International Trade

U.S Trade Information exports: 1.0 trillion dollars 9.7 % of GDP imports: 1.4 trillion dollars 13.7 % of GDP Source: A&CCODE=USA&CNAME=United+States&PTYPE=CP

When a country does not trade: production possibilities = consumption possibilities. This is not true when the country trades.

Example: Production Possibilities for the U.S. & Japan Food and Computers

Production Possibilities for the U.S. food computers C cost 20 F or 1C costs 2 F

Production Possibilities for the U.S. food computers C cost 20 F or 1C costs 2 F computers food

Production Possibilities for the U.S. food computers C cost 20 F or 1C costs 2 F computers food

Production Possibilities for the U.S. food computers C cost 20 F or 1C costs 2 F computers food

Production Possibilities for Japan food computers C cost 10 F or 1 C costs 2/3 F

Production Possibilities for Japan food computers C cost 10 F or 1 C costs 2/3 F computers food

Production Possibilities for Japan food computers C cost 10 F or 1 C costs 2/3 F computers food

Production Possibilities for Japan food computers C cost 10 F or 1 C costs 2/3 F computers food

Trade Arrangement Since 1 C costs 2 F in the U.S., and 1 C costs 2/3 F in Japan, 1 C will trade for between 2/3 F and 2 F. Suppose they agree to trade 1C for 1 F.

Consumption Possibilities for the U.S. computers food The consumption possibilities are now greater than the production possibilities. consumption production

Consumption Possibilities for Japan computers food Again, the consumption possibilities are greater than the production possibilities. consumption production

Natural Barriers to Trade u u contracting costs u u negotiating costs u u transportation costs

Artificial Barriers to Trade u u tariff: a tax on imported goods u u quota: a limit on the quantity of a good that is imported

Free Trade exchange of goods between countries without artificial barriers.

Benefits of Free Trade

Consumer Surplus difference between the price paid and the amount the consumer is willing to pay. P Q P* the area under the demand curve and above the price D

Producer Surplus difference between the amount the producer must receive to be willing to provide the good and the price paid. P Q P* the area under the price and above the supply curve S

Domestic Demand Curve (D D ): Demand for Cars by U.S. Consumers quantity price D A

Domestic Supply Curve (S D ): Supply of Cars to U.S. Consumers by U.S. Producers quantity price SDSD D ADAD

Without trade: price is OB and quantity is OI. quantity price SDSD D ABDOABDO E I

Without trade: consumer surplus is area ABE... quantity price SDSD D ABDOABDO E I

... and producer surplus is area DBE. quantity price SDSD D ABDOABDO E I

Total Supply Curve (S T ): Supply of Cars to U.S. Consumers by All Producers quantity price SDSD D ABDOABDO E I STST

With trade: price is OC and quantity purchased by U.S. consumers is OJ. quantity price SDSD D ABCDOABCDO E I J STST G

The quantity sold by U.S. producers is OH and the quantity of imports is HJ. quantity price SDSD D ABCDOABCDO E H I J STST G F

With trade: Consumer Surplus is area ACG quantity price SDSD D ABCDOABCDO E H I J STST G F

Recall: Without trade, consumer surplus was area ABE. quantity price SDSD D ABCDOABCDO E H I J STST G F Consumers have gained area CBEG from trade.

Suppose we are viewing this issue from the perspective of the U.S. government. Our concern is the welfare of U.S. consumers and U.S. producers (not foreign producers). Domestic producer surplus is the area above the domestic supply curve and below the price.

With trade: (Domestic) Producer Surplus is area CDF quantity price SDSD D ABCDOABCDO E H I J STST G F

Recall: Without trade, producer surplus was area DBE. quantity price SDSD D ABCDOABCDO E H I J STST G F Producers have lost area CBEF from trade.

So consumers have gained area CBEG and... quantity price SDSD D ABCDOABCDO E H I J STST G F

... producers have lost area CBEF. quantity price SDSD D ABCDOABCDO E H I J STST G F

So for U.S. citizens, there is a net gain from trade of area EFG. quantity price SDSD D ABCDOABCDO E H I J STST G F

Putting it all together: Relative to the no-trade situation, when there is free trade, u u the price paid by U.S. consumers is lower. u u the quantity purchased by U.S. consumers is higher. u u there is a gain in consumer surplus. u u there is a loss of producer surplus. u u there is a net gain to U.S. citizens.

How do tariffs & quotas affect U.S. citizens? Relative to the free trade situation, u u the price paid by U.S. consumers is higher. u u the quantity purchased by U.S. consumers is lower. u u there is a loss of consumer surplus. u u there is a gain in producer surplus.