1st unbundling key concepts Flashcards
Demand and supply
- Demand is the quantity of goods consumers are willing to purchase for a given price. It results from consumers maximizing their utility (=happiness) subject to their budget constraint
- Supply is the quantity of a good producers are willing to sell for a given price. It results from producers maximizing their profits (=sales - costs)
- -The equilibrium occurs when demand = supply: at the equilibrium price, producers are willing to sell the same quantity that consumers want to buy, the equilibrium quantity
- -Changes in the supply or demand will have an effect on the equilibrium. For instance, a bad year of crops (due to climatic conditions) will result in a lower supply and a higher equilibrium price. Similarly, a sudden increase in taste for a good by consumers will push the price and the quantity upwards.
Infant-Industry Argument
- Infant-Industry Argument (Import-substitution industrialization): This policy aims at protecting domestic industries until they get competitive on the world market
- -Until then, tariffs are imposed on imports
- –Ad valorem tariff: tax expressed as a % of the purchasing price
- –Specific tariff: tax expressed in $ per unit (per lb, piece, gallon)
- -Tried by many countries across times
- -Criticized for many reasons. For instance, why not target directly the source of the problem? (Financing? Lack of entrepreneurship? Training?)
Government should protect industries that are growing until they are competitive enough for the global market. To do this they impose tariffs on imports
Comparative Advantage
-Comparative advantage: A firm/country has a comparative advantage in the production of a good over another firm/country if it’s opportunity cost of producing that good is lower
- A comparative advantage can come from multiple sources: abundance in natural resources, endowment in puts (land, labour, physical and human capital), increasing returns to scale, institutions
- Canada has a comparative advantage in producing wheat, lumber, oil, chemicals because of its abundance in land and natural resources
- the US have a comparative advantage in producing capital-intensive goods because it’s capital-abundant
Opportunity Cost
Opportunity cost: The opportunity cost of choosing an alternative is the value of the next best alternative that was given up
- Example: the opportunity cost of one hour of leisure is the hourly wage one could earn by working instead of having fun
- The opportunity cost of consuming today is the interest rate one could gain by saving that money until tomorrow
Purchasing something today has OC, interest rate of not buying this good and keeping the money in the bank
Economies of scale (internal and external)
-Economies of Scale: A firm/industry experiences economies of scale if the average cost of production, AC (q) = C(q) / q, decreases as q increases. Two cases:
-Internal economies of scale: occur when average cost at firm level decreases when quantity produced increases
Ex: Amazon: Large one time fixed cost gets paid for, or learning by doing
-External economies of scale: occur when average cost of production of all the firms in a country/region/city decreases when the quantity produced in the area increases
Ex: Tech industry in silicon valley: Concentration of expertise or exchange of ideas
- -New firms typically experience economies of scale: with few employees, any extra employee is very productive and the average cost of producing more units decreases
- -After some point, the AC increases as firms get big, plants reach capacity, and coordination of the production process is more difficult
Roles of The GATT (now WTO)
- It is a multilateral forum aimed at negotiating freer trade and avoid/restrict the use of non-tariff barriers. It also requires to declare export subsidies
- It is based on the fundamental principle of “non-discrimination”:
- The “most favored nation” clause: every country belonging to GATT/WTO must be treated the same. If a country belonging to GATT/WTO must be treated the same. If a country benefits from a lower tariff, all members should benefit too (exceptions allowed if the goal is free trade)
- “National treatment”: once a product has crossed the border, it should be treated “no less favourably” than a domestic product - Binding tariff schedules: once tariffs have been negotiated, they should not be increased - “Binding” means you cannot cancel easy
- Tariffs can be temporarily raised for specific products in particular situations:
- In reaction to foreign subsidies creating injuries in a domestic industry
- When a surge in imports creates serious injury to domestic products
Formula tariff cuts
Instead of negotiating each tariff rate, a formula is negotiated and applies to all tariff rates under consideration
-Linear tariff cut: a % cut is negotiated and the cut is applied to all existing rates
-Nonlinear tariff cut: more than one tariff cut is negotiated. For instance, 30% cut for tariffs less than 20% and 50% cut for tariffs higher than 20%
-The “Swiss Formula”: tnew = A x told / A + told ;
And A is negotiated. Assume A = 30%
If told = 45%, then tnew = 18%
If told = 20% then tnew = 12%
If told = 10% then tnew = 7.5%
Cuts higher rates more. Main advantage: only A needs to be negotiated!
Regional trade agreements
- Regional trade agreement (RTA: Treaty between two or more governments that define the rules of trade for all signatories.There are two types of regional agreements:
- Two types of regional agreements:
- -Free trade area: free trade among members. Every member keeps its own tariff schedule with respect to non members (eg NAFTA)
- -Custom union: free trade among members with common tariff schedule with respect to non members (eg EEC, now EU)
- Regional agreements are discriminating: free among members, costly to non members
- Can be costly to members too if there is trade diversion or no trade creation
trade creation/trade diversion
- Trade creation: creation of new flows of international trade between members for goods/services:
- -New imports benefiting domestic consumers and new exports benefiting domestic firms
- -Both members gain from new trade and the volume of trade increases
- Trade diversion: trade increases between two members but at the expense of trade with a non member
- -Eg: Canada imported a good from Korea before NAFTA. Now it is imported from Mexico, a NAFTA member
- -It can divert trade to a less efficient producer of a good (korea was more efficient than Mexico)
- -Trade diversion may make RTA members worse off!
Non-tariff barriers and countervailing measures
Non-tariff barriers: Barriers to trade other than tariffs such as:
- Quotas: quantitative restrictions (cannot import more than a specific number of units/tons)
- Anti-dumping: process through which domestic firms ask governments to investigate whether specific foreign firms “dump” (sell below fair price”
- Domestic procurement policies: purchases by governments restricted to domestic firms
- Other: subsidies, technical barriers, import licensing procedures, etc.
-Countervailing measures are used to offset the effect of a country subsidizing a good it exports: if an exported good is subsidized by its country, foreign countries have a right to impose a tariff on that equal to the rate at which it is subsidized. It is called a countervailing duty
Effect of a tariff on domestic country
- A tariff raises domestic prices: Pd = (1 + t)Pw where Pw is the world price
- It helps import-competing industries (eg Canadian dairy farmers if there is a tariff on foreign milk)
- Harms consumers as demand is downward sloping
- The government earns a revenue equal to the tariff x import levels
Good for domestic producers (Local farmers happy with tariff)
Harms consumers: Gov’t earns revenue; these tariffs imply DWL
Prisoners Dilemma
- Countries are stuck in a prisoner’s dilemma if they don’t negotiate a joint binding agreement
- Thus the US prefers “Protectionism” irrespective of what Canada chooses: “Protectionism” is a dominant strategy for the US in this example
- And vice versa for Canada
- Only way to break the dilemma; cooperate and agree to a binding agreement (hence NAFTA, EU, GATT/WTO)
