Máster en Relaciones Internacionales y Comercio Exterior Módulo Unión Europea

1Aliter/Master en RRII/ Módulo/Materia/Entidad/Iniciales profesor//fecha

Máster en Relaciones Internacionales

y Comercio Exterior

MóduloUnión Europea

Profesor Alberto Romero Ania3 de marzo de 2010

Página web de la asignatura: www.aeue.weebly.com


Welcome to Our 2nd Meeting


European Union

European Union Lecturer: Alberto Romero Ania

1. Why the international trade?

2. The determinants of trade

3. The equilibrium without trade

4. The world price and comparative advantage

5. The winners and losers from trade

6. The gains and losses of an exporting country

7. The gains and losses of an importing country

8. The effects of a tariff

9. Answers to the key questions on trade policy

10.The arguments for restricting trade

11.Trade agreements and the role of institutions (NAFTA, GATT, EU)


1.- Why the international trade?

• Benefits from international trade

• Benefits from specialization

• Worldwide market benefits based on the comparative advantage

• Graphic analysis



Benefits from international trade: Graphic analysis


Less developed country More developed country

Food (Kg)

Tools (Units)

Food (kg)

Tools (Units)

a b c d e f

1000 800 600 400 200 0

0 100 200 300 400 500

g h I j k l m

1200 1000 800 600 400 200 0

0 400 800 1200 1600 2000 2400


Production and consumption possibilities before trade


Less developed

country

Foo

d (K

g)

Tools (Units)

0

400

800

1200

1600

2000

2400

0 400 800 1200 1600 2000 2400

More developed

country

Foo

d (K

g)

Tools (Units)




Less developed

country

Foo

d (K

g)

Tools (Units)

0

400

800

1200

1600

2000

2400

0 400 800 1200 1600 2000 2400

More developed

country

Foo

d (K

g)

Tools (Units)

Slope (Opportunity cost) = 2/1





Less developed

country

Foo

d (K

g)

Tools (Units)

More developed

country

Foo

d (K

g)

Tools (Units)

0

200

400

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1000

0 200 400 600 800 1000

0

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Less developed

country

Foo

d (K

g)

Tools (Units)More

developed country

Foo

d (K

g)

Tools (Units)

0

200

400

600

800

1000

0 200 400 600 800 10000

400

800

1200

1600

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0 400 800 1200 1600 2000 2400

Produce: 1000 Kg of foodImports: 600 tools

Exports: 600 Kg of food

Produce: 2400 toolsExports: 600 tools

Imports: 600 Kg of food

Both of them are better off after trade


1.- Why the international trade? • International economic trade policy

• Free trade or trade restrictions?

• Comparative advantage:

All countries can benefit from trading with one another because trade allows each country to specialize in doing what it does

best.



1.- Why the international trade?

Free international trade increase the gains, but …

• How does international trade affect the well-being?

• Who gains and who losses from international trade?

• How the international marketplace achieve this benefits?

• How the gains are distributed among various economic actors?



2.- The determinants of trade

• Case of study: Steel worldwide market

• Steel is made in many countries around the world

• Let´s examine the gains and losses from international steel trade !



3.- The equilibrium without trade

• Case of study: One autarkic (self-sufficient) country without international trade called “Isoland”

• Isolandian steel markets are isolated from the rest of the world. It is not allowed to import or export steel.

• No international trade, so only Isolandian buyers and sellers




• The price adjust to balance domestic supply and demand.

• The figure shows the consumer and producer surplus in an equilibrium without international trade



3 questions about its international economic policy

A new government wants to know:

1. If the government allowed Isolandians to import and export steel, what would happen to the price of steel and the quantity of steel sold in the domestic steel market.

2. Who would gain from free trade in steel and who would lose, and would the gains exceed the losses?

3. What happens if the government have a new trade policy with a tariff-tax on steel imports?



4.- The world price and comparative advantage

• First issue is to know if Isoland will become a steel importer or exporter. Would it end up buying or selling steel in the world market?

• If the the world price* of steel is higher (lower) than the domestic price, then will become an exporter (importer).

• The price of national steel is the opportunity cost of steel (says how much should give up for one unit of steel)

• If the domestic price of steel is lower means that Isoland has a comparative advantage producing steel relative to the rest of the world

*The world



5.- The winners and losers from trade

• The small economy assumption: To analyze the welfare effects, winners and losers from free trade, it is generally assumed that the small economy (compared with the rest of the world) actions have no effect on the worldwide markets.

• So we assume that the Isoland´s trade policy will not affect the world price of steel.

• Isoland is “price taker” in the world economy. The price is given.



6.- The gains and losses of an exporting country

• Isoland is an exporting country because the domestic equilibrium price before trade is below the world price.

• With free trade domestic prices rises to equal the world price

• No seller would accept less than the world price

• No buyers would pay more than the world price European Union Lecturer: Alberto Romero Ania


6.- The gains and losses of an exporting country

• Now the domestic price is equal to the world price

• But the domestic quantity supplied differs from the domestic quantity demanded.

• Because the domestic quantity supplied is higher than the domestic quantity demanded, steel will be exported



Analysis of an exporting country:



The world price demand curve

• Although domestic demand and supply differs

the market continue in equilibrium

because of the new actor: the world price demand curve.

• This world demand curve is perfectly elastic* because it is possible to sell as much steel as Isolate wants in the world market at the world market price.

*it describes how sensitive the price is to a quantity change



After opening up free trade no everyone benefits

• Domestic prices rise to the world price.

• Domestic producers are better off because now they sell at higher price

• Domestic consumers are worse off because they have to buy at a higher price

• How to measure winners and losers ?

– By looking at the changes in consumer and producer surplus !



Analysis of an exporting country:



Conclusions for an exporting country:

• When a country allows trade and becomes an exporter of a good, because it has a comparative advantage (domestic price is lower than world price):

• domestic producers of the good are better off

• domestic consumers of the good are worse off

• Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.



7.- The gains and losses of an importing country

• Now the domestic price before trade is above the world price

• After international free trade, domestic price must equal the world price

• Domestic quantity supplied is less than domestic quantity demanded.

• This quantity is imported from other countries



Analysis of an importing country:




• The horizontal line represents the supply of the rest of the world. It is horizontal because as small economy it can buy as much steel as it wants at the world price.

• Not everyone benefits from trade.

• Trade forces the domestic price to fall

• Domestic consumers are better off (they can buy at lower price)

• Domestic producers are worse off (they have to sell at lower price)

• Changes in the producer and consumer surplus show gains and losses



Conclusions for an importing country:

• When a country allows trade and becomes an importer of a good, because it has not a comparative advantage (domestic price is higher than world price):

• domestic consumers of the good are better off

• domestic producers of the good are worse off

• Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.



CONCLUSION !

• It doesn´t matter if the country is importer or exporter, after trade the gains of winners exceed the losses of the losers, so the winners could compensate the losers and still be better of

Trade can make everyone better off !!!



But, will trade make everyone better off?

• Probably not, because compensation for the losers from international trade is rare.

• Without the compensation, opening the economy to international trade could be a policy that expands the size of the economic pie, while perhaps leaving some participants in the economy with a smaller slice.



The political battle on trade policy

• Nations sometimes fail to enjoy the gains from trade simply because the losers from free trade have more political influence power than the winners

• The losers lobby for trade restrictions, such as tariffs.



The effects of a tariff

O

P

Q

Sdom

World pricePW

Ddom



O

P

Q

Sdom

World price

a

c b

Q1 Q2

PW

Ddom




O

P

Q

Sdom

World price

Q1 Q2

PW

Ddom



Imports


O

P

Q

Sdom

World price + tariff

World price

a

c b

Q1 Q2

TariffPW + t

PW

Ddom




8.-The effects of a tariff• A tariff has no effect if it is an exporting country

• So let´s analyze the effects of a tariff on an importing country

• To this aim we have to compare welfare with and without the tariff

• Under free trade, the domestic price equals the world price.

• A tariff raises the price of imported steed above the world price by the amount of the tariff.



8.-The effects of a tariff

• Domestic suppliers of steel, who compete with suppliers of imported steel, can now sell their steel for the world price plus the amount of the tariff

• So the price of steel (both imported and domestic) rises by the amount of the tariff and is closer to the price that would prevail without trade




• The changes in price affects the behavior of domestic buyers and sellers.

• Price rises, so it reduces the domestic quantity demanded

• Price rises, so it rises the domestic quantity supplied

• The tariff reduces the quantity of imports

• The tariff moves the domestic market equilibrium closer to its equilibrium without trade




• The tariff rises the domestic price, so:

• Domestic sellers are better off

• Domestic buyers are worse off

• And the government obtains a revenue

• To analyze the gains and losses,

• we look at the changes in consumer surplus, producer surplus and the government revenue.



O

P

Q

Sdom


World price

a

c b

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom




O

P

Q

Sdom

World price + Tariff

World price

a

de

c b

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom



Imports with tariff

Imports without tariff


O

P

Q

Sdom


World price

a

de

c bf

D E F

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom




O

P

Q

Sdom


World price

a

de

cb

fC D E F

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom



B

A

G


O

P

Q

Sdom


World price

a

de

cb

fC D F

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom



B

A

G

E


8.-Conclusion about effects of a tariff

The imported quantity is reduced




• Change in consumer surplus: -C-D-E-F

• Before tariff: A+B+C+D+E+F

• After tariff: A+B

• Change in producer surplus: +C

• Before tariff: G

• After tariff: C+G

• Change in the government revenue: +E

• Total surplus: -D -F




• A tariff causes a deadweight loss simply because a tariff is a type of tax

• Tax distorts incentives and pushes the allocation of scarce resources away from the optimum



9.- Answers to the key trade policy questions

1.- If the government allowed Isolandians to import and export steel, what would happen to the price of steel and the quantity of steel sold in the domestic steel market ?




1.- If the government allowed Isolandians to import and export steel, what would happen to the price of steel and the quantity of steel sold in the domestic steel market ?

– With international trade and free market, the domestic price will equal the price prevailing around the world

– If the world price is higher (lower) than the domestic price, the domestic price will rise (decrease) and reduce (increase) the quantity consumed and rise (decrease) the quantity produced

– If the world price is higher (lower) we have (not) a comparative advantage




2.- Who would gain from free trade in steel and who would lose, and would the gains exceed the losses?




2.- Who would gain from free trade in steel and who would lose, and would the gains exceed the losses?

• The answer depends on whether the price rises or falls when trade is allowed.

• If the price rises, the producers of steel gain, and consumers of steel lose.

• If the price falls, consumers gain, and producers lose.

In both cases the gains are higher than the losses.

Free trade always raises the total welfare of the society




3.- What happens if the government have a new trade policy with a tariff-tax on steel imports?




3.- What happens if the government have a new trade policy with a tariff-tax on steel imports?

• Tariffs have deadweight losses.

• The revenue raised would be smaller than the losses of buyers and sellers

The best trade policy, from the standpoint of the economic efficiency,

would be to allow international trade without a tariff



10.- The arguments for restricting trade

What arguments could support a trade restriction ?

Why ?




• The jobs argument

• The national security argument

• The infant industry argument

• The unfair competition argument

• The protection as a bargaining chip argument




The jobs argument



The jobs argument for restricting trade

• Trade with other countries destroy domestic jobs

• It happens when the country become an importer, the price of the product is reduced, so there are a reduction in the quantity supplied and as consequence a reduction of employment

• The domestic workers should move from the inefficient activity to a new activity where the country has a comparative advantage



The jobs argument for restricting trade

• So the money expend on imports will be recovered by exporting the new goods where they have a comparative advantage to the country

• It could impose hardship on some workers in the short run, but it allows the country as a whole to enjoy a higher standard of living



The jobs argument for restricting trade• Opponents of trade are often skeptical that trade creates

job

• They say that everything can be produced cheaply abroad

• Under free trade, domestic workers will not be profitably employed in any industry

However, the gains from trade are based on comparative advantage, not absolute advantage.

Every country can gain by trading with others



The national security argument for restricting trade

• Opponents to trade often argue that their industry is vital for national security. (Example: CAP = Common Agricultural Policy, or production of steel to produce weapons)

• If a war breaks out, might be unable to produce enough steel and weapons to defend itself.

• Usually the industry exaggerate their role in national defense to obtain protection from foreign countries

Economist acknowledge that protection key industries may be appropriate when there are legitimate concerns

over national security




The national security argument



The national security argument for restricting trade

• European Union restrictions to trade: the CAP

• The Common Agricultural Policy (CAP) is a system of European Union agricultural subsidies and programmes.

• It represents 46.7% of the EU's budget, €49.8 billion (in 2006)

• The aim of the common agricultural policy (CAP) is to

• provide farmers with a reasonable standard of living,

• consumers with quality food at fair prices

• to preserve rural heritage.




The infant industry argument



The infant industry argument for restricting trade

• New industries sometimes argue for temporary restrictions to help them get started.

• After the protection time, will be able to compete worldwide

• To apply this the government should know a priori which industries will eventually be profitable and decide whether the benefits of establishing these industries exceed the costs to consumers of protection



The infant industry argument for restricting trade

• Once a powerful industry is protected from foreign competition, the “temporary” policy is hard to remove

• Protection is not necessary for a industry to growth

• Firms incur temporary losses in the hope of growing and becoming profitable in future




The unfair competition argument



The unfair competition argument to restrict trade

• Opponents of free trade says that free trade is desirable only if all countries play by the same rules

• Firms in different countries are subject to different laws and regulations

• Then it is unfair to expect the firms to compete in the international marketplace

• If one government subsidizes a industry, this industry is not competing fairly



The unfair competition argument to restrict trade

• With unfair competition the domestic supplies will suffer, although the consumers will benefit from the lower international price

• The country, as a whole, will benefit from the opportunity to buy steel at a subsidized price




The protection as a bargaining chip argument



The protection as a bargaining chip argument

• Another argument for trade restrictions concerns the strategy of bargaining

• Trade restrictions could be useful when bargain with our trading partners

• The threat of a trade restriction can help remove a trade restriction already imposed by a foreign country government

• Country A might threaten to impose a tariff on X unless Country B removes its tariff on Y



Different trade barriers

• Tariff barriers: have a direct influence on market prices.

• Major instruments:

1. Tariffs: tax on imports prices

2. Export subsidies: subsidy on exports prices

3. Quotas: quantitative restrictions to imports

4. Currency exchange control: effects on imports and exports through currency exchange rates



Non tariff barriers:

- Sanitary

- Administrative

- Technical



The effects of economic integration

• Enhanced efficiency in production made possible by increased specialisation in accordance with the law of comparative advantage

• Increased production level due to better exploitation of economies of scale made possible by the increased size of the market



The effects of economic integration

• An improved international bargaining position made possible by larger size, leading to better terms of trade

• Enforced changes in economic efficiency brought about by enhanced competition

• Changes affecting both the amount and the quality of the factors of production arising from technological advances



Further sources of gain become as a result of:

- Factor mobility

- The coordination of monetary and fiscal policies

- The goals of near full employment, higher rates of growth and better income distribution becoming unified targets.



Customs unions theory: the static effects

• Jacob Viner (1950): International trade neoclassical theory pioneer.

• Viner challenged the belief that Cusoms Union formation is equivalent to a move to free trade, since it amounts to free trade among the members and protection vis-à-vis the outside world.

• This combination of free trade and protection can have varied results in terms of welfare gain or loss.



Customs unions theory: the static effects

• Trade creation: the replacement of expensive domestic production by cheaper imports from a partner (positive effect)

• Trade diversion: the replacement of cheaper initial imports from the outside world by more expensive imports from a partner (harmful effect).

The larger the Custom Union the higher the trade creation, the smaller the Custom Union the higher the trade deviation



The dynamic effects of economic integration

• The integration process activates certain mechanisms which influence the growth potential of the economy, by improving factor productivity or factor availability.

• Economies of scale and economies of learning: decrease in unitary production costs. Industrial sectors highly affected by economies of scale in the EU are those more challenged by third countries competition, those with increasing demands and those which are more technology intensive.



The dynamic effects of economic integration

– Investment effects:

- Higher investment in the former sectors

- Des-investments in ‘weaker’ sectors

- Delocalisation of investment

- Attraction of foreign investment (defensive and offensive)



Pro-competitive effects (if increase competition)

Price differentials: competition tends to be more ‘perfect’. It is not reasonable however to expect price total convergence. Important differential factors remain: consumers’ preferences, distribution schemes, transport costs, etc.

Internal inefficiency. An open market encourages improvements in management and efficiency

– Stimulus to innovation: competition encourages companies to improve the quality and diversity of their products. Technological cooperation, higher R&D intensity



‘Anti-competitive’ effects

• The exploitation of economies of scale might lead to high levels of industrial concentration through companies mergers and integration.

• Competition European Policy is a key instrument to supervise the correct and fair functioning of the European market.



Bibliography:

• Principles of Economics. Gregory Mankiw. Ed. Thomson.• Internet webs:

• www.europa.eu

www.economist.com

www.glossarist.com/glossaries/economy-finance/

www.amosweb.com

http://www.economyprofessor.com/http://economics.about.com/od/microeconomics/a/micro_text.htm

http://www.bus.msu.edu/econ/brown/pim/http://bcs.worthpublishers.com/mankiw5/default.asp?s=&n=&i=&v=&o=&ns=0&t=&uid=0&rau=0

http://economics.about.com/cs/studentresources/f/macroeconomics.htm

http://www.hartford-hwp.com/archives/25/index.html


Máster en Relaciones Internacionales y Comercio Exterior Módulo Unión Europea

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