1. INTERNATIONAL TRADE Principles of Microeconomic Theory, ECO 284
John Eastwood
CBA 247
Harmonized tariff schedule (HTS) of the United States:

2. Learning Objectives Review the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Review the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Explain why the welfare effects of quotas are worse than those of tariffs
Analyze the welfare effects of a domestic production subsidy
Tariffs

3. Static Gains from Trade
Eastwood's ECO486 Notes
Static Gains from Trade
Specialization along the lines of comparative advantage increases world output.
Trade raises consumption beyond autarky.
Greater variety of goods and services
Imported resources
Tariffs

4. Dynamic Gains from Trade
Eastwood's ECO486 Notes
Dynamic Gains from Trade
Trade speeds economic growth
When more K goods are imported than produced in autarky, PPF shifts out.
Trade diffuses new technology.
Trade raises real income. Savings rise.
Free trade an effective anti-trust policy
Trade expands the market; firms achieve economies of scale.
Tariffs

5. Eastwood's ECO486 Notes
Commercial Policy
Governments action that may change the composition and volume of trade flows
Tariffs
Quotas
Other non-tariff barriers
Subsidies
Tariffs

6. Tariffs Taxes on Components Imports Exports Ad valorem-- % of value
Eastwood's ECO486 Notes
Tariffs
Taxes on
Imports
Exports
Components
Ad valorem-- % of value
Specific -- flat fee per unit
Compound -- both
Tariffs

7. Positive Effects of Tariffs
Eastwood's ECO486 Notes
Positive Effects of Tariffs
Revenue Effect -- provide tax revenue
Protective Effect -- shelter domestic producers from foreign competition
A pure-revenue tariff is one imposed on a good not produced domestically
A tariff on bananas imported to Iceland
A prohibitive tariff is one that is so high that none of the good is imported
no revenue is collected
Developing countries may rely on tariffs to provide tax revenue
Developed countries impose tariffs for their protective effect
Tariffs

8. Tariffs as tools of int’l policy
Most Favored Nation status, MFN
granted as a reward, withheld as a punishment
Generalized System of Preferences, GSP
Most developed countries have GSP as means of helping developing countries
access to markets of developed countries

9. Non-tariff Barriers Voluntary export restraints (VER)
Eastwood's ECO486 Notes
Non-tariff Barriers
Voluntary export restraints (VER)
Tariff-rate quotas (TRQs),
WTO members are replacing existing quotas with TRQs
Quotas (on apparel and textiles) are to be phased out by 2005
Voluntary export restraints (VER) are agreements between two governments in which the government of the exporting country agrees to restrain the volume of its own exports.
Met letter, but not spirit, of GATT prohibition of quotas
Tariff-rate quotas (TRQs), allow quantities below the quota to enter at low tariff rates. Once the quota is exceeded a higher tariff applies.
WTO members are beginning to replace existing quotas with TRQs
Quotas (on apparel and textiles) are to be phased out by 2005
Exceptions are allowed
Tariffs

10. Welfare Cost Analysis Use Supply and Demand
One import or export good
Measure Changes in Consumer Surplus and Producer Surplus
Start with a small country
Its trade is too small to affect terms of trade

11. Consumers’ Surplus
Consumers’ Surplus is the difference between consumers’ maximum willingness-to-pay and the amount they actually paid.
The amount actually paid equals PQ.
Graphically, Consumers’ Surplus (CS) is the area under the demand curve above P.

12. Eastwood's ECO486 Notes
Producer Surplus
Producer surplus is the price of a good minus the opportunity cost of producing it.
Graphically, Producers’ Surplus (PS) is the area under the Price line and above Supply.
Tariffs

13. An Efficient Market for Pizza
Eastwood's ECO486 Notes
An Efficient Market for Pizza
Consumer
surplus S 25
Price (dollars per pizza) 20 15 10
At Pe, CS + PS is greatest.
At a price below Pe, fewer units are sold.
CS may be larger, but PS is smaller.
Some surplus is transferred from producers to consumers.
Some surplus is lost.
At a price above Pe, fewer units are sold.
PS may be larger, but CS is smaller.
Producer
surplus 5 D
Quantity (thousands of pizzas per day)
Tariffs

14. Gains from free trade -- imports
Eastwood's ECO486 Notes
Gains from free trade -- imports
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 6 a b c 3
World price of grapes 2
Domestic demand for grapes 1 4 7 10
Quantity (millions bushels of grapes per year)
Tariffs

15. Welfare of a Move to Free Trade A Small Country’s Imports
Eastwood's ECO486 Notes
Welfare of a Move to Free Trade A Small Country’s Imports
Tariffs

16. Gains from free trade -- exports
Eastwood's ECO486 Notes
Gains from free trade -- exports
Domestic Supply
of honey 10 9
World price of honey
Price ($ per jar of honey) g e f 6 2
Domestic demand for honey 1 4 7 10
Quantity (millions jars of honey per year)
Tariffs

17. Welfare of a Move to Free Trade A Small Country’s Exports
Eastwood's ECO486 Notes
Welfare of a Move to Free Trade A Small Country’s Exports
Tariffs

18. Pure Revenue Tariff Versus Free Trade
Eastwood's ECO486 Notes
Pure Revenue Tariff Versus Free Trade
Domestic Supply
of grapes lies along y-axis 10
Price ($ per bushel of bananas) a 5
World price + tariff $2/bu b c 3
World price of bananas 2
Iceland’s demand for bananas 1 3 5 7 10
Quantity (millions bushels of bananas per year)
Tariffs

19. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 5
World price + tariff $2/bu c a b d 3
World price of grapes 2
Domestic demand for grapes 1 3 5 7 10
Quantity (millions bushels of grapes per year)
Tariffs

20. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country
Loss = 0.5 x tariff x change in imports
Tariffs

21. Exhibit 6: Effect of a Quota
Eastwood's ECO486 Notes
Exhibit 6: Effect of a Quota
In panel a, D is the U.S. demand curve and S is the supply curve of U.S. producers. The world price of sugar is $0.10 (the price that would prevail in the U.S. market) and a total of 70 million pounds would be demanded  U.S. producers would supply 20 million pounds and importers 50 million pounds.
(a) S
Price per pound
Now suppose that U.S. officials impose a quota of 30 million pounds per month
0.10
As long as the U.S. price is at or above the world price of $0.10 per pound, foreigners supply 30 million pounds  the total supply of sugar to the U.S. market is found by adding 30 million pounds of imported sugar to the amount supplied by U.S. producers D
Sugar
(millions of pounds per month) 20 70
Tariffs

22. Exhibit 6: Effect of a Quota
Eastwood's ECO486 Notes
Exhibit 6: Effect of a Quota
Thus, the supply curve that sums domestic production and imports is horizontal at the world price of $0.10 per pound and remains so until the quantity supplied reaches 50 million pounds.
(a) S
S +30
For prices above $0.10, the new supply curve, S + 30, adds horizontally the 30 million pound quota to S, the supply curve of U.S. producers as shown by the dark red line. The U.S. price is found where this new supply curve intersects the domestic demand curve  point e  an effective quota, by limiting imports, raises the price of domestic sugar above the world price and reduces quantity below the free trade level. e
Price per pound
$0.15
0.10 D
Sugar
(millions of pounds per month) 20 50 70
Tariffs

23. Exhibit 6: Effect of a Quota
Eastwood's ECO486 Notes
Exhibit 6: Effect of a Quota
(a)
(b)
The right panel shows the distribution and efficiency aspects of the quota. As a result of the quota, U.S. consumer surplus declines by the blue and pink shaded areas.
Price per pound S
S +30 S
S +30 e
$0.15
$0.15 a c b d
0.10
0.10 D D
Sugar
(millions of pounds per month) 20 50 70
Sugar
(millions of pounds per month) 20 30 60 70
Area a becomes producer surplus  no loss of U.S. welfare. The blue rectangle, c, shows the increased profit to those permitted by the quota to sell Americans 30 million pounds at $0.15 per pound. To the extent that foreign exporters rather than U.S. importers reap this profit, area c reflects a net loss in domestic welfare.
Tariffs

24. Exhibit 6: Effect of a Quota
Eastwood's ECO486 Notes
Exhibit 6: Effect of a Quota
The pink triangle, b, shows by how much the marginal cost of producing another 10 million pounds in the U.S. exceeds the world price  a welfare loss to the U.S. economy because sugar could have been purchased abroad for $0.10 and the resources employed to increase sugar production could have been used more efficiently to produce other goods.
(a)
(b)
Price per pound S
S +30 S
S +30 e
$0.15
$0.15 a c b d
0.10
0.10 D D
Sugar
(millions of pounds per month) 20 50 70
Sugar
(millions of pounds per month) 20 30 60 70
The pink triangle, d, is also a welfare loss, because it reflects a reduction in consumer surplus with no offsetting gain to anyone  the two pink shaded areas measure the minimum welfare cost imposed on the domestic economy by an effective quota. To the extent that the profit from quota rights, area c, accrues to foreigners, this increases the U.S. welfare loss resulting from the quota
Tariffs

25. Welfare effects of a domestic production subsidy
Eastwood's ECO486 Notes
Welfare effects of a domestic production subsidy
Domestic supply
of small cars
Domestic supply with subsidy 20
Subsidy = $T
Price ($1000 per car) 12 10
World price + new equivalent tariff a b 6
World price of small cars 4
Domestic demand 2 4 6 8 10 14 18
Quantity (thousands of cars per year)
Tariffs

26. Welfare effects of a domestic production subsidy
Eastwood's ECO486 Notes
Welfare effects of a domestic production subsidy
Tariffs

27. Welfare Cost of Tariffs as a Percentage of GDP
Eastwood's ECO486 Notes
Welfare Cost of Tariffs as a Percentage of GDP
Tariffs & NTBs often exclude new goods
e.g., computers, just-in-time inventory processes
GDP loss almost twice the tariff rate
Ten percent tariff lowers GDP by 19.8%
Twenty-five percent tariff lowers GDP by 47%
Tariffs & NTBs often exclude new goods (e.g., computers, just-in-time inventory processes)
Tariffs

28. Eastwood's ECO486 Notes
Review homework
Tariffs