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PowerPoint Presentations for Principles of Microeconomics Sixth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Sixth Canadian Edition by.

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Presentation on theme: "PowerPoint Presentations for Principles of Microeconomics Sixth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Sixth Canadian Edition by."— Presentation transcript:

1 PowerPoint Presentations for Principles of Microeconomics Sixth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Sixth Canadian Edition by Marc Prud’homme University of Ottawa

2 APPLICATION: INTERNATIONAL TRADE Chapter 9 Copyright © 2014 by Nelson Education Ltd.9-2

3 INTERNATIONAL TRADE  Chapter 3 introduced the study of international trade by applying the principle of comparative advantage.  According to this principle, all countries can benefit from trading with one another because trade allows each country to specialize in doing what it does best. Copyright © 2014 by Nelson Education Ltd.9-3

4 INTERNATIONAL TRADE  But the analysis in Chapter 3 was incomplete. It did not explain how the international marketplace achieves these gains from trade or how the gains are distributed among various economic participants.  The effects of international trade on economic well- being will be examined with the analytical tools developed in the previous chapters. Copyright © 2014 by Nelson Education Ltd.9-4

5 THE DETERMINANTS OF TRADE  Consider the market for textiles, which is well suited to examining the gains and losses from international trade:  Textiles are made in many countries around the world, and there is much world trade in textiles.  The textile market is one in which policymakers often consider trade restrictions to protect domestic producers from foreign competitors.  The textile market in the imaginary country of Isoland will be studied here. Copyright © 2014 by Nelson Education Ltd.9-5

6 The Equilibrium without Trade  Lets start with the case of no international trade.  The market for textiles in Isoland consists solely of Isolandian buyers and sellers. Copyright © 2014 by Nelson Education Ltd.9-6

7 FIGURE 9.1: The Equilibrium without International Trade Copyright © 2014 by Nelson Education Ltd.9-7

8 The Equilibrium without Trade  Following an election, the new president wants answers to the following three questions in order to evaluate a possible change in trade policy: 1.If the government allowed Isolandians to import and export textiles, what would happen to the price of textiles and the quantity of textiles sold in the domestic textile market? 2.Who would gain from free trade in textiles and who would lose, and would the gains exceed the losses? 3.Should a tariff (a tax on textile imports) or an import quota (a limit on textile imports) be part of the new trade policy? Copyright © 2014 by Nelson Education Ltd.9-8

9 The World Price and Comparative Advantage  The first issue to tackle is to find out that if free trade was allowed, would Isolandians end up buying or selling textiles in world markets?  To answer this question, the economists compare the current Isolandian price of textiles to the price of textiles in other countries.  World price : the price of a good that prevails in the world market for that good Copyright © 2014 by Nelson Education Ltd.9-9

10 The World Price and Comparative Advantage  If the world price of textiles is higher than the domestic price, then Isoland would become an exporter of textiles once trade is permitted.  If the world price of textiles is lower than the domestic price, then Isoland would become an importer of textiles.  By comparing the world price and the domestic price before trade, we can determine whether Isoland is better or worse at producing textiles than the rest of the world. Copyright © 2014 by Nelson Education Ltd.9-10

11 QuickQuiz The country Autarka does not allow international trade. In Autarka, you can buy a wool suit for 100 grams of gold. Meanwhile, in neighbouring countries, you can buy the same suit for 60 grams of gold. If Autarka was to allow free trade, would it import or export suits? 9-11Copyright © 2014 by Nelson Education Ltd.

12 THE WINNERS AND LOSERS FROM TRADE  To analyze the welfare effects of free trade, the Isolandian economists begin with the assumption that Isoland is a small economy compared to the rest of the world.  The Isolandians are said to be price takers in the world economy. Copyright © 2014 by Nelson Education Ltd.9-12

13 The Gains and Losses of an Exporting Country  Figure 9.2 shows the Isolandian textile market when the domestic equilibrium price before trade is below the world price.  Once free trade is allowed, the domestic price rises to equal the world price.  No seller of textiles would accept less than the world price, and no buyer would pay more than the world price. Copyright © 2014 by Nelson Education Ltd. Ribah /Shutterstock 9-13

14 FIGURE 9.2: International Trade in an Exporting Country Copyright © 2014 by Nelson Education Ltd.9-14

15 Copyright © 2014 by Nelson Education Ltd.9-15 FIGURE 9.2 (continued)

16  This analysis of an exporting country yields two conclusions: 1.When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off and domestic consumers of the good are worse off. 2.Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers. Copyright © 2014 by Nelson Education Ltd.9-16 The Gains and Losses of an Exporting Country

17 The Gains and Losses of an Importing Country  Now suppose that the domestic price before trade is above the world price.  Once again, after free trade is allowed, the domestic price must equal the world price. Copyright © 2014 by Nelson Education Ltd.9-17

18  Figure 9.3 shows that the domestic quantity supplied is less than the domestic quantity demanded.  The difference between the domestic quantity demanded and the domestic quantity supplied is bought from other countries, and Isoland becomes a textile importer. Copyright © 2014 by Nelson Education Ltd.9-18 The Gains and Losses of an Importing Country

19 FIGURE 9.3: International Trade in an Importing Country Copyright © 2014 by Nelson Education Ltd.9-19

20 Copyright © 2014 by Nelson Education Ltd.9-20 FIGURE 9.3 (continued)

21  This analysis of an importing country yields two conclusions parallel to those for an exporting country:  When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are worse off.  Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers. Copyright © 2014 by Nelson Education Ltd.9-21 The Gains and Losses of an Importing Country

22  We can now see why the debate over trade policy is so often contentious.  Whenever a policy creates winners and losers, the stage is set for a political battle.  Nations sometimes fail to enjoy the gains from trade simply because the losers lobby for trade restrictions, such as tariffs and import quotas. Copyright © 2014 by Nelson Education Ltd.9-22 The Gains and Losses of an Importing Country

23 Copyright © 2014 by Nelson Education Ltd. Without trade, P D = $3000, Q = 400 In world markets, P W = $1500 Under free trade, how many TVs will the country import or export? Identify CS, PS, and total surplus without trade, and with trade. P Q D S $ $ Plasma TVs 9-23 Active Learning Analysis of Trade

24 Copyright © 2014 by Nelson Education Ltd. Under free trade,  domestic consumers demand 600  domestic producers supply 200  imports = 400 P Q D S $ $ Plasma TVs imports 9-24 Active Learning Answers

25 Copyright © 2014 by Nelson Education Ltd. Without trade, CS = A PS = B + C Total surplus = A + B + C With trade, CS = A + B + D PS = C Total surplus = A + B + C + D P Q D S $1500 $3000 Plasma TVs A B D C gains from trade imports 9-25 Active Learning Answers

26 The Effects of a Tariff  The Isolandian economists next consider the effects of a tariff.  Tariff : a tax on goods produced abroad and sold domestically Copyright © 2014 by Nelson Education Ltd.9-26

27 The Effects of a Tariff  The tariff matters only if Isoland becomes a textile importer.  Concentrating their attention on this case, the economists compare welfare with and without the tariff. Copyright © 2014 by Nelson Education Ltd.9-27

28 FIGURE 9.4: The Effects of a Tariff Copyright © 2014 by Nelson Education Ltd.9-28

29 Copyright © 2014 by Nelson Education Ltd.9-29 FIGURE 9.4: The Effects of a Tariff

30 The Effects of a Tariff  A tariff causes a deadweight loss because a tariff is a type of tax.  Like most taxes, it distorts incentives and pushes the allocation of scarce resources away from the optimum.  In this case, we can identify two effects. 1.The tariff raises the domestic price of textiles above the world price. 2.The tariff raises the price that domestic textile consumers have to pay, it encourages them to reduce consumption of textiles. Copyright © 2014 by Nelson Education Ltd.9-30

31 The Lessons for Trade Policy  Question: If the government allowed Isolandians to import and export textiles, what would happen to the price of textiles and the quantity of textiles sold in the domestic textile market?  Answer: Once trade is allowed, the Isolandian price of textiles would be driven to equal the price prevailing around the world. Copyright © 2014 by Nelson Education Ltd.9-31

32 The Lessons for Trade Policy  Question : Who would gain from free trade in textiles and who would lose, and would the gains exceed the losses?  Answer : The answer depends on whether the price rises or falls when trade is allowed. If the price rises, producers of textiles gain, and consumers of textiles lose. If the price falls, consumers gain, and producers lose. In both cases, the gains are larger than the losses. Copyright © 2014 by Nelson Education Ltd.9-32

33 The Lessons for Trade Policy  Question : Should a tariff or an import quota be part of the new trade policy?  Answer : A tariff, like most taxes, has deadweight losses. The best policy, from the standpoint of economic efficiency, would be to allow trade without a tariff or an import quota. Copyright © 2014 by Nelson Education Ltd.9-33

34 QuickQuiz Draw the supply and demand curves for wool suits in the country of Autarka. When trade is allowed, the price of a suit falls from 100 to 60 grams of gold. In your diagram, what is the change in consumer surplus, the change in producer surplus, and the change in total surplus? How would a tariff on suit imports alter these effects? 9-34Copyright © 2014 by Nelson Education Ltd.

35 Other Benefits of International Trade  Increased variety of goods  Lower costs through economies of scale  Increased competition  Enhanced flow of ideas Copyright © 2014 by Nelson Education Ltd. Ribah /Shutterstock 9-35

36 THE ARGUMENTS FOR RESTRICTING TRADE  The Jobs Argument  The National-Security Argument  The Infant-Industry Argument  The Unfair-Competition Argument  The Protection-as-a-Bargaining-Chip Argument Copyright © 2014 by Nelson Education Ltd.9-36

37 QuickQuiz The textile industry of Autarka advocates a ban on the import of wool suits. Describe five arguments its lobbyists might make. Give a response to each of these arguments. 9-37Copyright © 2014 by Nelson Education Ltd.

38 Free Trade or Protection? 1.Which to do you favour, free trade or protection? Explain why. 2.Assume you are voting on a request before the ministry called International Trade Canada to raise the tariff on imports of rubber thread. Rubber thread is made from latex and is a relatively small industry. It is used in the manufacture of elastic in items like socks, underwear, and bungee cords. Increasing the tariff would allow Canadian producers to avoid layoffs and to invest in technology. Would you vote for the tariff increase, or against it? 9-38 Classroom Activity

39 Copyright © 2014 by Nelson Education Ltd. Free Trade or Protection? (continued) 3.More generally, what are the benefits of keeping a job in Canada? 4.The costs of protectionism are paid by consumers in the form of higher prices. The obvious question is “At what point do these costs exceed the benefits?” In your opinion, how much extra should consumers pay to keep a job in Canada? (Express this figure in dollars/per job.) 9-39 Classroom Activity

40 THE END Chapter 9 Copyright © 2014 by Nelson Education Ltd.9-40


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