Economics 2 Professor Christina Romer Spring 2018 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2018 Professor David Romer LECTURE 12 SUPPLY AND DEMAND MODEL OF INTERNATIONAL TRADE AND TRADE POLICY February 27, 2018 I. O VERVIEW II. R EVIEW OF THE G AINS FROM S PECIALIZATION A. The case of

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Economics 2 Professor Christina Romer Spring 2018 Professor David Romer LECTURE 12 SUPPLY AND DEMAND MODEL OF INTERNATIONAL TRADE AND TRADE POLICY February 27, 2018 I. OVERVIEW

  • II. REVIEW OF THE GAINS FROM SPECIALIZATION
  • A. The case of rising opportunity cost
  • B. How much does a country want to specialize?
  • C. Consumption possibilities with trade
  • III. SUPPLY AND DEMAND ANALYSIS OF INTERNATIONAL TRADE
  • A. Export good
  • B. Import good
  • IV. WELFARE AND EMPLOYMENT EFFECTS OF TRADE
  • A. Welfare analysis of trade for an import good
  • B. Employment effects of trade

V. TRADE POLICY

  • A. Some definitions
  • B. Effects of a tariff
  • C. Welfare analysis of a tariff
  • VI. POSSIBLE ARGUMENTS FOR PROTECTION
  • A. National security
  • B. Diversification
  • C. Rearranging jobs
  • D. Positive externality
  • E. Others?
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LECTURE 12

Supply and Demand Model of International Trade and Trade Policy

February 27, 2018

Economics 2 Christina Romer Spring 2018 David Romer

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Announcements

  • We handed out Problem Set 3:
  • It is due next Tuesday (March 6).
  • Problem set work session, Thursday (March

1st), 4–6 p.m. in 648 Evans

  • Journal article reading for next time:
  • David Card, “The Impact of the Mariel

Boatlift on the Miami Labor Market.”

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  • I. OVERVIEW
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Topics

  • Supply and demand framework with international

trade.

  • Welfare and employment effects of trade.
  • How does a country go about limiting trade?
  • Are there good reasons for limiting trade?
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SLIDE 6
  • II. REVIEW OF THE GAINS FROM SPECIALIZATION
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Example

  • Suppose the U.S. makes two goods (wheat and

washing machines).

  • Assume that the PPC for the U.S. is curved (there

is rising opportunity cost).

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Example (continued)

  • Assume the world price of wheat is $400 and the

world price of washing machines is $300 (in the same currency), so the terms of trade (also called the world relative price) is 1⅓ washing machines per ton of wheat.

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Optimal Specialization when the PPC is Curved

Wheat (W)

Washing

Machines (WM)

U.S. PPC

  • Point of Tangency

CPC

(Slope = (minus) WM per 1 W; in our example it is −1⅓)

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Consumption Possibilities Curve with Trade

  • Graphically, it is a line with slope (minus) the

world relative price of the good on the horizontal axis that is tangent to the PPC.

  • Intuitively, it shows the combinations of the two

goods that the country can consume if it makes the bundle at the point of tangency and then trades at world prices.

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  • III. SUPPLY AND DEMAND MODEL OF INTERNATIONAL

TRADE

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Some Notes on the Interpretation of the Supply and Demand Diagram with Trade

  • The U.S. supply curve is upward sloping to capture

the notion of rising opportunity cost (the curved PPC).

  • The world price is the world relative price:
  • The price in a supply and demand diagram is

always the price relative to other prices in the economy.

  • We assume that the world demand and world supply

at that world relative price is perfectly elastic.

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Supply and Demand Diagram for an Export Good

P1

US

Q1

US

DUS Q P SUS PWorld

World Price with Trade U.S. Price without Trade

QD

US

QS

US

Exports

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SLIDE 14

Supply and Demand Diagram for an Import Good

P1

US

Q1

US

DUS Q P SUS PWorld

World Price with Trade U.S. Price without Trade

QS

US

QD

US

Imports

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  • IV. WELFARE AND EMPLOYMENT EFFECTS OF TRADE
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Welfare Analysis of Trade (Import Good)

a c b d e

DUS Q P SUS

P1

US

QS

US

QD

US

Q1

US

Without Trade(Q1

US) With Trade(QD US, QS US)

Consumer Surplus a a+b+c+d Producer Surplus b+e e Total Surplus a+b+e a+b+c+d+e Gains from Trade c+d

PWorld

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U.S. Price Index for All Goods and Appliances

Source: FRED, Federal Reserve Bank of St. Louis. Major Appliances All Consumer Goods

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Welfare Analysis of Trade (Export Good)

Without Trade(Q1

US) With Trade(QD US, QS US)

Consumer Surplus a+b+c a Producer Surplus e+f b+c+d+e+f Total Surplus a+b+c+e+f a+b+c+d+e+f Gains from Trade d

a c b d e

DUS Q P SUS

P1

US

QD

US

QS

US

Q1

US

f

PWorld

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Supply and Demand Diagram for an Import Good

P1

US

Q1

US

DUS Q P SUS PWorld

World Price with Trade U.S. Price without Trade

QS

US

QD

US

The decrease in US production after trade implies less employment in this industry.

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Supply and Demand Diagram for an Export Good

P1

US

Q1

US

DUS Q P SUS PWorld

World Price with Trade U.S. Price without Trade

QD

US

QS

US

The increase in US production after trade implies more employment in this industry.

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Employment Effects of Trade

  • When a country goes from no trade to free trade, it

will produce less of the good it imports and more of the good it exports.

  • Employment will tend to fall in the import industry

and rise in the export industry.

  • Trade tends to rearrange jobs, rather than raise or

lower employment overall.

  • But, the rearrangement can be very painful for

workers who lose their jobs (and who may not have the skills needed to move to the industries where jobs are available).

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  • V. TRADE POLICY
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Some Definitions

  • Free trade: A country puts no barriers to

international trade.

  • Protection: A country puts limits on trade.
  • Trade policy: A country’s policies toward trade.
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Trade Policy is Not the Only Determinant of Trade

  • Shipping costs matter.
  • Improved logistics can make trade easier.
  • Better communication makes trade in services

possible.

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The Advent of the Container Ship

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Methods of Protection

  • Tariff: A tax on imports.
  • Quota: A limit on the number of imports.
  • Subsidies for domestic production.
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Average U.S. Tariff Rates on Dutiable Imports

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Effects of a Tariff

DUS Q P SUS PWorld

PWorld + tariff QS1

US

QD1

US

QS2

US QD2 US

Imports before Tariff Imports after Tariff

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Welfare Analysis of a Tariff

Before Tariff(QS1

US, QD1 US) After Tariff(QD2 US, QS2 US)

Consumer Surplus a+b+c+d+e+f a+b Producer Surplus g c+g Tariff Revenue e Total Surplus a+b+c+d+e+f+g a+b+c+e+g Deadweight Loss d+f

a c b d g

DUS Q P SUS

QS1

US

QD1

US

QS2

US QD2 US

f e

PWorld + tariff

PWorld

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  • VI. POSSIBLE ARGUMENTS FOR PROTECTION
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Possible Arguments for Protection

  • National security
  • Diversification
  • Jobs for particular kinds of workers
  • Positive externalities
  • Others?
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Source: The Economist, February 22, 2018, Economist.com.

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Positive Externality of Production and a Tariff

SMBUS DUS, PMBUS

Q P

SUS PWorld QS1

US

QD1

US

PWorld + tariff QS2

US QD2 US a b c d

Change in the total social surplus due to the tariff: b – (c+d)

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Some Statistics on the Midterm

  • Median: 64.5
  • 75th percentile: 77.0
  • 25th percentile: 53.5
  • Median corresponds roughly to a B.
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Some Notes on Grading

  • We reward improvement.
  • Regrade requests must be submitted in writing to

your GSI by March 6th.