Lecture 5 International and Environmental Economics

Transcription

1 Lecture 5 International and Environmental Economics Business 5017 Managerial Economics Kam Yu Fall 2013

2 Outline 1 International Trade Gain from Trade Distributional Effects of Trade 2 International Trade Policy Tariff Effects of Other Policy Instruments 3 International Finance International Monetary Exchange Determination of Exchange Rates 4 Environmental Economics Externality and Market Failure Remedies 5 Capital Mobility Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

3 International Trade Gain from Trade Why People Trade? When a buyer and a seller engage in a voluntary transaction, both receive something that they want and both can be made better off. Canadian consumers could buy oranges through international trade that they otherwise would have a difficult time producing. The producer of the oranges receives income that it can use to buy the things that it desires. Countries can use those resources to produce what they are most productive at (compared to their other production choices), then trade those products for goods and services that they want to consume. Countries can specialize in production, while consuming many goods and services through trade. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

4 International Trade Gain from Trade More Reasons Trade is predicted to benefit a country by making it more efficient when it exports goods which use abundant resources and imports goods which use scarce resources. When countries specialize, they may also be more efficient due to large scale production. Countries may also gain by trading current resources for future resources (lending and borrowing). Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

5 International Trade Gain from Trade Trade Expends Consumption Possibilities The economy by itself can produce any combination of cloth and food along the production possibility frontier TT. The isovalue line reflects the international relative price of cloth to food. When the economy opens to trade, it can switch from whatever it is producing on the PPF to point Q. Consumption is at D. Trade effectively expends the consumption possibility from the red line to the black line. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

6 International Trade Distributional Effects of Trade Which Producers Gains from Trade? The exporting sector gains from the increase in demand from D 1 to D 2. The shaded area measures the increase in revenue. The area P 1 abp 2 represents the increase in producer surplus (profit). The area Q 2 abq 3 represents the extra cost of production due to the export. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

7 International Trade Distributional Effects of Trade Someone May Get Hurt Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular groups within a country. Domestic producers of imports goods and services face increased competition from foreign firms. Consequently trade can adversely affect the owners of resources that are used intensively in industries that compete with imports. Trade may therefore have effects on the distribution of income within a country. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

8 International Trade Distributional Effects of Trade Losses from Competition with Imports The supply curve shifts from S 1 to S 2. The shaded area measures the decrease in domestic firms revenue. Lost profit is represented by the area P 2 abp 1. Cost of production decreased by the area Q 2 abq 1, which is total lost income by workers and factor suppliers. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

9 International Trade Policy Tools that Governments Use in Trade Restriction Governments use trade restrictions to protect domestic producers: Tariffs: a tax on imports or exports Quotas: a quantity restriction on imports or exports Export subsidies: a payment to producers that export Other regulations (e.g., health and safety, product standards) that exclude foreign products from the market, but still allow domestic products. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

10 International Trade Policy Tariff Effects of an Import Tariff An import tariff is an excise tax on imports only. This shifts S 2 upward by the amount of the tariff. It alleviates the revenue loss by domestic firms. Domestic consumers lose surplus from the price increase. For a small economy, when all the costs and benefits are accounted for, total welfare decreases because of the tariff. Example: Currently imported rice in Japan has a 778% tariff. The domestic price is five times higher than the world price. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

11 International Trade Policy Tariff Political Economy Why some politicians support tariffs: The affected domestic firms and workers are concentrated and therefore have strong incentive to form a lobby group. This will occur if the expected gain from the tariff is higher than the cost of lobbying. The loss of welfare for each consumer is small and therefore the political resistance is smaller. Possible consequences of a tariff: Retaliation from the targeted countries All out trade war Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

12 International Trade Policy Effects of Other Policy Instruments Nothing is Better Than Free Trade Import quotas: Even worse than an import tariff for the domestic economy because the effective tariff revenue goes to foreign producers instead of the domestic government. Export subsidies: The domestic government tries to help its exporters but in reality subsidizing foreign consumers. Regulations: If the domestic government does not apply the same rules to domestic firms, consumers suffer from high product prices. In all the above cases foreign governments will complain to the WTO and retaliate with some trade sanctions. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

13 International Trade Policy But Some Do It Anyway Effects of Other Policy Instruments Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

14 International Trade Policy Effects of Other Policy Instruments Misleading Trade Statistics Some trade statistics on the trade surplus of China are misleading, creating unnecessary political tension. For example, take the ipad from Apple Inc. The ipads are assembled in China using parts produced all over the world. The total cost of production add $275 to the trade deficit in the U.S. for each ipad, with a total of $4 billion. A cost breakdown shows that Chinese labour input is only 2% of the total cost. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

15 International Finance Feeling a Little Bit Loony? International Monetary Exchange Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

16 International Finance International Monetary Exchange Exchange Rate International trade involves two national currencies. Exchange rates measure how much domestic currency can be exchanged for foreign currency. They also affect how much goods that are denominated in foreign currency (imports) cost. And they affect how much goods denominated in domestic currency (exports) cost in foreign markets. Depreciation of a foreign currency: Foreign currencies become less expansive. Example: In July 2011, one euro costed $1.43. On February 3, 2013, it costed $1.32. The euro had depreciated during the period (or the Canadian dollar had appreciated against the euro). Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

17 International Finance Effects on the Economy International Monetary Exchange As a small-open economy, the exchange rates of the Canadian dollar have significant impacts on our imports and exports: Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

18 International Finance International Monetary Exchange Foreign Exchange Market When we buy an bottle of French wine, we pay Canadian dollars to the LCBO. LCBO buys euro from TD Bank, who wires the money to a French bank, say Société Générale. The French winemaker receives a deposit in its bank. The exchange rate is observed from the foreign exchange market (FX), with daily trading volume in the order of trillions of U.S. dollar. Buyers and sellers are mostly major banks in the world, central banks, and currency speculators. The major currencies traded are the U.S. dollar, euro, and Japanese yen. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

19 International Finance Determination of Exchange Rates The Asset Approach Canadians can save by buying financial assets denominated in domestic or foreign currency. Factors affecting the demand for foreign assets: rates of return inflation rates risk of default liquidity of the assets expected future exchange rates The foreign exchange market is in equilibrium when deposits of all currencies offer the same expected rate of return. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

20 International Finance Determination of Exchange Rates Monetary Policy An increase in a country s money supply causes its currency to depreciate. For example, an increase in money supply by the ECB reduces interest rates in the euro countries, reducing the expected return on euro deposits. This reduction in the expected return on euro deposits leads to a depreciation of the euro, making its products cheaper to Canadians. In the long run, however, inflation kicks in and reverses the trade pattern. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

21 International Finance Determination of Exchange Rates Other Factors Change in preference: Canadians buying more Chilean wine and other agricultural products, causing the peso to appreciate against the Canadian dollar. Change in real income: As average income rises rapidly in China, its citizens are buying more high-end products such as iphones. Although the iphone is made in China, it contains a large percentage of foreign parts. This mitigates the upward pressure of the Chinese yuan. Fiscal policy: The U.S. large government budget deficits over the years cause inflows of foreign currencies such as the Chinese yuan and Japanese yen, which prevent the U.S. dollar to depreciate against them. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

22 International Finance Determination of Exchange Rates The Trilemma of International Finance Three desirable goals for any government: 1 Free flow of capital across its border 2 Use monetary policy to stabilize the economy by controlling its money supply or interest rate 3 Control the currency exchange rates with its major trading partners Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

23 International Finance Determination of Exchange Rates The Trilemma of International Finance Three desirable goals for any government: 1 Free flow of capital across its border 2 Use monetary policy to stabilize the economy by controlling its money supply or interest rate 3 Control the currency exchange rates with its major trading partners Economic reality: A country can only choose two of the above and lose control of the third one. Examples: Canada and the U.S. choose the first two. Euro-area countries choose the first and the third one among the member countries. But each member lose the control of monetary policy. China chooses the second and the third. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

24 Environmental Economics Externality and Market Failure Market Failure The market economy based on voluntary exchanges is socially efficient. But what if the transaction imposes a cost on a third party, like dumping harmful chemicals into someone s drinking water (negative externality)? A market failure occurs when the third party s damages are not incorporated into the cost-benefit analysis of the original transaction. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

25 Environmental Economics Externality and Market Failure Positive Externalities Sometimes an economic transaction between two parties can be beneficial to a third party. Examples: flu shots, early childhood education, course materials online, Skype network, honey production, house renovations. In these cases the market demand curves understate the social marginal benefit of the good. This creates a form of economic inefficiency. Government can provide a subsidy (a negative tax) to encourage additional production of the good. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

26 Environmental Economics Externality and Market Failure The Bee Thing D 1 is the market demand curve with market equilibrium (Q 1, P 1 ). D 2 is the marginal social benefit. The optimal equilibrium is (Q 2, P 2 ). The area abc represents efficiency loss. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

27 Environmental Economics Externality and Market Failure The Bee Thing D 1 is the market demand curve with market equilibrium (Q 1, P 1 ). D 2 is the marginal social benefit. The optimal equilibrium is (Q 2, P 2 ). The area abc represents efficiency loss. Fable of the bees: Economist Steven Cheung went to Washington to investigate honey production. He found that farmers paid the bee keepers to bring their bees to the orchids for pollination. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

28 Environmental Economics Remedies Correcting Negative Externalities Ways to correct the economic inefficiency of negative externalities: Persuasion: Using public campaigns to promote environmental responsibility Reassignment of property rights: forcing the polluters to face the consequences of their actions. Government regulations: put a limit on the amount of pollution Put the price of the damage back into the market: taxing the polluters Cap-and-trade: specify the total amount of allowable pollution, issue licences to polluters and let them trade the licences in an open market Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

29 Environmental Economics Remedies What Works, and What Not? Persuasion Work to a certain degree in cases like second-hand smoking, littering, and prevention of forrest fire. Large scale pollution, however, is mainly from business and industrial production. Market competition prevents them to undertake costly environment remedies. Reassignment of property rights Work in cases where property rights can be clearly assigned. Examples, fishing rights of people living upstream of a proposed hydroelectric dam, private ownership of forrest, voiding rule of capture, etc. Not working: Open sea fishing, acid rain in Ontario, Kyoto Accord,... Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

30 Environmental Economics Remedies Government Regulations Popular in the 1970s. Examples: Noise control after midnight Car emission standards Banning leaded gasoline and lead paint Energy Star in household appliances Improving the building codes Bylaws on hazardous waste disposal Did not work well in the case of acid rain: The costs of installing sulphur dioxide scrubbers in old coal-fired power plants were prohibitory high. By applying the same rule to all plants, the law lacks flexibility and creativity. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

31 Environmental Economics Remedies Pigovian Tax First proposed by the British economist Arthur Pigou in Impose a tax on pollution, effective shifting the supply curve in Figure 5.6 from S 1 to S 2. Considered by some environmentalists as morally repugnant: pollution is a crime, not something to get away with by paying. Examples: A waste water tax introduced by the Dutch government in Pollution from the manufacturing sector fell by 80% between 1980 and A revenue neutral carbon tax in British Columbia: estimated to save three million tonnes of CO 2 per year. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

32 Environmental Economics International Comparison Remedies Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

33 Environmental Economics Remedies Cap-and-Trade Provide the same incentive to reduce pollution as a Pigovian tax. Two differences: 1 The tax acts like a price, which is known. But the total amount of pollution is uncertain. In the cap-and-trade system, the amount of pollution is fixed, but the price of the licence paid by the firms is uncertain. 2 The tax revenue goes to the government. The cap and trade depends on whether the licences are auctioned off or given to the firms. The Clean Air Act of 1990 that resolved the acid rain problem was negotiated by President Ronald Reagan and PM Brain Mulroney. It was a cap-and-trade system for sulphur dioxide emissions. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

34 Environmental Economics Remedies Why the Clean Air Act is More Efficient Suppose that there are five power plants, each with a different marginal cost structure in eliminating each unit of SO 2. Typo error: The Fifth unit of Firm B should be 5,600 instead of 16,200. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

35 Environmental Economics Remedies Emission Regulation Suppose the EPA proposes to limit total emission to 10 units. Each plant is therefore allowed to emit no more than two units. The cost of eliminating three units from Plant A is = $700. The cost of eliminating three units from Plant E is 1, , , 000 = $6, 000. The total cost of all five plants to eliminate three units each is $13,500. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

36 Environmental Economics Remedies Cap and Trade System An alternative system is to auction off licences of SO 2 emission. At the price of $0, all plants will get five licences each. Total quantity demanded is 25 licences. At the price of $101, the quantity demanded will be 24 licences because Plant A can eliminate one unit at the cost of $100. At the price of $201, the quantity demanded will be 21 licences. Plant A will eliminate two units itself, and both Plants B and C will eliminate one unit each. A complete demand schedule can be worked out with price up to $5,601, with zero demand. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

37 Environmental Economics Market for Emission Licence Remedies Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

38 Environmental Economics Remedies More Efficient? The EPA controls the supply of licences at 10 units. The market equilibrium price will be around $1,500. Quantities demanded from each plant: Q A = 1, Q B = 3, Q C = 0, Q D = 2, Q E = 4. The total cost of reducing pollution for all five plant is $9,300. This is significantly lower than the total cost of $13,500 with the emission regulation. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

39 Environmental Economics Comparing the Two Systems Remedies Emission Regulation Cap and Trade The cap-and-trade system allows low-cost plants to eliminate more pollution than the high-cost plants do. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

40 Capital Mobility Physical, Financial, and Human Capital Over the past two decades the world economy has become globalized. More than two billion people have joined the world labour market after the reforms in China and India. In many developed countries, the service sector has overshadowed manufacturing. At the same time the development of computer technology and the Internet have lowered the cost of outsourcing. Production, together with physical and financial capital, moves more quickly to countries with the comparative advantage. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

41 Workshop of the World Capital Mobility Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

42 Capital Mobility Capital Mobility and Competitiveness Business enterprises are under increasing competitive pressure to become more efficient by lowering cost (Dell, Walmart) or by increasing revenue with product innovations (Apple). Labour Unions are under pressure to lower wages and fringe benefits. Even governments face the global pressure to compete with their policies on tax and regulation. Corporate tax rates: Japan 39.5% United States 39.2% Canada 25.0% In 2011, Forbes magazine ranked Canada as the No. 1 country in the world to do business. Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

43 Here is Another Reason Capital Mobility Japan U.K. Italy Canada Germany France U.S.A. Public private Spending on Health Care as % GDP, 2005 Spending on Health Care as % GDP, 2005 Source: WHO (2008) U.S.A. France Germany Canada Italy U.K. Japan Source: WHO (2008) Public private Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42

44 Thought du jour Capital Mobility Does Canada have a housing bubble? Kam Yu (LU) Lecture 5 International and Environmental Economics Fall / 42