barriers (tariffs, quotas, etc) Limits on labor mobility, Limits on ability to shift production from one industry to other…

Limitations on comparative advantage:

Trade barriers (tariffs, quotas, etc)

Limits on labor mobility,

Limits on ability to shift production from one industry to other…

Comparative Advantage Example: A ppliances B ananas USA 200* 100 Honduras 60 80 *Max # units per year: Note: US absolute better at both

A ppliances B ananas

USA 200* 100

Honduras 60 80

*Max # units per year:

Note: US absolute better at both

Comparative Advantage Example: A B USA 200 100 Honduras 60 80 Relative : 200/60 100/80 advantage USA: = 3.33x = 1.25x 333% more efficient Note: USA has BIGGER advantage in appliances

A B

USA 200 100

Honduras 60 80

Relative : 200/60 100/80

advantage USA: = 3.33x = 1.25x

333% more efficient

Note: USA has BIGGER advantage in appliances

Question: Will both countries really be better off if each specializes in “comparative advantage” and if they engage in free trade? If so, by how much?

Will both countries really be better off if each specializes in “comparative advantage” and if they engage in free trade?

If so, by how much?

With no trade:

Production if both countries specialize + trade A B USA 200 0 Honduras 0 80 total = 200 + 80 = 280 Production / consumption with NO trade A B USA 120 40 Honduras 40 30 total = 160 + 70 = 230

A B

USA 200 0

Honduras 0 80

total = 200 + 80 = 280

How much SHOULD they trade? Need to trade enough to meet minimum consumption desires of both countries. All extra = surplus So, if the US makes 200 (A), and Honduras wants 40, then 40 = min export…can keep 160…which is more than could be kept without trade Benefit from trade! (more goods overall)

Need to trade enough to meet minimum consumption desires of both countries.

All extra = surplus

So, if the US makes 200 (A), and Honduras wants 40, then 40 = min export…can keep 160…which is more than could be kept without trade

Benefit from trade! (more goods overall)

What exchange rates make trade possible Assume: Price appliance US = $10 Price appliances Hon = L200 Banana What does price in US have to be? 200 / 100 ratio….so 200 appliances have same value as 100 bananas Price bananas US = $20 (must be able to calculate!) Price bananas Hon = 60/80… 200 *60 / 80 = L150

Assume:

Price appliance US = $10

Price appliances Hon = L200

Banana

What does price in US have to be? 200 / 100 ratio….so 200 appliances have same value as 100 bananas

Price bananas US = $20 (must be able to calculate!)

Price bananas Hon = 60/80… 200 *60 / 80 = L150

What FX rates give trade? Appliances bananas USA $10 $20 Honduras L200 L150 Lempira/ USD = L20 / 1 =L7.5/1 Trade range= L 20/1 < x < L7.5/1 If HON weaken to L100 / dollar…it would limit US appliance exports to HON. If HON strengthens to L5 /dollar…it would limit HON bananas exports to USA If FX = L20/1… which country has advantage?

Appliances bananas

USA $10 $20

Honduras L200 L150

Lempira/ USD = L20 / 1 =L7.5/1

Trade range= L 20/1 < x < L7.5/1

If HON weaken to L100 / dollar…it would limit US appliance exports to HON.

If HON strengthens to L5 /dollar…it would limit HON bananas exports to USA

If FX = L20/1… which country has advantage?

Comparative vs. Absolute? Heckscher-Ohlin Theory: Takes what Ricardo did But adds….factor product proportions Land, resources, minerals, etc…

Heckscher-Ohlin Theory:

Takes what Ricardo did

But adds….factor product proportions

Land, resources, minerals, etc…

Trade: definitions Import tariff : taxes levied on imports…raises the price of imported goods inside country vs price outside Export subsidy : payments given to domestic producers who sell abroad…incentive to export…effect is to raise prices at home Terms of trade : relative prices of a country's exports to imports

Import tariff : taxes levied on imports…raises the price of imported goods inside country vs price outside

Export subsidy : payments given to domestic producers who sell abroad…incentive to export…effect is to raise prices at home

Terms of trade : relative prices of a country's exports to imports

Trade: Comparative Advantage: “ undeniably true yet not obvious to intelligent people” Samuelson Opportunity costs= trade off Ex: opportunity cost of roses in terms of computers Ex: 10 million roses (resources to grow) = 100,000 computers So, opportunity cost of 10 mm roses = 100k computers But, other country might have different ratio… 10 mm roses = just 30 k computers So, other country should grow roses! Each specialize, Import + increase world production!

“ undeniably true yet not obvious to intelligent people” Samuelson

Opportunity costs= trade off

Ex: opportunity cost of roses in terms of computers

Ex: 10 million roses (resources to grow) = 100,000 computers

So, opportunity cost of 10 mm roses = 100k computers

But, other country might have different ratio…

10 mm roses = just 30 k computers

So, other country should grow roses!

Each specialize, Import + increase world production!