Lecture 7(iii) Announcements None. Lecture. 0. Winners and Losers from Free Trade. 1 Trade Based on comparative advantage. (Robinson/Friday Trade)

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1 Lectre 7(iii) Annoncements None Lectre 0. Winners and Losers from Free Trade 1 Trade Based on comparative advantage. (Robinson/Friday Trade) 2. Trade based on increasing retrns. (Robinson 1/Robinsin 2 Trade) 3. The iphone and the international division of labor.

2 Review Economic Impact of Tariff in Econland Q$DSPworldPEconImportswithtarifImportsfreetradetarifPEcon=PWorld+tarifEffects of the Tariff CS (mins) PS (pls) GS (pls) (tariff revene) Total Econland Srpls (mins) Breakdown Q con too small Q prod too big And with qota = same, except gov t dosn t get

3 If start with tariff, overall srpls is higher, bt there are winners and losers. What abot affect on government revene? Prodcers worse off. Since total pie is bigger, in principle there maybe ways to ct prodcers into the deal. Trade Adjstment Assistance Program (for retraining) More generally society can have a safety net to help displaced workers.

4 Compare: Widget consmption tax $1 Widget tariff of $2. 10 $ D S Q Now trn to or new graph when can see qantities of two good Remember Robinson Crsoe from last class: Has 8 hors a day. Can prodce 3 fish in an hor or 1 cocont.

5 Prodction Possibility Frontier for Robinson Crsoe C o c n t s Fish Sppose atarky (no trade, on his own). We will talk abot choice next week. Bt let s say he decides to work half on each. Prodction point and consmption point prodce, consme 12 fish prodce, consme 4 coconts Slope: =1/3 Opportnity Cost of one more fish (in terms of coconts)

6 Sppose another person named Friday lives on a neighboring island Friday works only 2 hors a day. In one hor, can collect 12 coconts or 4 fish. Remember: Crsoe can catch 3 fish or pick one cocont in an hor. So Friday has an absolte advantage at both jobs compared to Robinson Crsoe in terms of prodctivity per hor.

7 Friday s PPF C o c n t s Fish Slope = 3. Opportnity cost of fish in terms of coconts Opportnity cost of fish: for Robinson: 1/3 coconts for Friday: 3 Robinson has a lower opportnity cost. Robinson has a comparative advantage in fish. Friday has a comparative advantage in coconts.

8 Sppose can go to the market and trade. Sppose market price is one cocont for one fish. What do these gys do? Specialize according to comparative advantage. Example how both can be better off Robinson Prodces fish coconts Friday Prodces fish coconts Robinson gives Friday Friday gives Robinson Robinson consmes : fish coconts Friday consmes : fish coconts Pareto improvement compared to atarky! Let s see the a famos pictre.

9 Comparative Advantage Robinson PPF C o c n t s Atarky 2 0 Trade Consme Trade Prodce Fish Op. Cost 1 Fish = 1/3 Coconts Prodce Consme Atarky 12 F, 4 C 12F, 4 C Trade 24F, 0 C 12F, 12 C as a Basis for Trade Friday PPF C o c n t s Atarky Trade Prodce Trade Consme Fish Op. Cost 1 Fish = 3 Coconts Prodce Consme Atarky 4 F, 12C 4 F, 12 C Trade 0 F, 24 C 12F, 12C

10 Robinson/Friday Trade: Trade Based on Comparative Advantage David Ricardo: Low skill contry: specialize in labor intensive,assemble snea akers High skill, high capital contry: do design, marketing, engi neering Ricardo challenged the ideas of mercantilism (16 th - 18 th centries) which were: Discorage imports (high tariffs), especially of manfactred goods. (importing raw materials OK) Encorage exports (export sbsidies), (exporting raw materials not OK, make something ot of them first.) Hoard gold. Ricardo arged instead that imports can benefit a contry, by allowing it to specialize according to its comparative advantage. (By the way, China has fond the mercantilist playbook!)

11 Comparative Advantage Trade Actal Economy Warm Climate Temperatee Climate Low Skill High Skill 2. Increasing Retrns and Gains from Trade Sppose ppf looks like: C o c n t s PPF Fish Opportnity cost one more fish falls as fish prodction increases (One reason: learning by doing)

12 Can specialize and make: 24 fish, 0 coconts or 0 fish 24 coconts Or try to do both and make 7 fish and 7 coconts Jack of all trades bt master of none With atarky might still might do both even if not particlarly good at either task withot specialization. Robinson in atarky Perhaps prodce and consme 7 coconts and 7 fish. Now sppose Robinson can trade with clones of himself? What do we expect to happen? Specialization! Robinson 1: Prodces Fish Coconts Robinson Clone: Prodces Fish Coconts Each consmers Fish Coconts

13 C o c n t s 6 4 Atarky 2 0 Increasing Retrns Robinson 1 PPF Trade Consme PPF Trade Prodce Fish Prodce Consme Atarky 7 F, 7 C 7F, 7 C Trade 24F, 0 C 12F, 12 C as a Basis for Trade Robinson 2 (clone) PPF C o c n t Atarky s 2 0 PPF Trade Prodce Trade Consme Fish Prodce Consme Atarky 7 F, 7C 7 F, 7 C Trade 0 F, 24 C 12F, 12C

14 Robinsonn 1/Robinsonn 2 Trade Trade Based on Increasing Retrns Trade Based on Increasing Actal Economy Retrns We can enjoy increasing retrns and more prodct variety. Rich Contry 1 Rich Contry 2 Pal Krgman Adam Smith -

15 Trade Based on Increasing Retrns Sppose Minnesota were a contry Interest in the theory driven by the empirical observation that mch trade is between similar contries U.S. and Canada, U.S. and Erope U.S. and Japan all high skill contries. Sppose atarky. (No trade with other states or contries) Vehicles: Polaris With increasing retrns, throgh trade possible for: (1) have large prodction volmes of any given prodct (2) consmers have a large variety Movies: Slingshot

16 Msic: International Division of Labor and the iphone Other Stff iphone 6 16GB With trade, we can enjoy more variety than this Price (from $ contract free T-mobile at Apple Web site)

17 Teardown of iphone Components (maybe $200?) (Robinson 1/Robinson 2 Trade ) All made in advanced economies. o Toshiba (Japan) making memory o TSMC (Taiwan) and Samsng (Korea) processor (designed by Apple) o Infineon (Germany) baseband o Broadcom (U.S) bletooth o Corning (U.S) Gorilla glass These nations are similar (U.S. = Robinson 1, Japan=Robinson 2) in having o high skill labor sed to develop these top-of-the-line technologies. o capital intensive prodction processes that se hardly any labor. Hge scale economies at work here, in R&D and development of prodction processes. Assembly in China (maybe $10-$15) (Robinson /Friday Trade)

18 I ve seen an estimate of $6.50 0, bt this strikes me as low, may not inclde manfactre of the very nice box, etc. All components go to the massive Foxconn complex (300,000 worker rs!) for assembly. Assembly is labor intensive. is labor intensive, so goes where labor is cheap and the poplation can speak English. Phillipines, where pay is $500 a month. Apple. (U.S) Estimated to keep more than half of the $650! Employs high skill workers. The $300 pls is a retrn on innovation, investment in apple stores, etc. Like the Apple Store in New York Specialization according to comparative advantage. Low skill workers earning abo t $170 a month. Cstomer Service (Robinson /Friday Trade) Consmers need to call some eone to get phone hooked p and resolve glitches. This

19 ... and Shanghai