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MECO 6303 – Business Economics Lesson 8 International Trade: Trade and welfare, tariffs and quotas.

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Presentation on theme: "MECO 6303 – Business Economics Lesson 8 International Trade: Trade and welfare, tariffs and quotas."— Presentation transcript:

1 MECO 6303 – Business Economics Lesson 8 International Trade: Trade and welfare, tariffs and quotas

2 Exhibit # 1 Lesson 11 International Trade Who gains and who loses from free trade among countries? Who gains and who loses from free trade among countries? What are the arguments that people use to advocate trade restrictions? What are the arguments that people use to advocate trade restrictions? Countries do not trade individuals do! Countries do not trade individuals do! The determinants of international trade are the same as the determinants of any trade – specialization and trade bring mutual gains. The determinants of international trade are the same as the determinants of any trade – specialization and trade bring mutual gains.

3 Exhibit # 2 Lesson 11 Comparative Advantage and differences in tastes Why do people trade? Diversity among people and in nature. Why do people trade? Diversity among people and in nature. Different Tastes Different Tastes Different Abilities and Resources – comparative advantage Different Abilities and Resources – comparative advantage Comparative Advantage (CA) plays a big role in determining the pattern of trade – internal and international Comparative Advantage (CA) plays a big role in determining the pattern of trade – internal and international CA refers to relative, rather than absolute, differences in costs (and prices) CA refers to relative, rather than absolute, differences in costs (and prices) Activity/ValueTyping Words per minute Legal Practice $ per hour Secretary750 Attorney90300 Example: The Secretary and the Attorney – it pays to specialize. The same principle applies in international trade.

4 Exhibit # 3 Lesson 11 Viva la differance! It Pays to be different It Pays to be different Any difference is an opportunity for mutual gain Any difference is an opportunity for mutual gain The more different you are, the more gains to be had The more different you are, the more gains to be had International Trade: small countries gain the most International Trade: small countries gain the most Adam Smith Adam Smith 18 th century economist th century economist Described the way trade benefit all parties Described the way trade benefit all parties Increased productivity through specialization Increased productivity through specialization David Ricardo David Ricardo 19 th century economist – c th century economist – c First to recognize importance of comparative advantage First to recognize importance of comparative advantage Analyzed consequences for mutually beneficial trade Analyzed consequences for mutually beneficial trade

5 Exhibit # 4 Lesson 11 Equilibrium Without Trade Assume: Assume: A country is isolated from rest of the world and produces steel. A country is isolated from rest of the world and produces steel. The market for steel consists of the buyers and sellers in the country. The market for steel consists of the buyers and sellers in the country. No one in the country is allowed to import or export steel. No one in the country is allowed to import or export steel.

6 Exhibit # 5 Lesson 11 Equilibrium without International Trade Consumer surplus Producer surplus Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Equilibrium price Equilibrium quantity Domestic price adjusts to balance demand and supply.Domestic price adjusts to balance demand and supply. The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.

7 Exhibit # 6 Lesson 11 The World Price and Comparative Advantage If the country decides to engage in international trade, will it be an importer or exporter of steel? If the country decides to engage in international trade, will it be an importer or exporter of steel? The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good. The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good. 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 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 country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good. If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good.

8 Exhibit # 7 Lesson 11 How Free Trade Affects Welfare in an Exporting Country D C B A Price of steel 0Quantity of Steel Domestic supply Price after trade World price Domestic demand Exports Price before trade Producer surplus before trade Consumer surplus before trade Exports Domestic Supply Domestic Demand PWPW PDPD

9 Exhibit # 8 Lesson 11 The Winners and Losers from Export Trade The analysis of an exporting country yields two conclusions: The analysis of an exporting country yields two conclusions: Domestic producers of the good are better off, and domestic consumers of the good are worse off. Domestic producers of the good are better off, and domestic consumers of the good are worse off. Trade raises the economic well-being of the nation as a whole – gains outweigh losses Trade raises the economic well-being of the nation as a whole – gains outweigh losses These are partial and short term results. These are partial and short term results.

10 Exhibit # 9 Lesson 11 The Gains and Losses of an Importing Country International Trade in an Importing Country International Trade in an Importing Country If the world price of steel is lower than the domestic price, the country will be an importer of steel when trade is permitted. If the world price of steel is lower than the domestic price, the country will be an importer of steel when trade is permitted. Domestic consumers will want to buy steel at the lower world price. Domestic consumers will want to buy steel at the lower world price. Domestic producers of steel will have to lower their output because the domestic price moves to the world price. Domestic producers of steel will have to lower their output because the domestic price moves to the world price.

11 Exhibit # 10 Lesson 11 International Trade in an Importing Country Price of Steel 0 Quantity Price after trade World price of Steel Domestic supply Domestic demand Imports Domestic quantity supplied Domestic quantity demanded Price before trade PDPD PWPW Imports Consumer surplus before trade C B D A Producer surplus before trade Domestic Supply Domestic Demand

12 Exhibit # 11 Lesson 11 The Winners and Losers from Import Trade The analysis of an importing country yields two conclusions: The analysis of an importing country yields two conclusions: Domestic producers of the good are worse off, and domestic consumers of the good are better off. Domestic producers of the good are worse off, and domestic consumers of the good are better off. Trade raises the economic well-being of the nation as a whole in the sense that the gains of consumers exceed the losses of producers. Trade raises the economic well-being of the nation as a whole in the sense that the gains of consumers exceed the losses of producers. These are partial and short term results. These are partial and short term results.

13 Exhibit # 12 Lesson 11 The Effects of a Tariff A tariff is a tax on goods produced abroad and sold domestically. A tariff is a tax on goods produced abroad and sold domestically. Tariffs raise the price of imported goods above the world price by the amount of the tariff. Tariffs raise the price of imported goods above the world price by the amount of the tariff.

14 Exhibit # 13 Lesson 11 Imposing a tariff Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Price without tariff World price Imports with tariff Q2SQ2S Q2DQ2D Q1SQ1S Q1DQ1D tariff Imports with tariff Producer surplus before tariff Consumer surplus before tariff A F E D G C B Tariff revenue Deadweight Loss Domestic Supply Domestic Demand

15 Exhibit # 14 Lesson 11 The Effects of a Tariff A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss. With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.

16 Exhibit # 15 Lesson 11 The Effects of an Import Quota An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically. An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

17 Exhibit # 16 Lesson 11 Price of Steel 0 Quantity of Steel Domestic supply + Import supply Domestic demand Price with quota Imports without quota Equilibrium with quota Equilibrium without trade Quota Imports with quota Q D World price World price Price without quota = Q S Q D Q S A E' C G D E" F B Imposing an Import Quota Domestic Supply

18 Exhibit # 17 Lesson 11 The Effects of an Import Quota Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off. Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off. License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price. License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price. With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss. With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss. The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses. The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.

19 Exhibit # 18 Lesson 11 The Lessons for Trade Policy If government sells import licenses for full value, revenue equals that of an equivalent tariff and the results of tariffs and quotas are identical. If government sells import licenses for full value, revenue equals that of an equivalent tariff and the results of tariffs and quotas are identical. Both tariffs and import quotas... Both tariffs and import quotas... raise domestic prices. raise domestic prices. reduce the welfare of domestic consumers. reduce the welfare of domestic consumers. increase the welfare of domestic producers. increase the welfare of domestic producers. cause deadweight losses. cause deadweight losses.

20 Exhibit # 19 Lesson 11 The Arguments for Restricting Trade Jobs Jobs National Security National Security Infant Industry Infant Industry Unfair Competition Unfair Competition Protection-as-a-Bargaining Chip Protection-as-a-Bargaining Chip

21 Exhibit # 20 Lesson 11 Other Benefits of International Trade Increased variety of goods Increased variety of goods Lower costs through economies of scale Lower costs through economies of scale Increased competition enhanced flow of ideas, Increased competition enhanced flow of ideas,


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