We now enter a new section of our exploration of economics. The previous chapters developed a working model of how an economy functions, how resources are directed to consumers and divided up among them. We know that a firm's revenues represent the happiness that society receives from the firm's output. We know that a firm's costs represent the happiness society could receive if those resources were freed up for their next best use. By comparing the two, we can tell whether the firm's resource transfers result in a net increase or net decrease in happiness. We also understand the tremendous problems that arise when the information that firms receive from the marketplace is distorted by subsidies and taxes. This theory represents the foundational building blocks of economics.

Our next task is to apply this framework to a number of issues that have likely been nagging at you this whole book. We begin with international trade. Is it a good thing for the economy? How do trade policies affect society's happiness? And trade deficits? Are they harbingers of doom? How can we be so sure that displaced workers will find jobs? In addition to these questions, we'll also look at how markets work to conserve natural resources for future generations. In the pages ahead we shall take a giant step toward our goal of making you an armchair economist...and a hit at cocktail parties.

While it might seem like a funny place to start, we're going to begin our study of international trade by looking at plant relocations. Let's consider the economic insights offered by the distinguished Representative from Wayne, Michigan. His big beef with the Federal Mogul Co. is that it decided to close down its plant in Detroit and open up a new plant in Alabama, not because it wasn't making money in Detroit, but because it could make more money in Alabama. We've got to admit, that does sound awfully greedy. We suspect that the owners are probably not very nice people (even the name of the company--the Federal Mogul Co.--sounds rather cold and heartless). But we're going to leave the moralizing to those who have earned the right to judge others by virtue of their own impeccable behavior--the politicians.

Let's consider why the Federal Mogul Co. might want to move from Detroit to Alabama. While we can only surmise, it seems reasonable that costs may have played the primary role in the firm's decision. Many plant closings are driven by the desire to move to locations where the costs of production are lower. How can this be represented in the context of our simple Profit Table? The key is to identify the gains and losses to the firm of shutting down the plant in Detroit and opening up another plant in Alabama.

Let's suppose that the costs of production in Detroit are $32 million. By shutting down the plant there, the firm saves $32 million. Since this is what the firm stands to gain by relocating to Alabama, we report this gain on the firm's "Revenues" line of the Profit Table. (The trick is to always report the dollar value of the gain to the firm on the "Revenues" line.) What is the cost of opening up the plant in Alabama? It is the cost of production there. Supposing that costs are expected to be only $20 million in Alabama, we report this on the associated "Costs" line. Now look at our Profit Table and see if we haven't captured the essence of the firm's relocation decision.

Ignoring the costs of moving for the moment, we see that the Federal Mogul Co. could increase their profits by $12 million if they relocated from Detroit to Alabama.

In order to keep the problem simple, let's assume that the Alabama and Detroit plants produce the same quantity and quality of goods. This simplification is consistent with our initial supposition that cost considerations are the driving force behind the move. As a result of this assumption, the customers of the firm are unaffected by its decision to relocate. We are now in a position to investigate the gains and losses to society caused by the firm's relocation decision.

Note that there are two sets of resource transfers represented in the Profit Table above. When the Federal Mogul Co. shuts down in Detroit, it releases its inputs (land, labor, locally purchased materials, etc.) so that other firms can employ them. As these other firms move in to put these resources to work, additional goods and services are produced. Consumers benefit from these additional goods and services. How much happiness do these consumers receive from the additional goods and services? Don't be bashful about saying approximately $32 million of happiness. After all, that was what the Federal Mogul Co. was paying to employ those inputs. And we know that the happiness that those inputs could produce elsewhere is reflected in their market price.

A second set of resource transfers takes place when the firm opens up in Alabama. In order to begin production, the Federal Mogul Co. has to take away inputs that could have been used to produce other goods and services. The workers who ended up working for the good folks at Federal Mogul were bid away from alternative employers. Who knows what they might have been doing otherwise? Flipping burgers at McDonald's, washing cars at the Skweeky Kleen Kar Wash, working as a barmaid at the Suds 'N Duds Laundromat, Bar, and Grill. No matter. As a result of these workers signing on with Federal Mogul, there will now be fewer burgers flipped, fewer "kars kleened," and fewer mugs of beer while customers wait for the spin cycle to end at the Suds 'N Duds. That means lost consumer happiness. How much? Approximately $20 million, of course.

Forgetting whatever heartless motives may have lurked in the minds of the evil corporate chieftains at Federal Mogul Co., the bottom line is that relocating the plant to Alabama results in an increase in society's happiness. We can say this because we know that the ultimate reason that costs were higher in Detroit is because resources were more valuable there. By releasing the more valuable resources in Detroit, and replacing them with less valuable resources in Alabama, the Federal Mogul Co. has acted in society's best interests. Thank goodness they weren't content with the money they were making in Detroit, but wanted to make even more!

Let's come back now to some points that we glossed over earlier. Haven't we ignored moving costs? Yes we have, but including moving costs leaves our essential analysis unchanged. To see this, just add the moving costs to the "Costs" line of the Profit Table. Say moving costs are $7 million, raising total costs to $27 million. Moving costs also represent resources that the Federal Mogul Co. has taken away from consumers who could have benefitted from them. As long as moving costs are less than $12 million, the firm will still decide to relocate, and society will be better off if they do.

Suppose the moving costs are greater than $12 million? Say they're 15 million? Then the firm doesn't relocate. But again, this is exactly what we want the firm to do. If total costs are $35 million ($20 million + $15 million), then the firm would tie up resources that could have produced a total of $35 million of happiness elsewhere, while releasing resources that will produce only $32 million of happiness. If the firm relocated, it would lower society's happiness by $3 million. The bottom line is always the same. IF THE FIRM'S PROFITS ARE INCREASED BY RELOCATING, THEN WE EXPECT THAT SOCIETY'S HAPPINESS IS ALSO INCREASED. WE CAN TRUST THE FIRM TO DO WHAT IS RIGHT FOR SOCIETY, AS LONG AS IT DOES WHAT IS BEST FOR ITSELF.

One last twist. Suppose the firm found it profitable to relocate from Detroit to Dallas, Texas, instead of Alabama. Would that increase society's happiness? "Of course!" you say. Suppose the firm found it profitable to relocate from Detroit to San Antonio, Texas. Would that increase society's happiness? "Of course!" you say again. Suppose the firm found it profitable to relocate from Detroit to El Paso, Texas. Would that increase society's happiness? "Of course!" you say for the third time.

One last question. Suppose the firm found it profitable to cross that short little bridge that leads from El Paso, Texas to Juarez, Mexico--a mere 100 yards further south. Would that increase society's happiness? "Oh no! I've been tricked!" you say. (You probably saw it coming all along.) Here's the question we want to wrestle with. If it increases society's happiness to have a plant relocate from Detroit, Michigan to El Paso, Texas, what could be so fundamentally different if we relocate that plant just 100 yards further south--in Juarez, Mexico. Shouldn't that also increase society's happiness?