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PROFESSOR: The first 2/3 of the
course were covering sort
of what you need to know to know
basic microeconomics--
consumer theory and
producer theory.
And basically you can now, if
you understand the material,
go forth in the world as a
qualified micro economist.
What we're going to do for the
rest of the semester is apply
what we've learned and show you
how you can use the tools
that we've learned from basic
consumer and producer theory
to understand a broader
range of phenomena.
Really, you can think
of this as--
as I talked in the first
lecture about we make
simplifying assumptions--
this is sort of as we bend those
simplifying assumptions,
and consider more and more
realistic applications of
these models.
And the hint of what the sort of
stuff you can get to see as
you move on in economics and
move to our other courses
beyond micro.
So what we're going to start
with today-- and of course,
unfortunately, since I'm going
to cover a lot of topics, I'll
give each way too little time.
Including today, which
is one lecture on
international trade.
You could take several
courses on it.
We have an excellent undergrad
course, 14.54 on
international trade.
And I'm going to sort of try to
shove down your throats in
one lecture the key things
you need to know about
international trade.
But if you find it interesting
I urge you to
follow up on this.
So, thinking about this--
a good way to think about
international trade is to
think about an example.
So let's think about
Valentine's Day.
Valentine's Day sort
of presents
an interesting conundrum.
Because Valentine's Day
happens in the winter.
And yet, the thing you're
supposed to do is give roses.
Which don't grow in the
winter in the US.
At least not very conveniently
in many places.
So you've got this difficult
issue that basically we're
supposed to represent this
holiday with something that
doesn't actually come
that time of year.
So historically what that meant
it was if you wanted to
get roses for Valentine's Day
you to buy them from specially
heated greenhouses.
Where they set up largely
to supply the roses for
Valentine's Day.
There wasn't really a large
purpose for them otherwise.
However, over the past couple of
decades, what's happened is
instead-- instead of growing
these in these specially
heated greenhouses, we've
started flying them in from
other places, from Colombia.
Where of course, Colombia's on
the other side of the equator.
So February is a wonderful
time to
grow roses in Colombia.
And as a result we've started
flying them in.
And the typical rose you will
give on Valentine's Day this
year will come from Colombia.
Now the issue is-- is that a
good thing or a bad thing?
Now on the one hand,
we get cheap roses.
That's good.
Especially for poor college
students who want to impress
their valentine by sending
a dozen roses.
It's good they're cheap.
And roses are way cheaper now
than they were when I was--
even in dollar terms when I was
in college giving roses.
Roses are just incredibly
cheap now compared to
20 or 30 years ago.
On the other hand, a lot
of rose producers
have lost their jobs.
A lot of people whose
livelihoods and source of
income was growing these roses
are now out of jobs.
OK, these are typically people
who are not high-skilled
people who can go find
another job easily.
These are people who have been
really displaced for something
which was a specialized skill
which they cannot easily use
other places.
And basically this trade-off is
sort of a microcosm of the
debate we have over
international trade every day.
A debate that's ongoing.
Obama just came back
to the G20 summit.
Where there was huge discussions
of the issues of
international trade.
It's an ongoing debate.
And it's a particularly
important topic right now in
the US because the US is running
what's called an
enormous trade deficit.
The trade deficit is the
difference between how much we
export, that is how much of
our goods we sell to other
countries, minus how
much we import.
Which is how much of
goods from other
countries that we buy.
Currently we export about
$160 billion worth
of goods every month.
So every month we send out $160
billion worth of goods
around the world.
We import about $200 billion
of goods every month.
So that means we have a trade
deficit that's running about
$40 billion.
Now the question is--
is that a problem?
Is it a problem that the US is
systematically buying more
stuff from the rest
of the world than
they're buying from us?
And the answer is it's not
necessarily a problem.
And really, it might in fact be
a natural outcome because
of the principle that we'll
focus on today--
the principle of comparative
advantage.
Comparative advantage is saying
if some other place is
particularly good at producing
roses in February, then we
shouldn't be that stressed
about the fact that we're
running a deficit of roses.
That's something which is OK in
terms of total efficiency.
So to see that, let's focus
as this rose example in a
particularly simplified way.
Imagine there's two
countries--
the US and Colombia.
And there's only two goods
in the world--
roses and computers.
Two countries, two
good models.
The standard model we work with
with international trade.
With two country two good models
you can develop almost
everything you need to know.
There is no need to make
it more complicated.
Now, as I mentioned it's really
hard to grow roses in
February in the US.
It's a lot easier in Colombia.
On the other hand, it's much
easier to produce good
computers in the US than in
Colombia because we have the
high skilled labor force that
can produce computers.
So we have a thing where the
US is relatively bad at
producing roses in February.
Colombia's relatively bad
at producing computers.
So the key point is that means
that the opportunity cost--
remember the opportunity cost,
this key concept we've come
back to a couple times.
The opportunity cost of
producing a rose in terms of
producing computers is
relatively high in the US.
That is to produce a rose we
have to use so many resources.
Those resources can be much more
effectively deployed to
producing computers.
Likewise, in Colombia, to
produce a computer would use a
ton of resources that would be
much more effectively deployed
to produce roses.
As a result we see that Colombia
has a comparative
advantage in roses.
And the US has a comparative
advantage in computers.
The point is that if a country
is relatively good at
something then they have a
comparative advantage.
And it's all about
relativities.
Because people are going
to want both.
But the key thing is who's
relatively good at producing
one versus the other.
So to see that let's
go to figure 19-1.
To see how we diagram this,
let's go to figure 19-1.
Figure 19-1 shows production
possibility frontiers.
You learned about these
a while back.
Let me remind you, a production
possibility
frontier we talked about in
the context of a firm.
It shows the trade-off between
the firm's ability to produce
one good versus another good.
So for a firm producing
two goods a production
possibilities frontier is the
combination of the two goods
they could produce at a
given level of inputs.
So we talked about it from the
context of firms. We can also
talk about this in the
context of countries.
That says, we can draw a US
production possibility frontier.
Which is given the resources the
US has, it could produce
up to 2000 computers
and no roses.
Or 1,000 dozen roses, boxes of
roses, and no computers.
And let's assume it's
linear in between.
So the US production possibility
frontier is given
the resources we have-- and
this is a very simplified
example-- but just
bear with me.
Given the resources we have, we
can produce 2000 computers
and no roses or 1,000 boxes
of roses and no computers.
Or any combination in between.
That's our production
possibility frontier.
Columbia has a production
possibility frontier
illustrated in the
second panel.
They can produce 1,000 computers
and no roses.
Or 2000 boxes of roses
and no computers.
That is, Columbia has
a comparative
advantage in roses.
Meaning that their production
possibility frontier is a lot
flatter than ours is.
We have a comparative advantage
in computers.
Meaning our production
possibility frontier is a lot
steeper than is Colombia's.
Ignore panel C for the moment.
Now remember what the slope of
the production possibility
frontier is.
It's the marginal rate of
technical substitution.
It's the marginal rate at
which the producer can
substitute one good
for another.
So basically, for the US, the
marginal rate of substitution
of roses for computers is -2.
That is you have to give
up two computers to
get one box of roses.
In Colombia it's -1/2.
You have to give up
1/2 a computer to
get a box of roses.
So since the marginal rate of
substitution is so much higher
in the US, we say that Colombia
has a comparative
advantage in producing roses.
Now let's go further and impose
tastes on consumers in
each country.
Let's say that tastes are such
that given these production
possibility frontiers, consumers
in the US choose
1,000 computers and 500
boxes of roses.
We choose production
over love.
Colombia chooses love
over production.
Given their production
possibility frontier, this is
not inherently about
taste necessarily.
Because you have very different
slopes here.
But given their tastes and their
production possibility
frontier, they choose
500 computers and
1,000 boxes of roses.
Now this we call the outcome.
We call this outcome the
autarchy outcome.
Autarchy.
Which is the word--
I don't know what the hell it
means, but it basically means
no trading.
Autarchy.
I don't know where
it comes from.
Must be some Russian
term or something.
Autarchy.
Which means no trading.
So the no trading outcome is
consumers in the US consume
1,000 computers and 500
boxes of roses.
Consumers in Colombia consume
500 computers and
1,000 boxes of roses.
Now the key point is that both
the US and Colombia can be
better off if we introduce
trade.
And how is that?
Well if we introduced trade,
then each country can
specialize in their comparative
advantage.
Trade allows for
specialization.
That is the key advantage
of trade.
Their comparative advantage
naturally yields
specialization.
Comparative advantage
naturally yields
specialization-- it makes
sense for the US to be a
computer producer and Columbia
to be a rose producer.
It doesn't make sense the two
countries to produce both.
But absent international trade
they have to produce both.
Because consumers want both.
So if we're shut off from the
world and Columbia's shut off
from the world, then we end up
as in figures A and B. But
once we introduce trade, then
we can take advantage of our
relative expertise.
And we get a new production
possibility frontier which
looks like panel C.
That is, if you want more
than 2000 computers--
so if you want 2000 computers
and 2000 roses--
then you simply have the US
produce just computers and
Colombia produce just roses.
And you can get 2000 of each.
Now you can get 3,000 computers
and no roses by
having everybody produce
computers.
Or 3,000 roses and no computers
by having everybody
produce roses.
So you know production
possibility frontier has its
sort of wedge point that
2000-2000 intersection.
You can label that point the
point of specialization where
those two dashed lines
hit the solid line.
That's the point of
specialization, pure
specialization.
That's the point where the US
does just what it's good at.
And Colombia does just
what it's good at.
Of course you could have
other combinations too.
And that's what leads
to this bent
production possibility frontier.
But the key point is this joint
production possibility
frontier is further out than
what any country could have
produced on its own.
We've increased the
opportunity set.
Specialization has led to a
larger opportunity set.
A larger opportunity set-- we've
expanded the opportunity
set for the world by allowing
countries to specialize.
And the result of that you can
see in the next figure.
In figure 19-2 which shows
gains from trade.
So what this figure shows--
this is the same autarchy
figure from
panels A and B before.
I've just added some
more labels.
So what we see is, in
autarchy, we're at
point C- sub US.
With the US producing and
consuming 1,000 computers and
500 boxes of roses.
If we move to specialization,
move to international trade,
what happens is the US moves
to producing 2000
computers at Q-US.
And, likewise, looking at the
second panel, Colombia moves
to producing 2000 box
of roses at Q-CO.
And US consumers now increase
their consumption of both
roses and computers.
As do Colombian consumers.
And you end up with total
consumption of 2000 computers
and 2000 roses.
So the US consumes 1250
computers and Colombia
consumes 750.
And the flip for roses.
So we are learning that
Colombians, even at the same
price, do prefer love
over production.
But nonetheless, the bottom
line is, both sets of
consumers are better off.
Both sets of consumers are
consuming at a higher point
than was possible
without trade.
It's magic.
The magic is that simply by
letting them trade we have
made both countries
better off.
And the magic, the key to the
magic, is specialization and
comparative advantage.
If the US and Colombia were
identical in terms of their
production possibility frontiers
then you should be
able to see that there would
be no gains from trade.
If they had the same production
possibility
frontier, if in A and B the
slopes were the same, then the
joint production possibility
frontier would be identical to
what's in each country.
There would be no gains
from trade.
Gains from trade come from the
fact that these production
possibility frontiers have
different slopes.
That there's comparative
advantage in one country and
not another.
Which allows specialization.
So, basically, the key insight
of international trade-- and
once again I'm doing now in 50
minutes what you do in 12
lectures when you
get it right.
But the rough insight is that
comparative advantage yields
specialization, yields
gains from trade.
That's sort of the chain
of logic to be
thinking about this.
Questions about that?
Yeah?
AUDIENCE: If we're going to
adjust to international
situations?
Or could it be any sort of
specialization between two companies?
PROFESSOR: Any specialization
between two companies.
So just we learned about
this originally in
the context of companies.
Same issue.
In the business world they
have a term for this.
What do they call it?
Synergy.
You all know that word, you've
got to if you're going to
business school.
Synergy.
Synergy means that somehow you
put two companies together and
they can produce the
same stuff better.
Synergy is a fancy
name for this.
Which is the idea is that
there may be gains from
specialization even
within a company.
But if you take the old
example, take two shoe
companies, both producing left
and right shoes inefficiently
and they could specialize.
And one could do better
producing left shoes and one
at right shoes.
You put them together
and overall you
can have more shoes.
That's actually a pretty
stupid example,
but you get the point.
That basically the same
principle can occur whenever
there are gains from trade.
Whenever there's comparative
advantage of specialization
you make gains from trade.
Good question.
Other questions?
Now, that raises the interesting
question of-- well
these comparative advantage
things sound great.
Where can I get one?
Where do comparative advantages
come from?
And there's really two sources
of comparative advantages.
Comparative advantage in
international trade.
So where does comparative
advantage come from?
One is differences in
factor endowment.
Differences in factor
endowment.
What that means, is that
for example, Canada
has a ton of trees.
Everywhere.
Canada is endowed
with an enormous
amount of lumber resources.
With that factor very well.
So Canada is an enormous
exporter of
lumber and paper products.
Because they happen to have the
main thing you need for
that which is unbelievable
amounts of trees, everywhere.
So Canada can specialize in
exporting lumber and paper.
So now that gives them
a comparative
advantage in that area.
Now let me ask you
another question.
Why does China export most of
the world's clothes now?
What?
AUDIENCE: [INAUDIBLE]
PROFESSOR: Cheap labor.
It's not that they have
cheaper textiles.
It's not that the
cloth itself--
and I realize that the silkworms
are in China.
But not like the actual
production of cloth is that
much cheaper.
It's that clothes
are primarily a
labor intensive good.
And the labor is cheapest
in China.
So they have a factor
endowment.
They have an advantage,
comparative advantage, in
labor intensive goods.
So China, with international
trade, will produce a
disproportionate share of
labor intensive goods.
Because they can specialize
in labor intensive goods.
And make them cheaper for
the rest of the world.
So likewise, a sweatshirt that
you would go and buy today--
especially if you go and buy
it at a not top end store.
At an Old Navy or even
at a Costco.
Is literally in dollar terms
cheaper than what I paid for
that same sweatshirt when
I was in college
in the early 1980s.
Because they're just
produced incredibly
cheaply in China now.
We bring them in and
they're just cheap.
Goods where you can specialize
in that are going to be--
when you take advantage
of specialization
will be a lot cheaper.
So that's one reason why you
see comparative advantage.
The second reason is going to
be technological leadership.
Technological leadership.
So, for example, Japan has no
natural comparative advantage
of producing cars.
There's no reason why Japan
should have a comparative
advantage of producing
cars over the US.
Except they developed the
technology to more efficiently
mass produce the modern
automobile.
As a result of that
technological leadership they
gave themselves, essentially,
comparative advantage.
Now, once that technology
becomes public, the production
shifts elsewhere.
So now China is a major
producer of cars.
Basically copy-catting the
technology developed in Japan.
So it does move elsewhere.
Unlike factor endowments--
if the US wanted to compete with
Canada I guess we could
plant trees and in 50 years
we would compete.
But factor endowments are kind
of hard to compete on.
Technology is potentially a
little bit easier because you
can reverse engineer things.
So once again, the
technology's shifting to China.
So really the answer is in the
long run everything's going to
be made in China.
Because they've got
the cheap labor.
And they're adopting
the technology.
And once again, to quote towards
our most important
sense of cultural relevance,
there's the episode of the
Simpsons where Homer says,
don't worry we're fine.
We're going to rule--
our country's going
to rule the world.
We're fine in the future.
He goes, wait a second
we're China, right?
So basically China is doing very
well because they've got
these factor endowments--
these great factor endowments
and because they are adopting
technology as well.
What's interesting about this
is this really leads to some
more interesting
policy issues.
Once again, factor endowment
you can't
do a whole lot about.
The interesting policy issues
are in technological progress.
This is an argument that many
people make for subsidizing
new technologies.
So you often hear President
Obama saying, we need to
subsidize green technologies.
This is the wave
of the future.
The idea, what he's saying
implicitly is if we get the
technological leadership, we
can make the green products
that are exported.
Not the color--
I mean environmental stuff--
that can be exported to the
rest of the world.
And that's the argument
that he's making.
Question about that?
Now let's talk about where we
started the lecture, which is
is trade a good thing
or a bad thing?
I just talked about how trade
can greatly increase
consumption possibilities.
But why haven't we talked
about the consumers?
What about overall
social welfare.
And the answer is that
trade unambiguously
increases social welfare.
That trade is unambiguously
a good thing to do.
So to see that let's go to the
next series of figures.
Start with figure 19-3.
So let's start with the
market for roses
and imagine we have--
[INAUDIBLE] autarchy is
sometimes spelled with a K,
sometimes with a CH, I don't
know what the right way to
spell it is.
But anyway, you have autarchy.
So the US-- imagine the old days
where we produced all our
roses and we're at some
equilibrium with some consumer
surplus and producer surplus.
So we produce Q sub A roses
at a price p sub A.
Now, in figure 19-4 we're
going to introduce
international trade.
It's a little confusing, so
let's go through it slowly.
Figure 19-4.
You can find on that figure the
domestic supply and the
domestic demand.
And they intersect at point A.
Figure 19-4, domestic supply
and domestic demand intersect
at A. Which is once again a
quantiy of Q sub A and
a price of P sub a.
Now let's say that what happens
is we now allow
imports of roses.
We now trade with Colombia
for roses.
What that does is that means now
instead of just drawing on
the domestic supply, we
can now draw on the
world's supply of roses.
We don't have to just rely
on domestic supply.
Well, that by definition has
shifted further out.
And it's shifted further out
because other countries
countries can produce roses so
much more cheaply than we can.
So we can rely on the world's
supply of roses.
Remember my cotton example where
you first buy from the
cheapest country, then the next
cheapest country, et cetera.
This is what we're saying--
if the US was the cheapest
producer of roses, this
wouldn't shift out.
But since the US is not the
cheapest producer of roses
this shifts out to
world supply.
And we get to a new
equilibrium at
quantity C sub t.
That's the new quantity
of roses we consume.
And a lower price P sub w.
The horizontal line's a little
distracting, actually.
But basically what you have
here-- the horizontal line is
just showing the price in
autarchy and the world price.
But the bottom line is, what
you get you get is you get
this new equilibrium with
a quantity C sub t and
a price P sub w.
And in particular, what we're
seeing is that total domestic
consumption of roses
has increased.
But domestic production
has fallen.
Because look, the new price
intersects the supply
curve at Q sub t.
So what happens is at that new
lower price P sub w, US rose
producers aren't actually
producing as much.
So US domestic production falls
from Q sub a to Q sub t.
But US consumption rises from
Q sub a to C sub t.
The difference is imports.
Production falls from
Q sub a to Q sub t.
Consumption rises from
Q sub a to C sub t.
The difference is imports.
And that's what happens
when we allow
Colombia to send us roses.
What are the welfare
implications of that?
Let's go to figure 19-5.
And what you can see is we
can show you the welfare
implications.
Previously consumer surplus was
W. Producer surplus was X
plus that other white triangle
below X. Now what's happened?
Consumer surplus has gone up by
X, because consumers have
gained that plus z.
So consumers have gained that
entire trapezoid, X plus Z.
Producers have lost x.
Producers have lost that
trapezoid, X. So in total
we've gained Z. We've gained
that entire triangle, Z. Z is
the entire triangle on both
sides of the dashed line.
So we've gained all of Z.
Consumers gained X plus Z,
producers lost X. We've gained
Z. So overall we've increased
welfare in the US.
So basically consumers
win, producers lose.
And that's the problem.
The political problem we have.
And I'll come back to this.
What you can see is consumers
win, producers lose.
But by definition, consumers win
more than producers lose.
So overall, social surplus
has gone up.
Now that's the case
of imports.
Now what about exports?
Well if imports make
us better, do
exports make us worse?
We just said imports
make us better.
What about exports?
Well let's look at that
in figure 19-6.
Now figure 19-6 shows what
happens with exports.
Once again we start at point A,
the domestic outcome, point
A. And now we're talking
about computers.
So now the US is going
to export computers.
What that means is that the
supply of computers to people
in the US is going to fall.
why?
Because a bunch of them are
going to get sent away.
So it used to be US consumers
got to consume on that
domestic supply--
so US producers used domestic
supply curve.
And we had domestic demand
intersecting at A. Well now,
domestic producers are shipping
a bunch of the
computers to Japan, and
China, and Colombia.
As a result, the supply
has shifted in.
Because they don't have
as many computers
to sell in the US.
That means the price rises.
So because of exports we pay
more for our computers.
And it sort of makes
sense, right?
They produce a bunch
of computers.
If there's been a great demand
for them elsewhere and we want
them too, we're going to have
to pay a higher price.
Because we're competing
with other
people for those computers.
So now that supply curve
has shifted up.
And now we end up that US
consumers only want to C sub t
computers at a new higher
price a P sub w.
But the world is now saying,
well we are interested in the
total amount of computer
we want is Q sub t.
So what that world
price of sub w--
the domestic producers say
great, at that higher price P
sub w, I'm delighted to produce
Q sub t computers.
So what I'm going to do is I'm
going to produce Q sub t, I'm
going to ship Q sub t minus
C sub t elsewhere.
And US consumers will
consume C sub t.
So consumers are worse off.
So unlike imports which make
consumers better off,
consumers are worse off.
So is trade bad?
Well, no.
Trade's not bad.
But the bottom line is, domestic
producers are going
to gain more than domestic
consumers lose.
The bottom line is we'll be
better off from exports.
But in this case, consumers
lose and producers win.
Society gains either way.
Society gains from imports
because consumers gain more
than producers lose.
Society gains from exports.
Because producers gain more
than consumers lose.
So what that means is that any
form of trade is going to make
the US better off.
But also inevitably
create losers.
Any form of trade will make
the US better off but
inevitably create losers.
And the problem is that those
losers are very loud in the
political process.
And the winners are
not so loud.
So, for example, if you polled
US consumers and said, how
much are you saving on
your sweat shirts?
Because we import textiles
from China.
They wouldn't know.
I mean they'd say a
couple bucks what
in fact it's maybe--
they'd say I don't know, 10% of
the price when it's maybe
more like 50% of the price.
But if you polled US textile
manufacturers, or guys who
have left the business, and
said how much did you lose
because of imports of China,
they'd tell you exactly how
much they lost. They'd tell
you 10 times as much.
But they know how much they
lost. And they go to their
politicians and they say, hey
we're losing jobs here.
And the consumers don't come
saying, hey I'm getting
cheaper sweatshirts here.
As a result, there's huge
political backlash against
imports in particular.
So that leads to policies
which limit imports into
countries like the US.
Like tariffs, which are
essentially taxes.
Tariffs, which are essentially
taxes on goods imported into
the US to us.
Which are taxes on goods that
are imported into the US.
Or quotas, which are limits
on how much companies
can send to the US.
What I think what you should
know now is by definition--
since I said free trade
is good, these things
are going to be bad.
And they're going to be bad--
things like tariffs are going
to be bad because they're
going to hurt US consumers more
than they're going to
help US producers.
So to see that let's
go to figure 19-8.
Let's show what happens
with a tariff.
This is saying that now we're
starting the world with trade.
So the world with trade we're
producing C sub 1, which is
where domestic demand equals
world supply at
a price P sub w.
That's where we were
with trade.
Now the US government comes
in and levies a tariff.
And says that that tariff is
going to be the difference
between P sub w and P sub t.
So that's the amount
of the tariff.
They are going to raise the
price essentially to P sub t.
They're essentially going to
levy a tax on roses that come
in from Colombia.
What that does is that means
that consumers now, at that
higher price, only want
C sub 2 roses.
That's where that intersects
demand.
So they wanted C sub 1 roses
without the tariff.
But now with the tariff at that
higher price intersects
demand at C sub 2, they only
want C sub 2 roses.
Producers, given that they have
to pay the tariff, are
only going to produce Q sub 2.
Domestic producers are now going
to produce Q sub 2 roses
because they get
a higher price.
So domestic consumers
are consuming less.
Domestic producers are
producing more.
Right, because now that
price is higher.
So now you could reopen those
heated greenhouses because
it's worth it now.
And we end up with a much
smaller amount of imports.
So in that sense the
tariff worked.
So in the sense that the goal
of the tariff was to reduce
imports, it worked.
Consumers wanted less
from Colombia.
Producers were happy
to produce more.
So imports fell.
So in that sense
tariffs worked.
They've lowered imports.
But what do they
do to welfare?
Well that's our final
figure 19-9.
What do they do to welfare?
Well what you can see is
domestic producers gained a
trapezoid A. Their producer
surplus, which used to be that
little white triangle below A,
became that entire triangle
that includes A and the
white part below it.
So their producer surplus became
A. They gained A in
producer surplus.
But consumers lost a ton.
They lost the entire trapezoid
A plus B plus C plus D. They
lost that entire trapezoid
gone up to higher prices.
And now we have one other
player which is the
government.
The government made
some money.
This is a tax.
How much did the government
make?
Well we taxed all imports
by the amount P sub
t minus P sub w.
So the government made the
rectangle C. The government
made C because we got
to tax all the
important at that tariff.
So on net, society as a whole
is worse off by B plus D.
Consumers have lost the entire
A plus B plus C plus D.
Producers got some of that, the
government got some of that.
But some of it's dead
weight loss.
Trades that would have made
consumers better off, and
worldwide producers better off
that are not happening.
So this tariff, it
had its effect.
It lowered imports.
But at the same time it lowered
social surplus.
So restrictions on trade
lower welfare.
And this is why economists
like free trade.
Because restrictions on
trade lower welfare.
Are there questions
about that?
Moreover, this is just what
we call static analysis.
What else could happen if the
US government voted a tariff
on roses coming from Colombia?
What else might happen?
Yeah?
AUDIENCE: Colombia might vote
for a tariff on the U.S.
PROFESSOR: Columbia might vote
for a tariff against computers
coming from the US.
Which of course would hurt
Colombian consumers.
But would also hurt
US producers.
So from the US's prospective,
that would be even worse.
So think about it--
we put a tariff on Colombian
roses which hurt us.
Then Colombia puts a tariffs on
US computers which hurts us
even further-- hurts Colombia
too, but we don't care about
them, we care about us.
It hurts us even further.
So dynamically restrictions on
trade can be even worse than
it looks in this diagram.
If they cause a trade war you
can actually end up with
things being even worse than
you look at this diagram.
So we talked about why
economists like free trade--
partly so that the gains
to consumers exceed
the losses to producers.
But partly it's because free
trade begets free trade.
And that exports make
us better off too.
So by allowing free trade not
only do we increase our
welfare by having more imports,
we also increased our
welfare by allowing
more exports.
And in fact, producers as a
class, if they could all get
together and have a cooperative
equilibrium, they
might be fine without
restrictions of trade.
Because the computer producers
and the rose producers get
together and say, wait a second,
we can trade, on net
we win from this.
On net we win from free trade.
Let's get together
and make a deal.
But of course we know that's
going to be an incredibly hard
cooperative equilibrium
to enforce.
And that's why you have
different sets of producers.
You have the rose producers
lobbying the congressmen.
Then they leave and the computer
producers walk in his
office and lobby him
the other way.
So you have producers lobbying
for different effects
depending if they're
competing with
imports or they're exporting.
They're going to lobby for and
against trade restrictions.
Moreover, there's yet another
thing we've missed.
There's yet another thing
we've missed.
So we've talked about the
dead weight loss.
We've talked about trade wars.
But let's say for a second--
let's think
about a third thing.
Let's say for a second
we're not just
heartless selfish Americans.
But we actually do care about
the rest of the world.
Well the third thing we miss
is allowing trade from
Colombia makes Colombia
better off too.
So not only have we improved
our welfare by importing
Colombian roses, we've improved
their welfare too.
And they're a poor country.
And we should be happy to
improve their welfare too.
We think about free
trade in Vietnam.
That is the application
for child labor.
By allowing the import of
Vietnamese rice we improved
the lives of the Vietnamese
children.
So independent of the fact we've
made our lives better
off we've made these
other country's
lives better off too.
So there's three reasons why
we should have free trade.
There's the simple welfare
gain, there's the dynamic
welfare gain, and there's the
fact that we might care about
the welfare of other
countries as well.
And as a result, there's been
a huge emphasis over time in
trying to increase free trade.
By economists saying this for
years, things going back to
the early economists.
But we've made a lot of headway
in the last 20 years.
And in particular, one big
source of headway was NAFTA--
The North American Free
Trade Agreement.
Which was passed
under Clinton.
Which basically demolished trade
barriers between Canada
the US and Mexico.
There used to be a lot
of trade barriers.
We would tax Canadian lumber.
They would tax our computers.
We would tax Mexican whatever
they sent to us.
They would tax our stuff.
It was a mess.
So basically NAFTA said let's
just get rid of all of it.
Let's have a cooperative
agreement.
Let's have a cooperative
agreement whereby we all agree
to get rid of trade barriers and
thereby making all of us
better off.
And it seems like it would be
a pretty simple thing to do.
But it was a mess.
And it was very hard.
And it was very hard because now
you had parties in every
country opposing this.
You had you had the
Canadian computer
producers getting upset.
You had the Mexican computer
producers getting upset.
You had the US lumber industry
getting upset.
And you had huge difficulties
because you had parties in
every case opposing it.
And the reason free trade
agreements are so difficult--
now eventually NAFTA did pass.
And has been by most measures
a huge success.
But ultimately the major
difficulty here is in another
failure of government policy.
Which is the inability of the
government to effectively tax
the winners and compensate
the losers from
international trade.
That is--
if the government could
work as a perfect--
in the way that I design
it to work--
what would happen is that we
would tax sweatshirts and take
the money from taxing
sweatshirts and send it to
compensate the guys who lost
jobs in the textile industry.
And if we did that, we can make
life much better off than
with the tariff.
So if consider two outcomes.
One is we don't import
Chinese sweatshirts.
The other is that we import them
but we levy a small tax
on all sweatshirts not just
Chinese lectures.
Levy a small tax on
all sweatshirts.
We import Chinese sweatshirts
but then we levy a tax on all
sweatshirts.
And we use that sweatshirt tax
money to pay off the guys who
lost their jobs in the
textile industry.
That would be better for society
than would not allow
sweatshirts to come in
in the first place.
So the fundamental failure in
trade policy ultimately is a
failure is that inability of the
government to effectively
compensate the losers by
taxing the winners.
Because just as the losers know
to go to lobby Congress,
the winners will get pissed
off if you start taxing
sweatshirts.
Because they don't realize that
they're saving all this
money from all these imports.
And in fact the typical American
voter would probably
vote to block Chinese imports
before they'd vote to have a
tax on their sweatshirts.
So really in some sense when you
have a very concentrated
set of winners or losers
competing against a very
concentrated set of losers,
defeating against a very
diffuse set of winners, that's a
hard policy to get in place.
Unless you can figure out a way
to get those winners to
compensate the losers.
And that's the tricky thing.
Are there question about that?
About free trade agreements,
things like that?
Now what I want to talk about
for a couple minutes then one
subtlety in these free
trade agreements.
And why things like
NAFTA are hard.
And the reason they're
hard is because this
makes enormous sense.
Free trade agreements make
enormous sense if it's true
comparative advantage like
Canada has more trees.
But what if Mexico's source of
comparative advantage is that
they treat their workers
like shit.
What if China's source of
comparative advantage is that
they have incredibly bad
working conditions?
And they have incredibly bad
environmental conditions?
China has an incredibly bad
environmental situation.
It is incredibly dangerous
just to live in
major Chinese cities.
The working conditions
are awful.
The wages are terrible.
Nonetheless, the result is
very, very cheap labor.
Then things get a
little dicier.
Because if the Chinese labor was
cheap or Mexican labor was
cheap just because inherently
that was just
the way life was.
At the same working conditions
and the same environmental
conditions they were just
cheaper, then that's great.
That's the comparative
advantage.
But if they're cheap because
they exploit their population
and put them in horrible working
conditions and facing
horrible environmental
conditions, then the welfare
gets a little trickier.
From the US's prospective it
doesn't get any trickier.
The US--
our welfare is exactly
the same.
We get these static and dynamic
gains from trade.
But from a world perspective,
now we're maybe not so sure we
want to promote Mexico producing
more clothes or
China producing more clothes.
Because it could just lead to
more exploitation of the
population.
So this comes back to when I
talked about free trade in
Vietnam and child labor.
Which is if free trade actually
let to an increased
use of child labor in Vietnam we
might worry that gee maybe
this isn't such a good thing.
So really what it comes down
to is we have to think not
just about the simple
dead weight loss
triangles and squares.
We have to think about some
broader social issues as well.
And once again there is
a right answer here.
And this is what a lot was
fought over with NAFTA.
Which is one of the conditions
for NAFTA was the US actually
lobbied and got significantly
improved work and
environmental standards
in Mexico.
This was like an opposite
of a trade war.
Instead of being a vicious
cycle, this
was a virtuous cycle.
We actually improved the life
for workers in Mexico because
Mexico is willing to do that in
order to get the benefits
of trade with the US.
So just like limiting trade with
Mexico will hurt us and
hurt Mexico, expanding trade
with Mexico and then tying it
to improve work conditions and
environmental conditions can
make both countries really
much better off.
And so that's where, once again,
trade becomes very
interesting.
And why it's worth
studying further.
Because it's not as simple
as these boxes.
It's thinking about
where comparative
advantage comes from.
And whether we really want to
promote trade with countries
that have comparative advantage
depending on the
source of what that comparative
advantage is.
And that's sort of
the free trade
versus fair trade argument.
The bottom line in
that argument--
the free trade versus fair trade
argument-- the bottom
line is free trade is
always a good thing.
But fair trade considerations
can be used to try to make it
work better than just simply
unfettered free trade.
And so really both sides have
a point in this debate.
So let me stop there.
That's international trade.
We're going to come back on
Wednesday to talk about
uncertainty and whether you
should play the lottery.
