Chapter 9 International Trade. Objectives 1. Understand the basis of international specialization 2. Learn who gains and who loses from international.
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Chapter 9
International Trade
Objectives1. Understand the basis of
international specialization
2. Learn who gains and wholoses from international trade
3. Recognize that the gains frominternational trade exceed the costs
4. Understand the welfare effectsof tariffs and quotas
5. Evaluate the merits of argumentsto restrict international trade
International Trade
How does international trade affect economic well-being?
Who gains and who loses from free trade among countries?
Chapter 3: The Principle of Comparative Advantage
Trade can benefit everyone in a society because it allows people to specialize
in activities in which they have a comparative advantage.
The Principle of Comparative Advantage
Comparative Advantage describes the comparison among producers of a good according to their opportunity cost.
The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
Determinants of International Trade
The effects of international trade are shown as the difference between the domestic price of a good without trade and the world price of a good.
A country will either be an exporter of the good or an importer of the good.
Determinants of International Trade
International trade issues are no
different from trading as it applies to
individuals within a community and
between states and regions within a
country.
Equilibrium without Trade
Assume:– A country that is isolated from rest of the
world and produces tomatoes.
– The market for tomatoes consists of the buyers and sellers of the country.
– Domestic Price adjusts to balance Demand and Supply.
– The sum of consumer and producer surplus measures the total benefits.
Equilibrium Without TradeDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
Equilibrium Without TradeDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
Consumer Surplus
Producer Surplus
Equilibrium Without Trade
When an economy cannot trade in world markets, the price adjusts to equilibrate domestic supply and demand.
The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive from the tomato market.
Impacts of International Trade, example
If the country decides to engage in international trade will it be an importer or exporter of tomatoes?
Who will gain from free trade in tomatoes and who would lose?
Would gains from trade exceed losses?
Start by comparing market prices. . .
Determinants of International Trade
If a country has a comparative advantage, then the domestic price will be below the world price and the country will be an exporter of the good.
If the rest of the world has a comparative advantage, then the domestic price will be higher than the world price and the country will be an importer of the good.
International Trade Example - Exporter
If the world price of tomatoes is higher than the domestic price, the country would be an exporter of tomatoes, when trade is permitted.
Producers of tomatoes will want to sell their tomatoes at the world price, hence output would increase and domestic price would rise.
International Trade Example - ExporterDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
International Trade Example - Exporter
As domestic suppliers produce more tomatoes and sell some of the
additional output in the world market, the domestic price will increase to the
world price.
The domestic country becomes an
Exporter!
International Trade Example - Exporter
The difference between domestic demand at the world price and domestic production is the amount exported!
International Trade Example - ExporterDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
QuantityExported!
How Free Trade Affects WelfareIn An Exporting Country (fig. 9-3)
Quantity of Steel
Priceof
Steel
WorldPrice
DB
C
A
Price before trade
Price after trade
Exports
Domesticsupply
Domesticdemand
}
Before Trade After Trade Change
Consumer Surplus A + B A - B
Producer Surplus C B + C + D +(B + D)
Total Surplus A + B + C A + B + C + D + D
Changes in Welfare From Free Trade:The Case of an Exporting Country
(Table 9-1)
International Trade Example - Importer If the world price of tomatoes is lower
than the domestic price, the country would be an importer of tomatoes, when trade is permitted.– Consumers will want to buy the lower
priced tomatoes at the world price. Producers of tomatoes will have to
lower their output until the supply price is equal to the world price.
International Trade Example - ImporterDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
International Trade Example - Importer
As a result of a lower world market price, the quantity demanded by the
domestic consumers will increase but the domestic production decreases,
hence
the domestic country becomes an
Importer!
International Trade Example - Importer
The difference between domestic demand at the world price and domestic production is the amount imported!
International Trade Example - ImporterDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
AmountImported!
Winners and Losers From Free International Trade
When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off. They receive a higher price.
However, domestic consumers of the good are worse off. They pay a higher price.
Winners and Losers From Free International Trade
When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off. They pay a lower price.
However, domestic producers of the good are worse off. They receive a lower price.
How Free Trade Affects WelfareIn An Importing Country (fig. 9-5)
Quantity of Steel
Priceof
Steel
WorldPrice
DB
C
A
Price before trade
Price after trade
Imports
Domesticsupply
Domesticdemand
}
Before Trade After Trade Change
Consumer Surplus A A + B + D +(B + D)
Producer Surplus B + C C - B
Total Surplus A + B + C A + B + C + D + D
Changes in Welfare From Free Trade:The Case of an Importing Country
(Table 9-2)
Winners and Losers From Free International Trade
Trade raises the economic well-being of the nation.
The net change in total surplus is positive.
The Welfare Effects of a Tariff
A tariff is a tax on imported goods. A tariff raises the price of imported
goods, above the world price by the amount of the tariff.
Domestic suppliers of the tariffed good are gainers while domestic consumers of the good are losers.
The Welfare Effects of a TariffDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
The Welfare Effects of a TariffDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
AmountImported
The Welfare Effects of a TariffDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
Tariff
}
The Welfare Effects of a TariffDomestic
Supply
Domestic Demand
Quantity
Pri
ceTomato Market
World Price
Tariff
}
The Welfare Effects of a TariffDomestic
Supply
Quantity
Pri
ceTomato Market
Tariff}
ReducedConsumption
IncreasedProduction
The Welfare Effects of a TariffDomestic
Supply
Quantity
Pri
ceTomato Market
Tariff}
GovernmentRevenue From
Tariff
The Welfare Effects of a TariffDomestic
Supply
Quantity
Pri
ceTomato Market
Tariff}
Deadweight Losses From
TariffA
C D E F
BB
G
The Welfare Effects of a Tariff Deadweight Losses
Like any tax on the sale of a good, it distorts incentives and pushes the allocation of scarce resources away from the optimum. – Raises domestic prices and encourages
more production.
– Higher domestic prices reduces the amount purchased by domestic consumers
The Effects of an Import Quota (fig. 9-7)
Quantity of Steel
Priceof
Steel
WorldPrice
D
B
C
A
Price without quota=Worldprice
Isolandian price with
quota
Imports w/quota
Domesticsupply
Domesticdemand
0QS
1 QS1 QD
2 QD1
Q
F
Imports w/o quota
Domestic supply+ Import supply
E’ E”
Equilibriumwithout trade
Equilibriumwith quota
Quota
Before Quota After Quota Change
Consumer Surplus A + B + C + D + E' + E" + F A + B - (C + D + E' + E" + F)
Producer Surplus G C + G + CLicense-holder surplus None E' + E" + (E' + E")
Total Surplus A + B + C + D + E' + E" + F + G A + B + C + E' + E" + G - (D + F)
Changes in Welfare From an Import Quota(Table 9-4)
Arguments for Restricting Trade
Arguments Against Free Trade Jobs National Security Infant Industry Unfair-Competition (Dumping) Protection-as-a-Bargaining-Chip Trade Imbalances
Other Benefits of International Trade
Increased variety of goods Lower costs through
economies of scale Increased competition Enhanced flow of ideas
Summary... A Parable of Free Trade
Throughout its history, the United States has allowed unrestricted trade among the states, and the country as a whole has benefited from the specialization that trade allows.
Parable of Isoland. . .
Summary The effects of free trade can be determined
by comparing the domestic price without trade to the world price.
A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter.
A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.
Summary When a country allows trade and
becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off.
When a country allows trade and becomes an importer of a good, consumers of the good are better off, and producers are worse off.
Summary
A tariff – a tax on imports – moves a market closer to the equilibrium than would exist without trade, and therefore reduces the gains from trade.
Import quotas will have effects similar to those of tariffs.
Summary
There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
Economists, however, believe that free trade is usually the better policy.
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