The benefits of free trade: an introduction

Transcription

1 The benefits of free trade: an introduction Dr Alexey Kravchenko Trade, Investment and Innovation Division United Nations ESCAP

2 A Simple Economic Model: Production Possibility Frontier (PPF) A graph that shows the combination of output that the economy can possibly produce given the available factors of production and the availably production technology. Points in side the curve show unemployment or productive inefficiencies

3 Suppose An economy produces two products: Tea Shirts Using all available resources, the maximum the economy can produce is either 5 shirts or 2, boxes of tea Or a combination in between

4 tea Production Possibility Frontier Opportunity cost (OC) of one shirt is four tea efficient 2, C 1,2 A F unobtainable inefficient 8 5 E B D shirts

5 Suppose there is new equipment that makes tea production more efficient

6 tea Production Possibility Frontier 2, C 1,2 A F 8 B D shirts

7 Trade is good Absolute Advantage Example Joe makes 4 shirts an hour or 2 kg of cheese Mark makes 8 shirts an hour or 12 kg of cheese Each works 8 hours a day Adam Smith

8 Absolute Advantage Shirts Cheese Joe 4/hr 2/hr Mark 8/hr 12/hr Each works 8 hours. What s the maximum that both can produce? Who is better at making what? Should they trade? Yes!

9 shirts shirts Absolute Advantage Joe Mark cheese 96 cheese

10 Lets assume they spend half their time on cheese and half their time on shirts

11 shirts shirts Absolute Advantage Joe Mark cheese cheese

12 Absolute Advantage Joe Mark Shirts Cheese Shirts Cheese Production & Consumption 16 (4 x 4hrs) 8 (2 x 4hrs) 32 (8 x 4hrs) 48 (12 x 4 hrs) Production (2 x 8hrs) (8 x 8hrs) Trade Consumption Gains

13 Absolute Advantage Joe is better at making cheese, so he will take more time making cheese Joe Mark is better at making shirts, so he will take more time making shirts Mark Shirts Cheese Shirts Cheese Production & Consumption 16 (4 x 4hrs) 8 (2 x 4hrs) 32 (8 x 4hrs) 48 (12 x 4 hrs) Production (2 x 8hrs) (8 x 8hrs) Trade Consumption Gains

14 Absolute Advantage Joe They exchange 24 shirts for 64 cheese Mark Shirts Cheese Shirts Cheese Production & Consumption 16 (4 x 4hrs) 8 (2 x 4hrs) 32 (8 x 4hrs) 48 (12 x 4 hrs) Production (2 x 8hrs) (8 x 8hrs) Trade Consumption Gains

15 Absolute Advantage Joe Mark Shirts Cheese Shirts Cheese Production & Consumption 16 (4 x 4hrs) 8 (2 x 4hrs) 32 (8 x 4hrs) 48 (12 x 4 hrs) Production (2 x 8hrs) (8 x 8hrs) Trade Consumption Gains

16 shirts shirts Absolute Advantage Joe Mark cheese cheese

17 Comparative Advantage David Ricardo What happens if someone has an absolute advantage in making both goods? Example: Joe makes 4 shirts an hour or 2 kg of cheese Mark makes 8 shirts an hour or 28 kg of cheese Each works 8 hours a day

18 Comparative Advantage Shirts Cheese Joe 4/hr 2/hr Mark 8/hr 28/hr Should they trade? Yes!

19 Comparative Advantage Absolute Comparative Shirts Cheese Shirts Cheese Joe 4/hr 2/hr Mark 8/hr 28/hr 5 cheese (2ch/4sh) 3.5 cheese (28ch/8sh).2 shirts (4sh/2ch).29 shirts (8sh/28ch) Mark has lower opportunity cost to make shirts Joe has lower opportunity cost to make cheese

20 Comparative Advantage Joe Mark Shirts Cheese Shirts Cheese Production & Consumption 16 (4 x 4hrs) 8 (2 x 4hrs) 32 (8 x 4hrs) 112 (28 x 4 hrs) Production (4 x 1hrs) (2 x 7hrs) (8 x 6hrs) (28 x 2hrs) Trade Consumption Gains

21 Price ($) Market Equilibrium Market Equilibrium is at Q 1 Quantity and P 1 Price P 1 Q 1 Quantity (thousands) 21

22 Price ($) Total Surplus Market Equilibrium is at Q 1 Quantity and P 1 Price P 1 Q 1 Quantity (thousands) 22

23 Imagine there are 2 countries in the world 23

24 Comparative Advantage NZ s Comparative Advantage is Cheese China s Comparative Advantage is Shirts Absolute Comparative Shirts Cheese Shirts Cheese NZ 4/hr 2/hr China 8/hr 28/hr 5 cheese (2ch/4sh) 3.5 cheese (28ch/8sh).2 shirts (4sh/2ch).29 shirts (8sh/28ch) Price of cheese would be between the original NZ Price and China s price 24

25 Comparative Advantage The exchange price is 14 shirts for 58 cheese NZ China Shirts Cheese Shirts Cheese Production & Consumption 16 (4 x 4hrs) 8 (2 x 4hrs) 32 (8 x 4hrs) 112 (28 x 4 hrs) Production (4 x 1hrs) (2 x 7hrs) (8 x 6hrs) (28 x 2hrs) Trade Consumption Gains Or about.24 shirts for one cheese Price of cheese would be between the original NZ Price and China s price 25

26 Price ($) NZ Cheese Market with no Trade Only Domestic Buyers and Domestic producers are in the market P 1 Q 1 Quantity (thousands) 26

27 Price ($) NZ Cheese Market with Trade Price for cheese rises because of the trade P 1 Price for cheese will be between the original NZ price and Chinese price Q 1 Quantity (thousands) 27

28 Price ($) NZ Cheese Market with Trade NZ Producers will make more cheese because the prices rise to P 2 P 1 Their production increases to Q 2 Q 1 Q 2 Quantity (thousands) 28

29 Price ($) NZ Cheese Market with Trade Consumer Surplus Falls P 1 Producer Surplus Increases Q 2 Quantity (thousands) 29

30 Price ($) NZ Cheese Market with Trade So overall, even though Consumer Surplus is smaller, the overall economy benefits P 1 Notice that Total Surplus (CS+PS) increases This area is the new addition to the total surplus Q 2 Quantity (thousands) 3

31 Price ($) Chinese Shirts Market with Trade Chinese Shirts Market experiences exactly the same effect because China has a CA in manufacturing shirts, hence with trade, prices will rise P 1 Q 2 Quantity (thousands) 31

32 Price ($) NZ Shirts Market without Trade Equilibrium is at P 1 Price and Q 1 Quantity P 1 Shirts Market in NZ experience exactly the opposite effect At P 1, Q 1, TS is maximum Q 1 Quantity (thousands) 32

33 Price ($) NZ Shirts Market with Trade P 1 P 2 Q 1 With trade, because shirts in China are cheaper, NZ prices for shirts fall to P 2 Quantity (thousands) 33

34 Price ($) NZ Shirts Market with Trade Because of the fall in the prices, QD for shirts rises to Q 2 P 1 P 2 Q 1 Q 2 Quantity (thousands) 34

35 Price ($) NZ Shirts Market with Trade This price fall Increases the overall consumer surplus P 1 but decreases producer surplus P 2 Overall effect, however, is that market s Total Surplus is increased Q 1 Q 2 Quantity (thousands) This area is the new addition to the total surplus 35

36 Price ($) Chinese Cheese Market with Trade P 2 Chinese Cheese Market experiences exactly the same scenario since prices fall once trade with NZ is established Q 2 Quantity (thousands) 36

37 Overall Effect NZ China Shirts Cheese Shirts Cheese Producers - ve + ve + ve - ve Consumers + ve - ve - ve + ve Whole Market (Total Surplus) + ve + ve + ve + ve 37

38 Price ($) NZ Market without Trade Equilibrium is at P 1 Price and Q 3 Quantity P 1 At P 1, Q 3, TS is maximum Q 3 Quantity (thousands) 38

39 Price ($) The Effects of Trade NZ CS Increases World Price P 1 PS NZ PS Falls Q 1 is produced domestically Q 1 Q 5 is consumed domestically Q 5 Q 1 is imported IMPORTS Quantity (thousands) Q 5

40 Price ($) The Effects of Trade P 1 World Price Gains from Trade Q 1 Quantity (thousands) Q 5

41 Price ($) The Effects of a Tariff NZ CS falls P 1 +a Tariff Revenue World Price + tariff World Price P 1 PS NZ PS rises Q 2 is produced domestically Q 1 Q 4 is consumed domestically Q 4 - Q 2 is imported Q 2 IMPORTS Q 4 Quantity (thousands) Q 5

42 Price ($) The Effects of a Tariff P 1 +a Tariff Revenue World Price + tariff World Price P 1 PS Dead Weight Loss Q 1 Q 2 IMPORTS Q 4 Quantity (thousands) Q 5

43 AHS Simple Average (%) GDP per capita vs AHS Simple Average, GDP per capita (constant 21 USD)

44 Why we still have tariffs?

45 China Decision High Tariffs Low Tariffs International Trade: A prisoner s dilemma Low Tariffs NZ Decision High Tariffs $5 billion $6 billion $5 billion $3 billion $3 billion $4 billion $6 billion $4 billion 45