econ 2301 dr. jacobson mr. stuckey week 4 chapters 4 & 5
TRANSCRIPT
Econ 2301Econ 2301
Dr. JacobsonDr. Jacobson
Mr. StuckeyMr. Stuckey
Week 4 Chapters 4 & 5Week 4 Chapters 4 & 5
Chapter 4Chapter 4
Price Controls and Price Controls and Quotas: Modeling With Quotas: Modeling With
MarketsMarkets
Governmental Policies Governmental Policies Effect Us All. Whether Effect Us All. Whether
It Be a For Profit or It Be a For Profit or Non-Profit Businesses, Non-Profit Businesses,
An Organization, or An Organization, or Simply as Individuals.Simply as Individuals.
Controls on PricesControls on Prices
Price CeilingsPrice CeilingsPrice FloorsPrice FloorsTaxesTaxes
Price CeilingPrice Ceiling
A legal Maximum On A legal Maximum On The Price At Which a The Price At Which a Good Can Be Sold.Good Can Be Sold.
In Chapter 3 We Looked at In Chapter 3 We Looked at Supply and Demand Supply and Demand Combined and We Combined and We
Discussed The Point Called Discussed The Point Called Equilibrium.Equilibrium.
We Looked at What We Looked at What Occurred Above and Below Occurred Above and Below
The Equilibrium Point in The Equilibrium Point in Terms of Supply and Terms of Supply and
Demand.Demand.
In Simplest Terms On Any In Simplest Terms On Any Given Graph of Supply and Given Graph of Supply and
Demand One of Three Demand One of Three Situations ExistSituations Exist
In Simplest Terms On Any Given In Simplest Terms On Any Given Graph of Supply and Demand One Graph of Supply and Demand One
of Three Situations Can Exist:of Three Situations Can Exist:
1. 1. There Can Be Equilibrium. A Price Where There Can Be Equilibrium. A Price Where The Buyers Can Buy All They Want and The Buyers Can Buy All They Want and The Sellers Can Sell All They Want.The Sellers Can Sell All They Want.
2.2. There Can Be a Shortage. A Price Where There Can Be a Shortage. A Price Where The Buyers Want to Buy More Than The The Buyers Want to Buy More Than The Sellers Are Willing to Sell.Sellers Are Willing to Sell.
3.3. There Can Be a Surplus. A Price Where There Can Be a Surplus. A Price Where Sellers Are Willing To Sell More Than Sellers Are Willing To Sell More Than Buyers Want to Buy.Buyers Want to Buy.
Important Note:Important Note:
Whether The Price of a Whether The Price of a Good or Service Is Above Good or Service Is Above or Below The Equilibrium or Below The Equilibrium Point Determines If There Point Determines If There Is a Surplus or Shortage.Is a Surplus or Shortage.
EquilibriumEquilibriumP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
Supply
S1
Demand
D1
Equilibrium
Surplus
Shortage
ShortageShortage
Is a Situation In Which Is a Situation In Which The Quantity Demanded The Quantity Demanded
Is Greater Than The Is Greater Than The Quantity Supplied At a Quantity Supplied At a
Given Price.Given Price.
ShortageShortageP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
---------------------------------------
----
----
----
----
----
----
----
-
Supply
S1
Demand
D1
Equilibrium
-----------------------------------------------
----
----
----
----
----
--
----
----
----
----
----
--
Quantity Demanded
Quantity
Supplied
Shortage
What Then Are The What Then Are The Effects of A Effects of A Price CeilingPrice Ceiling in Relation To The Price in Relation To The Price of Goods or Services?of Goods or Services?
Price CeilingPrice CeilingP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
---------------------------------------
----
----
----
----
----
----
----
-
S1
Supply
Demand
D1
Equilibrium
-----------------------------------------------
----
----
----
----
----
--
----
----
----
----
----
--
Quantity Demanded
Quantity
Supplied
Shortage
Price Ceiling Not Binding
Price CeilingPrice CeilingP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
---------------------------------------
----
----
----
----
----
----
----
-
S1
Supply
Demand
D1
Equilibrium
-----------------------------------------------
----
----
----
----
----
--
----
----
----
----
----
--
Quantity Demanded
Quantity
Supplied
Shortage
Price Ceiling Is Binding
Therefore a Binding Therefore a Binding Price Ceiling Causes Price Ceiling Causes
A Shortage.A Shortage.
Therefore When the Therefore When the Government Imposes a Government Imposes a
Binding Price Ceiling On a Binding Price Ceiling On a Competitive Market, A Competitive Market, A Shortage of The Good Shortage of The Good
Arises, and Sellers Must Arises, and Sellers Must Ration The Scarce Goods Ration The Scarce Goods Among The Large Number Among The Large Number
Of Potential Buyers.Of Potential Buyers.
Why and Where Why and Where Would The Would The
Government Want Government Want To Impose a Price To Impose a Price
Ceiling?Ceiling?
Places for Price CeilingsPlaces for Price Ceilings
Gasoline (1973)Gasoline (1973) Rent ControlRent Control Flu ShotsFlu Shots MedicinesMedicines Interest RatesInterest Rates TaxesTaxes
Now Let Us Look At Now Let Us Look At The Other Side of The Other Side of
The Spectrum, The Spectrum, SurplusSurplus..
SurplusSurplus
Is a Situation In Which Is a Situation In Which Quantity Supplied is Quantity Supplied is
Greater Than Quantity Greater Than Quantity Demanded at a Given Demanded at a Given
Price.Price.
EquilibriumEquilibriumP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
---------------------------------------
----
----
----
----
----
----
----
-
Supply
S1
Demand
D1
Equilibrium
-----------------------------------------------
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
---
Quantity Demanded
Quantity
Supplied
Surplus
Price FloorPrice Floor
A Legal Minimum On A Legal Minimum On The Price At Which a The Price At Which a Good Can Be Sold.Good Can Be Sold.
The Government May The Government May Also Impose a Legal Also Impose a Legal
Minimum On The Price of Minimum On The Price of Goods or Services. Goods or Services.
Because The Price Cannot Because The Price Cannot Fall Below This Level, The Fall Below This Level, The
Legislated Minimum Is Legislated Minimum Is Called a Called a Price FloorPrice Floor..
What Then Are The What Then Are The Effects of A Effects of A Price FloorPrice Floor in in Relation To The Price of Relation To The Price of
Goods or Services?Goods or Services?
Price FloorPrice FloorP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
---------------------------------------
----
----
----
----
----
----
----
-
Supply
S1
Demand
D1
Equilibrium
-----------------------------------------------
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
----
---
Surplus
Price Floor Not Binding
Price FloorPrice FloorP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10
---------------------------------------
----
----
----
----
----
----
----
-
Supply
S1
Demand
D1
Equilibrium
-----------------------------------------------
Surplus Price Floor That Is Binding
Therefore a Binding Therefore a Binding Price Floor Causes a Price Floor Causes a
SurplusSurplus
Therefore When the Therefore When the Government Imposes a Government Imposes a Binding Price Floor On a Binding Price Floor On a Competitive Market, A Competitive Market, A
Surplus of the Good Arises, Surplus of the Good Arises, and The Buyers Must and The Buyers Must
Decide Which Goods to Buy, Decide Which Goods to Buy, Among The Large Number Among The Large Number
Of Goods or Potential Of Goods or Potential Sellers.Sellers.
Why and Where Why and Where Would The Would The
Government Want Government Want To Impose a Price To Impose a Price
Floor?Floor?
Places for Price FloorsPlaces for Price Floors Minimum WageMinimum Wage Legal ServicesLegal Services Certain Occupations (Youth, Certain Occupations (Youth,
Seniors)Seniors) Farm ProductsFarm Products Tariffs Tariffs Taxes Minimum Alternative TaxTaxes Minimum Alternative Tax
Wage and Price ControlsWage and Price Controls
In 1971 Under President In 1971 Under President Nixon the Government Nixon the Government Instituted A Mandatory Instituted A Mandatory
Wage and Price Freeze In Wage and Price Freeze In Order To Combat Order To Combat
Inflation.Inflation.
SubsidiesSubsidies Housing Help Pay Portion of Housing Help Pay Portion of
Rent.Rent. Wage Pay Portion of a Persons Wage Pay Portion of a Persons
Salary.Salary.Earned Income Tax CreditEarned Income Tax CreditOn-The-Job TrainingOn-The-Job Training
Education ( Student Loans)Education ( Student Loans)
Government Policy Government Policy As It Relates To As It Relates To
Taxes.Taxes.
TAXES AND EFFICIENCYTAXES AND EFFICIENCY
Policymakers have two Policymakers have two objectives in designing a objectives in designing a tax system...tax system...
Efficiency Efficiency EquityEquity
TAXES AND EFFICIENCYTAXES AND EFFICIENCY
One tax system is more One tax system is more efficientefficient than another if it raises the same than another if it raises the same amount of revenue at a smaller cost amount of revenue at a smaller cost to taxpayers. to taxpayers.
An An efficientefficient tax system is one that tax system is one that imposes small deadweight losses imposes small deadweight losses and small administrative burdens. and small administrative burdens.
TAXES AND EFFICIENCY TAXES AND EFFICIENCY
The Cost of Taxes to TaxpayersThe Cost of Taxes to Taxpayers The tax payment itselfThe tax payment itself Deadweight lossesDeadweight losses Administrative burdensAdministrative burdens
Deadweight LossesDeadweight Losses
Because taxes distort incentives, Because taxes distort incentives, they entail deadweight losses.they entail deadweight losses. The deadweight loss of a tax is the The deadweight loss of a tax is the
reduction of the economic well-reduction of the economic well-being of taxpayers in excess of the being of taxpayers in excess of the amount of revenue raised by the amount of revenue raised by the government.government.
Administrative BurdensAdministrative Burdens
Complying with tax laws creates Complying with tax laws creates additional deadweight losses. additional deadweight losses. Taxpayers lose additional time and Taxpayers lose additional time and
money documenting, computing, and money documenting, computing, and avoiding taxes over and above the avoiding taxes over and above the actual taxes they pay.actual taxes they pay.
The administrative burden of any tax The administrative burden of any tax system is part of the inefficiency it system is part of the inefficiency it creates. creates.
TaxesTaxes
Are Used To Raise Are Used To Raise Revenue For Public Revenue For Public Projects, Such as Projects, Such as
Roads, Schools, and Roads, Schools, and National Defense.National Defense.
Tax IncidenceTax Incidence
Is The Manner In Is The Manner In Which The Burden of Which The Burden of Tax Is Shared Among Tax Is Shared Among
Participants In a Participants In a Market.Market.
Tax IncidenceTax Incidence
Refers to The Refers to The Distribution Of The Distribution Of The
Tax Burden. Tax Burden.
The Question The The Question The Government Must Government Must
Answer, Is Who (and Answer, Is Who (and How) They Are How) They Are
Going To Tax and Going To Tax and How Much?How Much?
This Question Has As This Question Has As Much Impact On The Much Impact On The
Individuals and Individuals and Companies Within a Companies Within a Nation As It Does On Nation As It Does On
The Government.The Government.
Let Us Look at The Let Us Look at The Government Tax Government Tax
Policies In Terms of Policies In Terms of Supply and Demand.Supply and Demand.
Let Us Say a That The Let Us Say a That The Government Places a Government Places a
$1 Tax on Movie $1 Tax on Movie Tickets. Who Pays The Tickets. Who Pays The
Tax?Tax?
Step #1Step #1
The Initial Impact of The The Initial Impact of The Tax Is on The Demand For Tax Is on The Demand For Movie Tickets. The Supply Movie Tickets. The Supply
Curve is Not Affected Curve is Not Affected Because Sellers Have The Because Sellers Have The
Same Incentive To Sell Same Incentive To Sell Movie Tickets.Movie Tickets.
Therefore, Initially The Therefore, Initially The Buyers Have to Pay The Tax Buyers Have to Pay The Tax To The Government As Well To The Government As Well As The Price to The Sellers. As The Price to The Sellers. This Causes a Shift In The This Causes a Shift In The
Demand Curve.Demand Curve.
Step #2Step #2
We Need To Determine We Need To Determine The Direction of The The Direction of The Shift. The Tax Makes Shift. The Tax Makes
Movie Going Less Movie Going Less Attractive, Therefore The Attractive, Therefore The
Demand Curve Shifts Demand Curve Shifts Downward By The Downward By The
Amount of The Tax.Amount of The Tax.
EquilibriumEquilibriumP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 30 90 100
Supply
S1
Demand
D1
Equilibrium
Without Tax
D2
Equilibrium With Tax
Tax Shifts Demand Curve By Size Of Tax
Price Buyers Pay
Price Without Tax
Step #3Step #3
The Effect of The Tax Can The Effect of The Tax Can Be Seen In Comparing Be Seen In Comparing The Old Equilibrium The Old Equilibrium
($2.00) With The New ($2.00) With The New Equilibrium ($1.50).Equilibrium ($1.50).
What We See Is That What We See Is That Because of The Tax, The Because of The Tax, The Movie Theater Has Lost Movie Theater Has Lost Patrons. Because Movie Patrons. Because Movie
Theater’s Also Make Theater’s Also Make Revenue on Concessions Revenue on Concessions They May Want to Pay They May Want to Pay
Some of The Tax.Some of The Tax.
Therefore, If The Movie Therefore, If The Movie Theater Wants Recover Theater Wants Recover Some of Its Lost Patrons Some of Its Lost Patrons
(Essentially Return to The (Essentially Return to The Original Demand Original Demand
Schedule) It Needs To Schedule) It Needs To Share In The Cost of The Share In The Cost of The
Tax.Tax.
EquilibriumEquilibriumP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 90 100
Supply
S1
Demand
D1
Equilibrium
Without Tax
D2
Equilibrium With Tax
Tax Shifts Demand Curve By Size Of Tax
Price Buyers Pay
Price Sellers Receive
Price Without Tax
We See From This We See From This Example That In A Example That In A
Situation Where The Tax Situation Where The Tax Could Be Picked Up Could Be Picked Up
Entirely By the Buyer The Entirely By the Buyer The Seller Also Has A Stake In Seller Also Has A Stake In The Overall Effect Of The The Overall Effect Of The
Tax.Tax.
Let Us Look At Another Let Us Look At Another Example Where The Example Where The
Government May Place a Government May Place a Tax Directly On Tax Directly On
Employers For Each Item Employers For Each Item They Sell.They Sell.
Again Let Us Consider Again Let Us Consider That The Tax Imposed By That The Tax Imposed By The Government Is $1.00 The Government Is $1.00
For Each Ticket Sold. For Each Ticket Sold. What Are The Effects Of What Are The Effects Of
This Law?This Law?
Step #1Step #1
In This Case The Tax Is In This Case The Tax Is Imposed On The Sellers Imposed On The Sellers
Therefore The Demand Curve Therefore The Demand Curve Does Not Change, But The Tax Does Not Change, But The Tax Makes The Movie Tickets Less Makes The Movie Tickets Less
Profitable At Any Price. Profitable At Any Price. Therefore We Have A Shift In Therefore We Have A Shift In
The Supply Curve.The Supply Curve.
EquilibriumEquilibriumP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 90 100
Supply
S1
Demand
D1
Equilibrium
Without Tax
S2
Equilibrium With Tax
Tax Shifts Supply Curve By Size Of Tax
Price Buyers Pay
Price Sellers Receive
Price Without Tax
Step #2Step #2
Because The Tax Raises The Because The Tax Raises The Sellers Cost, It Reduces The Sellers Cost, It Reduces The Quantity Supplied At Every Quantity Supplied At Every Price, So The Supply Curve Price, So The Supply Curve Shifts To The Left In The Shifts To The Left In The
Amount of The Tax.Amount of The Tax.
Step #3Step #3
After The Shift of The After The Shift of The Supply Curve We Again See Supply Curve We Again See That The Initial Equilibrium That The Initial Equilibrium Has Changed From $2.00 To Has Changed From $2.00 To
$2.50.$2.50.
EquilibriumEquilibriumP
rice
Quantity
P
Q
$3.00
2.50
2.00
1.50
1.00
.50
0 90 100
Supply
S1
Demand
D1
Equilibrium
Without Tax
D2
Equilibrium With Tax
Tax Shifts Demand Curve By Size Of Tax
Price Buyers Pay
Price Sellers Receive
Price Without Tax
Again The Buyers and Again The Buyers and The Sellers End Up The Sellers End Up Sharing The Cost of Sharing The Cost of The Tax. The Tax The Tax. The Tax
Reduces The Size of Reduces The Size of The Market.The Market.
In Both Cases The Tax In Both Cases The Tax Changes The Equilibrium Changes The Equilibrium
Point Either Through A Shift Point Either Through A Shift In The Demand or Supply In The Demand or Supply
Curve. The Results In Curve. The Results In Either Case Are The Same.Either Case Are The Same.
Elasticity and Tax Elasticity and Tax IncidenceIncidence
In The Last Chapter In The Last Chapter We Examined We Examined
Elasticity As It Applied Elasticity As It Applied To Both The Demand To Both The Demand and Supply Curves.and Supply Curves.
When A Good Is Taxed, When A Good Is Taxed, Buyers And Sellers Share Buyers And Sellers Share
The Tax Burden. Only The Tax Burden. Only Rarely Is It Shared Rarely Is It Shared
Equally, So How Then Is Equally, So How Then Is The Tax Burden Really The Tax Burden Really
Divided?Divided?
RememberRemember That Elasticity of Either That Elasticity of Either
Supply or Demand Is Supply or Demand Is Measured By the Measured By the
Willingness of Either Buyers Willingness of Either Buyers (Demand Elasticity) or (Demand Elasticity) or
Sellers (Supply Elasticity) Sellers (Supply Elasticity) To Leave The Market When To Leave The Market When
Conditions Become Conditions Become Unfavorable.Unfavorable.
A Tax Burden Falls A Tax Burden Falls More Heavily On The More Heavily On The Side Of The Market Side Of The Market That Is Less ElasticThat Is Less Elastic
This Makes Sense As The This Makes Sense As The More Elastic, The More More Elastic, The More Willing The Buyer Or Willing The Buyer Or
Seller Is To Move Away Seller Is To Move Away From or To Produce The From or To Produce The
Product Due To Price Product Due To Price Increases or Decreases.Increases or Decreases.
Elastic Supply, Inelastic Elastic Supply, Inelastic DemandDemand
Pri
ce
Quantity
P
Q
Supply
S1
Demand
D1
The Incidence of Tax Falls More Heavily On Consumers
TAX
Price Buyers Pay
Price Without TaxPrice Sellers Receive Tax
Incidence on Sellers
Inelastic Supply, Elastic Inelastic Supply, Elastic DemandDemand
Pri
ce
Quantity
P
Q
Supply
S1
Demand
D1
The Incidence of Tax On ConsumersTAX
Price Buyers Pay
Price Without TaxPrice Sellers Receive Tax Incidence Falls
More Heavily on Sellers
The Law of Supply and The Law of Supply and Demand Describes The Demand Describes The Way Markets Allocate Way Markets Allocate Scarce Resources. In Scarce Resources. In
Short, We Have Short, We Have Looked At What Is, Looked At What Is, Rather Than What Rather Than What
Should Be.Should Be.
We Know That The Prices of We Know That The Prices of Toys During The Holidays Toys During The Holidays
Adjusts To Ensure That The Adjusts To Ensure That The Quantity of Toys Supplied Quantity of Toys Supplied
Equals The Quantity of Toys Equals The Quantity of Toys Demanded. But At This Demanded. But At This
Equilibrium Is That Quantity Equilibrium Is That Quantity Produced and Consumed Produced and Consumed
Too Large, Too Small or Just Too Large, Too Small or Just Right?Right?
That Takes Us To That Takes Us To The Topic of Welfare The Topic of Welfare
EconomicsEconomics
Welfare EconomicsWelfare Economics
Is The Study Of How Is The Study Of How The Allocation of The Allocation of Resources Affects Resources Affects
Economic Well-Being.Economic Well-Being.
Imagine That You Have Just Imagine That You Have Just Developed A New Product Developed A New Product
and Are About To Take It To and Are About To Take It To Market. You Ask 10 People Market. You Ask 10 People What They Are Willing To What They Are Willing To Pay For The Product and Pay For The Product and
They All Give You (As They All Give You (As Expected) Different Expected) Different
Answers.Answers.
From The Information From The Information Given You By These Given You By These Ten People Can You Ten People Can You Develop A Strategy Develop A Strategy
For Pricing Your For Pricing Your Product?Product?
Let Us Explore This Let Us Explore This Question From Several Question From Several Different Approaches.Different Approaches.
Willingness To PayWillingness To Pay
Is The Maximum Is The Maximum Amount That A Buyer Amount That A Buyer Will Pay For a Good.Will Pay For a Good.
But What If, In Our But What If, In Our Example, A Person Has Example, A Person Has Told You They Will Be Told You They Will Be Willing To Pay $50 For Willing To Pay $50 For
Your Product But, Your Product But, Actually They Would Be Actually They Would Be
Willing To Pay $75.Willing To Pay $75.
Product Demand Product Demand CurveCurvePrice
Quantity
$75
$65
$55
$45
$35
$25
$15
$5
1 2 3 4 5
A
Consumer SurplusConsumer Surplus
Is The Amount A Buyer Is The Amount A Buyer Is Willing To Pay For a Is Willing To Pay For a
Good Minus The Good Minus The Amount The Buyer Amount The Buyer
Actually Pays For It.Actually Pays For It.
Consumer SurplusConsumer Surplus
Consumer Surplus =
Amount A Buyer Is Willing to Pay
Amount They Paid
Consumer SurplusConsumer Surplus
Consumer Surplus = $75 $50 = $25
Now Let Us Assume That Now Let Us Assume That Your Product Is A Your Product Is A
Painting and You Have Painting and You Have Made Two Copies. This Made Two Copies. This Time Instead of Asking Time Instead of Asking People What They Will People What They Will
Pay For Them, You Pay For Them, You Decide Auction Them Off.Decide Auction Them Off.
We Conduct The Auction We Conduct The Auction Until Two Bidders Are Left Until Two Bidders Are Left
and The Price Is At $45. Let and The Price Is At $45. Let Us Again Say That One Of Us Again Say That One Of The Two Persons Would The Two Persons Would
Have Been Willing to Pay Have Been Willing to Pay $75 For the Painting, But $75 For the Painting, But the Other Person Would the Other Person Would
Only Have Paid $50.Only Have Paid $50.
Using Our Formula for Using Our Formula for Finding Consumer Finding Consumer
Surplus We Find That The Surplus We Find That The First Person Has A First Person Has A
Consumer Surplus of $30 Consumer Surplus of $30 and The Second Person A and The Second Person A Consumer Surplus of $5 Consumer Surplus of $5
For The Same Item.For The Same Item.
Consumer SurplusConsumer Surplus
Consumer Surplus =
Amount A Buyer Is Willing to Pay
Amount They Paid
Consumer SurplusConsumer SurplusFor 1For 1stst Person Person
Consumer Surplus = $75 $45 = $30
Consumer SurplusConsumer SurplusFor 2For 2ndnd Person Person
Consumer Surplus = $50 $45 = $5
Product Demand Product Demand CurveCurvePrice
Quantity
$75
$65
$55
$45
$35
$25
$15
$5
1 2 3 4 5
A
B Price Actually Paid
Person A’s Consumer Surplus
Person B’s Consumer Surplus
Consumer Surplus Is Consumer Surplus Is Closely Related To The Closely Related To The
Demand Curve.Demand Curve.
The Area Below The The Area Below The Demand Curve and Above Demand Curve and Above The Price Measures The The Price Measures The
Consumer Surplus In The Consumer Surplus In The Market.Market.
The Area Below The The Area Below The Demand Curve and Above Demand Curve and Above The Price Measures The The Price Measures The Consumer Surplus In The Consumer Surplus In The
Market.Market.
The Reason Is That The Reason Is That The Height of The The Height of The
Demand Curve Demand Curve Measures The Value Measures The Value Buyers Place On The Buyers Place On The
Good, As Measured By Good, As Measured By Their Willingness To Their Willingness To
Pay For It.Pay For It.
The Difference The Difference Between This Between This
Willingness To Pay Willingness To Pay and The Market Price and The Market Price
Is Each Buyer’s Is Each Buyer’s Consumer Surplus.Consumer Surplus.
Therefore, The Total Area Therefore, The Total Area Below The Demand Curve Below The Demand Curve
and Above The Price Is and Above The Price Is The Sum Of The The Sum Of The
Consumer Surplus Of All Consumer Surplus Of All Buyers In The Market For Buyers In The Market For
A Good or Service.A Good or Service.
Product Demand Product Demand CurveCurvePrice
Quantity
$75
$65
$55
$45
$35
$25
$15
$5
1 2 3 4 5
A
B Price Actually Paid
Person A’s Consumer Surplus
Person B’s Consumer Surplus
Product Demand Product Demand CurveCurvePrice
Quantity
$75
$65
$55
$45
$35
$25
$15
$5
1 2 3 4 5
A
B Price Actually Paid
Person A’s Consumer Surplus
Person B’s Consumer Surplus
Total Of The Consumer Surplus Of All Buyers
Buyers Always Want To Buyers Always Want To Pay Less and Paying Less Pay Less and Paying Less Makes The Buyer Better Makes The Buyer Better Off. But How Much Does Off. But How Much Does a Buyers Well-Being Rise a Buyers Well-Being Rise In Response To a Lower In Response To a Lower
Price?Price?
Consumer Surplus Consumer Surplus Measures The Benefit Measures The Benefit That Buyers Receive That Buyers Receive From A Good As The From A Good As The Buyers Themselves Buyers Themselves
Perceive It.Perceive It.
This Is Because Buyers This Is Because Buyers Have Determined Have Determined What They Would What They Would Have Paid For The Have Paid For The Good Or Service.Good Or Service.
Government Policy Government Policy Makers However, May Or Makers However, May Or May Not Care About What May Not Care About What
Creates Consumer Creates Consumer Surplus. Example of A Surplus. Example of A Drug Addict Being Able Drug Addict Being Able
To Purchase Drugs To Purchase Drugs Cheaper Therefore Cheaper Therefore Creating Consumer Creating Consumer
Surplus.Surplus.
In This Case Consumer In This Case Consumer Surplus is Not A Good Surplus is Not A Good
Measure of Well-Measure of Well-Being, As The Drug Being, As The Drug
Addict is Not Looking Addict is Not Looking After Their Own Best After Their Own Best
Interests.Interests.
However, In Most Markets, However, In Most Markets, Consumer Surplus Does Consumer Surplus Does Reflect Economic Well-Reflect Economic Well-
Being. Rational People Do Being. Rational People Do The Best They Can To The Best They Can To
Achieve Their Objectives, Achieve Their Objectives, Given Their Opportunities.Given Their Opportunities.
Consumer SurplusConsumer Surplus
Consumer Surplus =
Amount A Buyer Is Willing to Pay
Amount They Paid
Now Lets Look At It Now Lets Look At It From The Other Side From The Other Side and Discuss Producer and Discuss Producer
Surplus.Surplus.
Let Us Assume That You Let Us Assume That You Are Going To Have Your Are Going To Have Your
Taxes Done and You Taxes Done and You Contact 4 CPA’s That You Contact 4 CPA’s That You
Know Are Capable of Know Are Capable of Doing The Work and Ask Doing The Work and Ask
Them For A Price For Them For A Price For Them To Do Your Taxes.Them To Do Your Taxes.
Each CPA Will Determine Each CPA Will Determine Their Costs In Order To Their Costs In Order To Determine A Price. The Determine A Price. The Term “ Cost” is Really Term “ Cost” is Really The Opportunity Cost, The Opportunity Cost,
That Includes Materials, That Includes Materials, Overhead, Time to Do the Overhead, Time to Do the
Work and Expected Work and Expected Profit.Profit.
Cost &Cost &Producer SurplusProducer Surplus
CostCost
The Value of The Value of Everything A Seller Everything A Seller
Must Give Up To Must Give Up To Produce a Good.Produce a Good.
Producer SurplusProducer Surplus
The Amount A Seller The Amount A Seller Is Paid For A Good Is Paid For A Good Minus The Seller’s Minus The Seller’s
Cost Of Producing or Cost Of Producing or Providing It.Providing It.
Producers SurplusProducers Surplus
Measures The Benefit Measures The Benefit To Sellers of To Sellers of
Participating In A Participating In A Market.Market.
Producer SurplusProducer Surplus
Producer Surplus =
Amount That a Seller Is Paid
Sellers Cost
Note:Note:
Because We Have Set Up Because We Have Set Up a Bidding Situation In Our a Bidding Situation In Our
Example, The CPA With Example, The CPA With The Lowest Cost Should The Lowest Cost Should
Win The Bid.Win The Bid.
Now Let Us Use The Now Let Us Use The Supply Curve To Supply Curve To
Measure Producer Measure Producer Surplus.Surplus.
Let Us Say That All 4 Let Us Say That All 4 CPA’s Submitted Bids CPA’s Submitted Bids
As Follows:As Follows:
CPA A = $10,000CPA A = $10,000CPA B = $12,000CPA B = $12,000CPA C = $14,000CPA C = $14,000CPA D = $16,000CPA D = $16,000
Let Us Now Plot A Let Us Now Plot A Supply Schedule For Supply Schedule For
Preparing Taxes.Preparing Taxes.
The Supply Curve The Supply Curve Shows The Cost of The Shows The Cost of The
Marginal Seller, The Marginal Seller, The Seller Who Would Seller Who Would
Leave The Market First Leave The Market First If The Price Were Any If The Price Were Any
LowerLower
Product Supply CurveProduct Supply CurvePrice
Quantity
$18
$16
$14
$12
$10
$8
$6
$4
$2
0
1 2 3 4 5
A
# of Suppliers
Thousands
B
C
D
Producer SurplusProducer Surplus
Producer Surplus =
Amount A Seller Is Paid For a Good or Service
Cost of Providing The Good or Service
Therefore Any Therefore Any Amount Above The Amount Above The
Suppliers Cost Suppliers Cost Would Be Producers Would Be Producers
Surplus.Surplus.
In Our Example The In Our Example The Area Below The Price Area Below The Price and Above The Supply and Above The Supply Curve Measures The Curve Measures The
Producer Surplus In A Producer Surplus In A Market.Market.
However, Producers However, Producers Always Want To Always Want To
Receive a Higher Price Receive a Higher Price For Their Goods and For Their Goods and Services That They Services That They
Sell.Sell.
Market EfficiencyMarket Efficiency
Consumer Surplus and Consumer Surplus and Producer Surplus Are The Producer Surplus Are The
Basic Tools Economists Use Basic Tools Economists Use To Study The Welfare Of To Study The Welfare Of Buyers and Sellers In a Buyers and Sellers In a
Market.Market.
If We Want To Maximize If We Want To Maximize The Economic Well-Being The Economic Well-Being Of Everyone In a Society. Of Everyone In a Society.
We Must First Decide We Must First Decide How We Are Going to How We Are Going to
Measure The Economic Measure The Economic Well-Being Of a Society.Well-Being Of a Society.
One Possible One Possible Measure Is The Sum Measure Is The Sum
of Consumer of Consumer Surplus and Surplus and
Producer Surplus, Producer Surplus, Which We Call Which We Call Total Total
SurplusSurplus..
Remember That Remember That Consumer Consumer SurplusSurplus Is The Benefit That Is The Benefit That
Buyers Receive From Buyers Receive From Participating In The Market Participating In The Market and and Producer SurplusProducer Surplus Is The Is The Benefit That Sellers Receive Benefit That Sellers Receive
From Participating In The From Participating In The Market.Market.
Remember Also, Remember Also, That The Formulas That The Formulas
For Each Are As For Each Are As Follows:Follows:
Consumer SurplusConsumer Surplus
Consumer Surplus =
Amount A Buyer Is Willing to Pay
Amount They Paid
Or
= Value To Buyers - Amount Paid By Buyers
Producer SurplusProducer Surplus
Producer Surplus =
Amount That a Seller Is Paid
Sellers Cost
Or
= Amount Received By Sellers – Cost To Sellers
Total Surplus Then Total Surplus Then Becomes:Becomes:
Total Surplus = Value To Total Surplus = Value To Buyer - Amount Paid By Buyer - Amount Paid By
Buyers + Amount Buyers + Amount Received By Sellers – Received By Sellers –
Cost To Sellers.Cost To Sellers.
OrOr
Because The Amount Paid Because The Amount Paid By Buyers Equals The By Buyers Equals The
Amount Received By Sellers Amount Received By Sellers The Equation Can Be The Equation Can Be
Rewritten As:Rewritten As:
Total Surplus = Value To Total Surplus = Value To Buyers – Cost To SellersBuyers – Cost To Sellers
If An Allocation of If An Allocation of Resources Maximizes Total Resources Maximizes Total Surplus, We Say That The Surplus, We Say That The
Allocation Exhibits Allocation Exhibits Efficiency.Efficiency. If An Allocation If An Allocation Is Is InefficientInefficient, Then Some Of , Then Some Of
The Gains Among Buyers The Gains Among Buyers and Sellers Are Not Being and Sellers Are Not Being Realized. i.e. Not Taking Realized. i.e. Not Taking
The Minimum Bid.The Minimum Bid.
EfficiencyEfficiency
The Property Of A The Property Of A Resource Allocation Of Resource Allocation Of Maximizing The Total Maximizing The Total Surplus Received By Surplus Received By
All Members Of All Members Of Society.Society.
Thus, Moving Production Thus, Moving Production From a High-Cost From a High-Cost
Producer To a Low-Cost Producer To a Low-Cost Producer Will Lower The Producer Will Lower The Total Cost To Sellers and Total Cost To Sellers and
Raise Total Surplus.Raise Total Surplus.
Also An Allocation Is Also An Allocation Is InefficientInefficient If A Good Is Not If A Good Is Not
Being Consumed By The Being Consumed By The Buyers Who Value It Most Buyers Who Value It Most Highly. Highly. Therefore, Moving Therefore, Moving Consumption Of The Good Consumption Of The Good From A Buyer With A Low From A Buyer With A Low Valuation To A Buyer With Valuation To A Buyer With A High Valuation Will Raise A High Valuation Will Raise
Total Surplus.Total Surplus.
EquityEquity
The Fairness Of The The Fairness Of The Distribution of Well-Distribution of Well-
Being Among The Being Among The Members of Society.Members of Society.
While While EfficiencyEfficiency Can Can Be Measured and Be Measured and
Judged On Judged On Performance, Performance, EquityEquity Involves Normative Involves Normative
Judgments That Enter Judgments That Enter Into The Area of Into The Area of
Political Philosophy.Political Philosophy.
Putting The Supply Putting The Supply Curve and Demand Curve and Demand Curve Together and Curve Together and Finding Equilibrium.Finding Equilibrium.
Remember That Remember That Consumer SurplusConsumer Surplus Equals Equals The Area Above The Price The Area Above The Price and Under The Demand and Under The Demand
Curve and Curve and Producer Producer SurplusSurplus Equals The Area Equals The Area
Below The Price and Below The Price and Above The Supply Curve.Above The Supply Curve.
Therefore, The Total Area Therefore, The Total Area Under Between The Supply Under Between The Supply
Curve and The Demand Curve and The Demand Curves Up To The Point of Curves Up To The Point of
Equilibrium Represents The Equilibrium Represents The Total Surplus.Total Surplus.
Observations:Observations:
1. Free Markets Allocate 1. Free Markets Allocate The Supply Of Goods To The Supply Of Goods To The Buyers Who Value The Buyers Who Value Them Most Highly, As Them Most Highly, As
Measured By Their Measured By Their Willingness To Pay.Willingness To Pay.
Observations:Observations:
2. Free Markets Allocate 2. Free Markets Allocate The Demand For Goods The Demand For Goods To The Sellers Who Can To The Sellers Who Can Produce Them At Least Produce Them At Least
Cost.Cost.
Observations:Observations:
3. Free Markets Produce 3. Free Markets Produce The Quantity of Goods The Quantity of Goods
That Maximizes The Sum That Maximizes The Sum Of Consumer and Of Consumer and Producer Surplus.Producer Surplus.
Consumer and Producer Surplus Consumer and Producer Surplus In Market EquilibriumIn Market Equilibrium
Price
Quantity
A
Equilibrium Quantity
BC
DSupply
Demand
EEquilibrium Price
Consumer Surplus
Producer Surplus
The Next Figure Shows The Next Figure Shows That At Quantities Less That At Quantities Less Than The Equilibrium Than The Equilibrium
Quantity Such As Q1, The Quantity Such As Q1, The Value To The Buyers Value To The Buyers
Exceeds The Cost To The Exceeds The Cost To The Sellers.Sellers.
At Quantities Greater Than At Quantities Greater Than The Equilibrium Quantity The Equilibrium Quantity Such As Q2, The Cost To Such As Q2, The Cost To The Sellers Exceeds The The Sellers Exceeds The Value To The Buyers. Value To The Buyers. Therefore The Market Therefore The Market
Equilibrium Maximizes The Equilibrium Maximizes The Sum Of Producer and Sum Of Producer and Consumer Surplus.Consumer Surplus.
The Efficiency of the Equilibrium The Efficiency of the Equilibrium QuantityQuantity
Price
QuantityEquilibrium Quantity
Supply
Demand
Cost To Sellers
Value
To Buyers
Value To Buyers
Cost
To Sellers
Q1 Q2
Value to Buyers Is Greater Than Cost To Sellers
Value to Buyers Is Less Than Cost To Sellers
QuestionsQuestions??
Chapter 5Chapter 5
International TradeInternational Trade
7-51
Adam Smith’s Dos and Adam Smith’s Dos and Don’tsDon’ts
DoDo Protect society from the violence and Protect society from the violence and
invasion of other countriesinvasion of other countries Establish an exact administration of Establish an exact administration of
justicejustice Erect and maintain certain public works Erect and maintain certain public works
and institutions where private enterprise and institutions where private enterprise could not profit from doing socould not profit from doing so
Don’t do anything elseDon’t do anything else
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Figure 1 The Internationalization of Figure 1 The Internationalization of the U.S. Economythe U.S. Economy
Percentof GDP
0
5
10
15
1950 1955 1960 1965 1970 1975 1980 19901985 2000 20051995
Imports
Exports
Table 1 International Flows of Goods Table 1 International Flows of Goods and Capital: Summaryand Capital: Summary
Government Government InterventionIntervention
ProtectionProtection
AllocationAllocation
BenefitBenefit
One of The Nine One of The Nine Principles of Economics Principles of Economics (From Chapter 1) Is That (From Chapter 1) Is That Trade Makes Everybody Trade Makes Everybody
Better Off.Better Off.
Comparative Comparative Advantage and TradeAdvantage and Trade
Gains From Specialization and Gains From Specialization and Trade Are Not Based on Absolute Trade Are Not Based on Absolute Advantage, But on Comparative Advantage, But on Comparative Advantage. When Each Person Advantage. When Each Person
Specializes in Producing the Good Specializes in Producing the Good For which They Have a For which They Have a
Comparative Advantage, Total Comparative Advantage, Total Production in the Economy Rises Production in the Economy Rises
an Everyone is Better Off.an Everyone is Better Off.
However, There Can Be However, There Can Be Other Factors Including Other Factors Including the Price of the Goods the Price of the Goods and How the Gains Are and How the Gains Are
Shared Among the Shared Among the Trading Partners.Trading Partners.
Applications of Applications of Comparative AdvantageComparative Advantage
Should Tiger Woods Mow Should Tiger Woods Mow His Own Lawn or Play His Own Lawn or Play
Golf?Golf?
The Principle of Comparative The Principle of Comparative Advantage Holds That a Advantage Holds That a
Country Can Benefit From Country Can Benefit From Trade Even If it is Absolutely Trade Even If it is Absolutely More Efficient (or Absolutely More Efficient (or Absolutely Less Efficient) Than Every Less Efficient) Than Every
Other Country in the Other Country in the Production of Every Good.Production of Every Good.
Therefore, Trade Therefore, Trade According to According to
Comparative Advantage Comparative Advantage Provides Mutual Benefits Provides Mutual Benefits
to All Countries.to All Countries.
In Addition-In Addition-
The Principle of The Principle of Comparative Advantage Comparative Advantage Holds That Each Country Holds That Each Country
Will Benefit If it Specializes Will Benefit If it Specializes in the Production and in the Production and
Export of Those Goods That Export of Those Goods That it Can Produce at Relatively it Can Produce at Relatively
Low Cost.Low Cost.
Conversely, Each Conversely, Each Country Will Benefit If it Country Will Benefit If it
Imports Those Goods Imports Those Goods Which it Produces at a Which it Produces at a Relatively High Cost.Relatively High Cost.
Trade Among Countries-Trade Among Countries-
Imports-Imports- Are Goods Produced Are Goods Produced Abroad and Sold Domestically.Abroad and Sold Domestically.
Exports-Exports- Are Goods Produced Are Goods Produced Domestically and Sold AbroadDomestically and Sold Abroad..
Nations Also Can Enjoy a Nations Also Can Enjoy a Comparative Advantage, Comparative Advantage, However That Does Not However That Does Not Necessarily Mean It Will Necessarily Mean It Will
or Will Not Produce a or Will Not Produce a Good.Good.
The United States Has A The United States Has A Comparative Advantage in Comparative Advantage in Certain Items Involving the Certain Items Involving the
Military and Warfare. Military and Warfare. However, This Does Not However, This Does Not
Mean That it is in The U.S.’s Mean That it is in The U.S.’s Best Interest to Sell these Best Interest to Sell these
Items.Items.
International Trade Can International Trade Can Make Some Individuals Make Some Individuals Worse Off, Even as it Worse Off, Even as it
Make the Country as a Make the Country as a whole Better Off.whole Better Off.
What Does It Matter?What Does It Matter?
We buy much more from foreigners than they We buy much more from foreigners than they buy from usbuy from us In effect, they lend or give us the money to make up In effect, they lend or give us the money to make up
the difference between our imports and our exportsthe difference between our imports and our exports We are essentially selling them a piece of the We are essentially selling them a piece of the
(American) rock consisting of corporate stock, real (American) rock consisting of corporate stock, real estate, corporate and government bonds and other estate, corporate and government bonds and other debt instrumentsdebt instruments
Should this continue for another three or four Should this continue for another three or four decades, foreign investors will own most of Americadecades, foreign investors will own most of America
32-9Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Main Arguments for Four Main Arguments for ProtectionProtection
The National Security The National Security ArgumentArgument
The Infant Industry ArgumentThe Infant Industry Argument The Low-Wage ArgumentThe Low-Wage Argument The Employment ArgumentThe Employment Argument
31-23Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The National Security The National Security ArgumentArgument
Our dependence on foreign suppliers Our dependence on foreign suppliers could make us vulnerable in time of could make us vulnerable in time of warwar It is possible that we need to maintain It is possible that we need to maintain
certain defense-related industriescertain defense-related industries What if we depended on foreign What if we depended on foreign
suppliers for critical components of suppliers for critical components of entire weapons systems?entire weapons systems?
The continued spread of nuclear arms The continued spread of nuclear arms technology may soon make the national technology may soon make the national security argument much more relevant security argument much more relevant
31-24Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Infant Industry The Infant Industry ArgumentArgument
American products are no longer American products are no longer produced by infant industries being produced by infant industries being swamped by foreign giantsswamped by foreign giants
About the best that can be said is About the best that can be said is that some of our infant industries that some of our infant industries never matured while others have never matured while others have evolved into senilityevolved into senility Textiles, steel, clothing, and Textiles, steel, clothing, and
automobiles may be in the senile automobiles may be in the senile categorycategory
31-25Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Low-wage ArgumentThe Low-wage Argument How can American workers compete with How can American workers compete with
foreigners who are paid sweatshop wages in foreigners who are paid sweatshop wages in labor intensive industries?labor intensive industries? There is no reason for American firms to There is no reason for American firms to
compete with foreign firms in these industriescompete with foreign firms in these industries We should import labor-intensive goods and We should import labor-intensive goods and
produce goods and services in which we can produce goods and services in which we can excel and competeexcel and compete
We should use the proceeds to buy the goods We should use the proceeds to buy the goods and services produced by people who are and services produced by people who are forced to work for very low wagesforced to work for very low wages
31-26Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Employment ArgumentThe Employment Argument The flood of imports throw millions of The flood of imports throw millions of
Americans out of workAmericans out of work But if we restrict imports, the governments of our But if we restrict imports, the governments of our
foreign competitors will restrict our exportsforeign competitors will restrict our exports By curbing imports, we will be depriving other By curbing imports, we will be depriving other
nations of the earnings they need to buy our exportsnations of the earnings they need to buy our exports If we restrict our imports, our exports will go down If we restrict our imports, our exports will go down
as wellas well We would just lose the jobs connected with these lost We would just lose the jobs connected with these lost
exportsexports Which would be best? Lose the jobs of workers who work Which would be best? Lose the jobs of workers who work
for companies who can’t or won’t compete or lose the jobs for companies who can’t or won’t compete or lose the jobs of workers who work for companies who can compete but of workers who work for companies who can compete but can’t export their products because of restrictions we can’t export their products because of restrictions we ourselves caused?ourselves caused?
31-27Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Tariffs or QuotasTariffs or Quotas
A tariff is a tax on importsA tariff is a tax on imports The government gets the resulting revenueThe government gets the resulting revenue A tariff affects all foreign sellers equally. Efficient A tariff affects all foreign sellers equally. Efficient
foreign producers will be able to pay a uniform tariff. foreign producers will be able to pay a uniform tariff. Less efficient producers will not Less efficient producers will not
A quota is a limit on the import of certain goodsA quota is a limit on the import of certain goods Import quotas produce no federal revenuesImport quotas produce no federal revenues Imports quotas are directed against particular Imports quotas are directed against particular
sellers on an arbitrary basissellers on an arbitrary basis Arbitrary quotas may allow relatively inefficient Arbitrary quotas may allow relatively inefficient
producers in and keep out more efficient producersproducers in and keep out more efficient producers
31-28Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Tariffs or QuotasTariffs or Quotas
A tariff, like any other excise tax, causes A tariff, like any other excise tax, causes a decrease in supplya decrease in supply
Both tariffs and quotas raise the price Both tariffs and quotas raise the price that consumers in the importing that consumers in the importing countries must paycountries must pay
Tariffs are better than quotasTariffs are better than quotas But free trade is bestBut free trade is best
31-29Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
A Tariff Lowers the SupplyA Tariff Lowers the Supply
31-30Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
ConclusionConclusion Economics is all about the efficient allocation Economics is all about the efficient allocation
of scarce resourcesof scarce resources There is no reason why this efficient allocation There is no reason why this efficient allocation
of resources should not be applied beyond of resources should not be applied beyond national boundariesnational boundaries
International trade helps every countryInternational trade helps every country To the degree that we can remove the tariffs, To the degree that we can remove the tariffs,
import quotas, and other impediments to free import quotas, and other impediments to free trade, we will all be better offtrade, we will all be better off
The economics profession nearly unanimously The economics profession nearly unanimously backs free tradebacks free trade
31-31Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Our Balance of TradeOur Balance of Trade Our balance of trade Our balance of trade compares the dollar compares the dollar
value of merchandise and services we value of merchandise and services we buy from foreigners with the dollar value buy from foreigners with the dollar value of the merchandise and services they buy of the merchandise and services they buy from usfrom us
Our balance of trade is Our balance of trade is our country’s our country’s record of all transactions between its record of all transactions between its residents and the residents of all foreign residents and the residents of all foreign nationsnations
31-32Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
What Are the Causes of What Are the Causes of Our Trade ImbalanceOur Trade Imbalance
““We are consuming more than we We are consuming more than we are producing, borrowing more than are producing, borrowing more than we are saving, and spending more we are saving, and spending more than we are earning.” – Murray than we are earning.” – Murray Weidenbaum Weidenbaum
31-33Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
What Are the Causes of What Are the Causes of Our Trade ImbalanceOur Trade Imbalance
We have become a nation of We have become a nation of consumption junkiesconsumption junkies We are borrowing about $2 billion a We are borrowing about $2 billion a
day to finance our consumption day to finance our consumption habit.habit.
Most Americans believe that Most Americans believe that somehow we’re entitled to all of somehow we’re entitled to all of these goods and services, even if we these goods and services, even if we need to borrow to pay for them.need to borrow to pay for them.
31-34Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
What Are the Causes of What Are the Causes of Our Trade ImbalanceOur Trade Imbalance
Our Low Saving RateOur Low Saving Rate Americans are notoriously poor savers. Americans are notoriously poor savers.
In 2005 we managed to spend 100.5 In 2005 we managed to spend 100.5 percent of our disposable incomepercent of our disposable income
If you don’t save, you can’t investIf you don’t save, you can’t invest If you don’t invest, you don’t growIf you don’t invest, you don’t grow Foreign savers have been picking up the Foreign savers have been picking up the
slackslack This will not continue indefinitelyThis will not continue indefinitely
31-35Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
What Are the Causes of What Are the Causes of Our Trade ImbalanceOur Trade Imbalance
Huge Oil ImportsHuge Oil Imports We import two-thirds of our oilWe import two-thirds of our oil We pay just a fraction of what citizens in other industrial We pay just a fraction of what citizens in other industrial
countries pay for gasolinecountries pay for gasoline Our dependency on oil imports will keep growingOur dependency on oil imports will keep growing In 2005, the cost of oil reached a record high of $252 In 2005, the cost of oil reached a record high of $252
billionbillion High Defense SpendingHigh Defense Spending
Today the United States spends more on defense than Today the United States spends more on defense than the rest of the world put togetherthe rest of the world put together
Stretching our armed forces around the world comes at Stretching our armed forces around the world comes at an extremely high pricean extremely high price
Can we afford to do this?Can we afford to do this?31-36Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Trade Deficit With Japan and U.S. Trade Deficit With Japan and China, 1995-2005China, 1995-2005
31-40Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Japanese Trading PracticesJapanese Trading Practices Japanese compete on the basis of price and Japanese compete on the basis of price and
qualityquality This is driving out American competitorsThis is driving out American competitors
The fundamental difference between ourselves The fundamental difference between ourselves and the Japanese is qualityand the Japanese is quality Better quality also means lower pricesBetter quality also means lower prices
We sell Japan agricultural products and buy We sell Japan agricultural products and buy manufactured products from themmanufactured products from them This is a colonial relationshipThis is a colonial relationship
The Japanese picks winners and then makes The Japanese picks winners and then makes sure they win sure they win
31-41Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Japanese Trading PracticesJapanese Trading Practices The Japanese consumer has long accepted a The Japanese consumer has long accepted a
lower standard of living because it was lower standard of living because it was necessary for the greater economic goodnecessary for the greater economic good They are willing to pay more for goods they They are willing to pay more for goods they
produce when they could have them cheaper produce when they could have them cheaper if they imported the same goodif they imported the same good
Can you imagine Americans being willing to Can you imagine Americans being willing to make that kind of sacrificemake that kind of sacrifice
Americans would not stand for restricting Americans would not stand for restricting Japanese imports because they are addicted to Japanese imports because they are addicted to Japanese goodsJapanese goods
31-42Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Our Trade Deficit with ChinaOur Trade Deficit with China We began trading with China in the mid-1970sWe began trading with China in the mid-1970s Although exports to China have grown rapidly, Although exports to China have grown rapidly,
our exports are only about one-sixth of our our exports are only about one-sixth of our importsimports
We import so much from China because U.S. We import so much from China because U.S. retailers are seeking the cheapest goods retailers are seeking the cheapest goods available and are finding them in Chinaavailable and are finding them in China
The Chinese are making unauthorized copies of The Chinese are making unauthorized copies of American movies, CDs, and computer softwareAmerican movies, CDs, and computer software
31-43Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Trading with China and JapanTrading with China and Japan There are more differences than There are more differences than
similaritiessimilarities Our trading position with Japan is Our trading position with Japan is
much like a colony and a colonial much like a colony and a colonial powerpower
We send airplanes, computers, movies, We send airplanes, computers, movies, compact disk, cars, cigarettes, power-compact disk, cars, cigarettes, power-generating equipment, and computer generating equipment, and computer software to China in exchange for toys, software to China in exchange for toys, clothing, shoes, and low-end consumer clothing, shoes, and low-end consumer electronics electronics
31-44Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Trading With China and Trading With China and JapanJapan
Japan has never been open to foreign tradeJapan has never been open to foreign trade China has been open to tradeChina has been open to trade Japanese gains in production have led directly Japanese gains in production have led directly
to the loss of millions of well-paying American to the loss of millions of well-paying American jobsjobs
Chinese exports so far have generally not Chinese exports so far have generally not translated into job losses in the United Statestranslated into job losses in the United States
In 2005 we ran a $202 billion trade deficit with In 2005 we ran a $202 billion trade deficit with China and one of $83 billion with JapanChina and one of $83 billion with Japan
31-45Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Trading with China and Trading with China and JapanJapan
The Chinese and the Japanese The Chinese and the Japanese both insist on licensing both insist on licensing agreements and large-scale agreements and large-scale transfer of technology as the price transfer of technology as the price for agreeing to importsfor agreeing to imports
These agreements, of course, lead These agreements, of course, lead to eventual elimination of imports to eventual elimination of imports from the United Statesfrom the United States
31-46Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Final WordFinal Word Reducing Our Overall Trade DeficitReducing Our Overall Trade Deficit
We need to maintain our high rate of productivity We need to maintain our high rate of productivity growth and keep improving the quality of American growth and keep improving the quality of American goods and servicesgoods and services
We need to lower our dependence on oil imports by We need to lower our dependence on oil imports by raising the tax on gasolineraising the tax on gasoline
We must, somehow, reduce our trade deficit with We must, somehow, reduce our trade deficit with JapanJapan
We need to do something about our rapidly rising We need to do something about our rapidly rising trade deficit with Chinatrade deficit with China
We need to face up to the fact that we are a nation of We need to face up to the fact that we are a nation of consumption junkiesconsumption junkies
We need to reduce our trade deficit with the rapidly We need to reduce our trade deficit with the rapidly expanding internet which make it much easier to expanding internet which make it much easier to provide services of all types provide services of all types
31-47Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Current Issue: Current Issue: Buy American? Buy American?
Are we as a nation becoming Are we as a nation becoming more inclined to “buy more inclined to “buy American?”American?”
The bottom line is that The bottom line is that Americans are consumers first, Americans are consumers first, while paying just lip service to while paying just lip service to economic nationalismeconomic nationalism
31-48Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
QuestionsQuestions??
Quick Write-Quick Write-What Kind of Absolute What Kind of Absolute
Advantage or Comparative Advantage or Comparative Advantage Do You Think Advantage Do You Think
You Have Over Other You Have Over Other Students and How Can This Students and How Can This be Used to Your Advantage be Used to Your Advantage
When You Graduate?When You Graduate?