Lecture 3: Arguments against trade

* The job argument * Trade with other countries destroys domestic jobs.
Economists’ response: * Free trade creates jobs at the same time that it destroys them. * Workers move from the importing industries to those industries in which a country has a comparative advantage. * The transition may impose hardship on some workers initially; in the long term, the country as a whole can enjoy a higher standard of living.

* The national security argument * A country should protect industries that are vital for national security.
Economists’ response * Protecting key industries may be appropriate when there are legitimate concerns over national security. * However, producers may exaggerate their role in national defence in order to obtain protection from foreign competition at consumers’ expense.

* The infant industry argument * New industries need temporary trade restrictions to help them get started.
Economists’ response: * To apply protection successfully, the government would need to ‘pick winners’. * If an industry will be profitable in the future, the owners of the firms should be willing to incur temporary losses in order to obtain the eventual profits.

* The unfair competition argument * If firms in different countries are subject to different laws and regulations, then it is unfair to expect the firms to compete in the international marketplace.
Economists’ response: * Even if production in another country is subsidised, it is still the case that the gains to consumers from buying at a low price exceed the losses of domestic producers. * Rather than objecting to foreign subsidies, we should thank foreign taxpayers for subsidising our consumption.

* The protection-as-a-bargaining-chip argument * The threat of trade restrictions can be useful when we bargain with our trading partners.
Economists’ response: * The threat may not work. * If it doesn’t work, the country has a difficult choice. * It can carry out its threat and implement the trade restriction, which would reduce its own economic welfare. * Or it can back down from its threat, which would cause it to lose credibility.

Lecture 4:

When do we have an externality problem? * A lack of clearly established property rights
e.g. overfishing in the ocean; no over-fishing in private fish farms * Difficulty in enforcing property rights
e.g., Pollution
How can our rights to clean air, water, etc. be effectively enforced?

Private solutions to externalities * Moral codes and social sanctions
Example: Litter
Laws against littering are not vigorously enforced. Most people choose not to litter simply because it is the wrong thing to do. * Charity
Example: Education
Private individuals and corporations sometimes sponsor scholarships and prizes for university students * Vertical integration * Consider an apple grower and a beekeeper located next to each other. By pollinating the flowers on the trees, the bees help the orchard produce apples. At the same time, the bees use the nectar they get from the apple trees to produce honey. * When the apple grower is deciding how many trees to plant and the beekeeper is deciding how many bees to keep, they neglect positive externality. Thus, the apple grower plants too few trees and the beekeeper keeps too few bees. * These externalities could be internalised if the beekeeper bought the apple orchard or if the apple grower bought the beehive. * Contract * The Coase theorem: If property rights are clearly assigned and if transaction costs, are low, then bargaining between relevant parties will result in efficient resource allocation. * How property rights are assigned affects wealth distribution, but does not affect resource allocation. Example * A contract between the apple grower and the beekeeper can solve the problem of too few trees and too few bees. The contract can specify the number of trees, the number of bees and perhaps a payment from one party to the other. * When does the Coase theorem apply? * The Coase theorem applies * If the interested parties can reach an agreement and enforce it. It may not work if * The transaction costs – the costs that parties incur in the process of agreeing and following through on a bargain – are so high that no agreement is reached.
E.g., When the number of interested parties is large, it is costly to reach consensus.

Public policies for solving externality problems * Command and control
Require or forbid certain activities by regulation * Market-based policies provide market participants with incentives to take externalities into account in their production and consumption decisions
Corrective taxes and subsidies
Tradable pollution permits
Command and Control * Require or forbid certain activities by regulation
Examples:
Requirements that all children be immunised.
Regulation specifying maximum emission levels * Difficulties
Information requirement:
The regulator needs to know the details about specific industries and about the alternative technologies that those industries could adopt.
Monitoring and compliance costs.
Corrective taxes and subsidies * Corrective taxes and subsidies provide market participants with incentives to account for externalities in their decisions. * Corrective taxes discourage activities with a negative externality, e.g., Carbon tax * Corrective subsidies encourage activities with a positive externality, e.g., government funding of CSIRO * An ideal corrective tax = the external cost; and an ideal corrective subsidy = the external
Difficulties
* Information requirement: the government must be able to determine the magnitude of the externality. * Monitoring costs (on government) and compliance costs (on firms) * Tradable pollution permits * Each permit allows a firm to emit a unit of pollution Total emissions are capped. * A market for the permits * Firms with high cost of reducing pollution are willing to pay more to buy permits * Firms with low costs of reducing pollution are willing to take action to reduce pollution and sell their permits. * Result
A target pollution level is achieved at a lower cost
Pollution is reduced by those firms that can do it more cheaply.

tragedy of the commons * Clean air and climate change
Negative externality: Greenhouse gasses emitted into the air in one country spread around the world
Tragedy of the commons:
When a government in one country regulates greenhouse gas emissions, it does not consider how local emission will affect the climate of other countries.
Collective solution:
Nations can enter into a treaty, such as the Kyoto Protocol, which commits the signatories to reduce their respective emissions. The treaty behaves like contract, internalising the externality. * Oil deposits
Negative externality: Consider an oilfield so large that it lies under many properties with different owners. When one owner extracts oil, less is available for the others.
Tragedy of the commons:
If owners of the properties decide individually how many oil wells to drill, they will drill too many.
Collective solution:
To ensure that the oil is extracted at lowest cost, the owners could reach an agreement among themselves about how to extract the oil and divide the profits. * Congested roads
Negative externality: Each individual driver adds to congestion, so other people must drive more slowly.
Solution:
To levy a toll or a congestion charge.
A toll is, in essence, a corrective tax on the externality of congestion.
Sometimes congestion is a problem only at certain times of day. The efficient way to deal with these externalities is to charge higher tolls during rush hour, providing an incentive for drivers to alter their schedules. * Fish, whales and other wildlife
Tragedy of the commons
Each person has little incentive to maintain the species for the next year.
Excessive fishing can destroy commercially valuable marine populations.
Two problems prevent regulation of fish stocks.
First, many countries have access to the oceans, so any solution would require international cooperation.
Second, because the oceans are so vast, enforcing any agreement is difficult.

Lecture 7

* The GDP deflator vs. the CPI
The GDP deflator reflects the prices of all goods and services produced domestically;
The CPI reflects the prices of all goods and services bought by consumers.
The CPI compares the price of a fixed basket of goods and services to the price of the same basket in the base year.
The GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.
The group of goods changes automatically over time.

* Nominal and Real interest rates
The nominal interest rate is the interest rate usually reported and not corrected for inflation.
It is the interest rate that a bank pays/charges.
The real interest rate is the interest rate that is corrected for the effects of inflation.
Real interest rate = nominal interest rate – inflation rate
Example:
You borrowed $1,000 for one year. Nominal interest rate was 15%. During the year inflation was 10%. Real interest rate = 15% - 10% = 5%

Lecture 8

* To raise productivity, government should have policies that encourage * saving and investment * investment from abroad * education, health and nutrition * secure property rights and political stability * free trade * research and development
...and discourage * Excessive population growth

* Saving and investment
One way to raise future productivity is to invest in capital.
Investment in physical capital is subject to diminishing returns:
As the stock of capital rises, the extra output produced from an additional unit of capital falls
Implications of diminishing returns:
Catch-up effect: poor countries tend to grow faster than rich ones.
In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth rates.

* Investment from abroad takes several forms: foreign direct investment: capital investment owned and operated by a foreign entity. foreign portfolio investment: investments financed with foreign money but operated by domestic residents.
Benefits for capital importing countries * Increase capital * Learn advanced technologies and processes * Education * Investment in human capital raises productivity * Each year of schooling increases a person’s wage by about 8 per cent on an average in Australia.

* Education has a positive externality
An educated person might generate new ideas that enter society’s pool of knowledge.
One problem facing some poor countries is the brain drain
The emigration of many of the most highly educated workers to rich countries.

* Health and nutrition
Investing in the health of the population increases productivity and raise living standards.
Other things equal, healthier workers are more productive.

* Property rights and political stability
Property rights refer to the ability of people to exercise authority over the resources they own.
An economy-wide respect for property rights is an important prerequisite for the price system to work.
It is necessary for investors to feel that their investments are secure.

* Political stability is important to the protection of property rights.

* Free trade
Countries may adopt * inward-oriented trade policies, avoiding interaction with other countries; or * outward-oriented trade policies, encouraging interaction with other countries.

* Research and development
The advance of technological knowledge has led to higher standards of living.
Most technological advance comes from private research by firms and individual inventors.
Government can encourage the development of new technologies through research grants, tax breaks, etc.

* Population growth
Excessive population growth reduce per capita natural resources and capital stock.
Reducing population growth is thought to be one way low income countries can increase their living standards
Direct population control policies
Equal education and employment opportunities for women
Excessively low fertility rates in some advanced economies also cause problems.
Aging population and related public finance problems.

Lecture 10