Extremely Competitive Markets Part 2: Open Economies

Closed Economy: Equilibrium Without Trade Price of Steel Equilibrium Price 0Quantity of SteelEquilibrium Quantity Domestic Supply Domestic Demand

Price of Steel 0Quantity of Steel Domestic Demand Open Economy: If world price > domestic price, country becomes an exporter Domestic Supply World Price Price after trade Exports Domestic demand Domestic supply Price before trade

Exporting Country: Who are the winners and who are the losers? Domestic producers Domestic consumers Foreign producers Foreign consumers Domestic and foreign governments

Price of Steel 0Quantity of Steel World Price Domestic demand Who are the Winners and Who are the Losers? Domestic Supply Price after trade Price before trade Consumer surplus after trade C Producer surplus after trade D Exports B

If world price < domestic price: country becomes an importer Price of Steel 0Quantity of Steel Domestic Supply Domestic demand World Price Price after trade Domestic quantity Supplied Domestic quantity Demanded Price before trade Imports

Importing Country: Who are the winners and who are the losers? Domestic producers Domestic consumers Foreign producers Foreign consumers Domestic and foreign governments

Who are the Winners and Who are the Losers? Price of Steel 0Quantity of Steel Domestic supply World Price Domestic demand Price after trade Price before trade A Consumer surplus after trade B D C Producer surplus after trade Imports

Gains and Losses from Free International Trade: 1. In each country, gains to winners exceed losses to losers 2. Therefore overall economic welfare increases 3. Also, can lead to: Increased variety of goods and service Lower costs through economies of scale Increased competition and efficiency Enhanced flow of ideas 4. But, losing producers have a strong incentive to oppose free trade through: Tariffs Quotas Subsidies

Price with tariff World price Price w/o tariff Effect of an Import Tariff on Price, Quantity of Imports and Gov Revenue Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Tariff Q1SQ1S Q1DQ1D Imports without tariff Imports with tariff Q2DQ2D Q2SQ2S Gov tariff rev

Price with quota World price Price without quota The Effects of an Import Quota on Price and Quantity of Imports Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Q1SQ1S Q2SQ2S Q2DQ2D Imports without quota Imports with quota Domestic supply +Import Supply Quota Q1DQ1D

World price The Effects of an Production Subsidy on Price and Quantity of Imports Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports Production subsidy Price (to producers) with subsidy QsQd

Effect of Large Domestic Subsidies on World Market Price Q/t 0 P/Q D S S’ Q2 P2 P1 Q1

So, what are the arguments for restricting trade?

Protect Domestic Production & Jobs

Protect National Security

Infant Industry Protection

Protection as a Bargaining Chip

Protection/Retaliation Against “Unfair” Competition Resulting From:  Tariffs  Subsidies  Quotas  Dumping  “Manipulation of” exchange rates

Macroeconomic Stability

Environmental/Health/Cultural Human Rights Considerations

International Trade Liberalization Agreements Bilateral Agreements: North American Free Trade Agreement(1993) US China WTO Agreement (1999) General Agreement on Tariffs and Trade (GATT): Reduced average tariff among member countries from 40% after WWII to < 5% today. World Trade Organization (WTO) 1. Promotes trade liberalization, where appropriate 2. Approves retaliatory actions with regard to “illegal” trade barriers.

WTO Rulings Retaliatory Tariffs $2 billion $300 million €200 million EU/US SteelBrazil/US CottonUS/EU Bananas