Chapter 9 International Trade

Objectives 1. Understand the basis of international specialization 2. Learn who gains and who loses from international trade 3. Recognize that the gains from international trade exceed the costs 4. Understand the welfare effects of tariffs and quotas 5. Evaluate the merits of arguments to restrict international trade

International Trade u How does international trade affect economic well-being? u Who gains and who loses from free trade among countries?

Chapter 3: The Principle of Comparative Advantage Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.

The Principle of Comparative Advantage u Comparative Advantage describes the comparison among producers of a good according to their opportunity cost. The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

Determinants of International Trade u The effects of international trade are shown as the difference between the domestic price of a good without trade and the world price of a good. u A country will either be an exporter of the good or an importer of the good.

Determinants of International Trade International trade issues are no different from trading as it applies to individuals within a community and between states and regions within a country.

Equilibrium without Trade Assume: –A country that is isolated from rest of the world and produces tomatoes. –The market for tomatoes consists of the buyers and sellers of the country. –Domestic Price adjusts to balance Demand and Supply. –The sum of consumer and producer surplus measures the total benefits.

Equilibrium Without Trade Domestic Supply Domestic Demand Quantity Price Tomato Market

Equilibrium Without Trade Domestic Supply Domestic Demand Quantity Price Tomato Market Consumer Surplus Producer Surplus

Equilibrium Without Trade u When an economy cannot trade in world markets, the price adjusts to equilibrate domestic supply and demand. u The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive from the tomato market.

Impacts of International Trade, example u If the country decides to engage in international trade will it be an importer or exporter of tomatoes? u Who will gain from free trade in tomatoes and who would lose? u Would gains from trade exceed losses? u Start by comparing market prices...

Determinants of International Trade u 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. u If the rest of the world has a comparative advantage, then the domestic price will be higher than the world price and the country will be an importer of the good.

International Trade Example - Exporter u If the world price of tomatoes is higher than the domestic price, the country would be an exporter of tomatoes, when trade is permitted. u Producers of tomatoes will want to sell their tomatoes at the world price, hence output would increase and domestic price would rise.

International Trade Example - Exporter Domestic Supply Domestic Demand Quantity Price Tomato Market World Price

International Trade Example - Exporter As domestic suppliers produce more tomatoes and sell some of the additional output in the world market, the domestic price will increase to the world price. The domestic country becomes an Exporter!

International Trade Example - Exporter u The difference between domestic demand at the world price and domestic production is the amount exported!

International Trade Example - Exporter Domestic Supply Domestic Demand Quantity Price Tomato Market World Price Quantity Exported!

How Free Trade Affects Welfare In An Exporting Country (fig. 9-3) Quantity of Steel Price of Steel World Price D B C A Price before trade Price after trade Exports Domestic supply Domestic demand }

Changes in Welfare From Free Trade: The Case of an Exporting Country (Table 9-1)

International Trade Example - Importer u If the world price of tomatoes is lower than the domestic price, the country would be an importer of tomatoes, when trade is permitted. –Consumers will want to buy the lower priced tomatoes at the world price. u Producers of tomatoes will have to lower their output until the supply price is equal to the world price.

International Trade Example - Importer Domestic Supply Domestic Demand Quantity Price Tomato Market World Price

International Trade Example - Importer As a result of a lower world market price, the quantity demanded by the domestic consumers will increase but the domestic production decreases, hence the domestic country becomes an Importer!

International Trade Example - Importer u The difference between domestic demand at the world price and domestic production is the amount imported!

International Trade Example - Importer Domestic Supply Domestic Demand Quantity Price Tomato Market World Price Amount Imported!

Winners and Losers From Free International Trade u When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off. They receive a higher price. u However, domestic consumers of the good are worse off. They pay a higher price.

Winners and Losers From Free International Trade u When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off. They pay a lower price. u However, domestic producers of the good are worse off. They receive a lower price.

How Free Trade Affects Welfare In An Importing Country (fig. 9-5) Quantity of Steel Price of Steel World Price DB C A Price before trade Price after trade Imports Domestic supply Domestic demand }

Changes in Welfare From Free Trade: The Case of an Importing Country (Table 9-2)

Winners and Losers From Free International Trade u Trade raises the economic well- being of the nation. u The net change in total surplus is positive.

The Welfare Effects of a Tariff u A tariff is a tax on imported goods. u A tariff raises the price of imported goods, above the world price by the amount of the tariff. u Domestic suppliers of the tariffed good are gainers while domestic consumers of the good are losers.

The Welfare Effects of a Tariff Domestic Supply Domestic Demand Quantity Price Tomato Market World Price

The Welfare Effects of a Tariff Domestic Supply Domestic Demand Quantity Price Tomato Market World Price Amount Imported

The Welfare Effects of a Tariff Domestic Supply Domestic Demand Quantity Price Tomato Market World Price Tariff }

The Welfare Effects of a Tariff Domestic Supply Domestic Demand Quantity Price Tomato Market World Price Tariff }

The Welfare Effects of a Tariff Domestic Supply Quantity Price Tomato Market Tariff } Reduced Consumption Increased Production

The Welfare Effects of a Tariff Domestic Supply Quantity Price Tomato Market Tariff } Government Revenue From Tariff

The Welfare Effects of a Tariff Domestic Supply Quantity Price Tomato Market Tariff } Deadweight Losses From Tariff A C DEF B G

The Welfare Effects of a Tariff Deadweight Losses u Like any tax on the sale of a good, it distorts incentives and pushes the allocation of scarce resources away from the optimum. –Raises domestic prices and encourages more production. –Higher domestic prices reduces the amount purchased by domestic consumers

The Effects of an Import Quota (fig. 9-7) Quantity of Steel Price of Steel World Price D B C A Price without quota= World price Isolandian price with quota Imports w/quota Domestic supply Domestic demand 0 QS1QS1 QS1QS1 QD2QD2 QD1QD1 Q F Imports w/o quota Domestic supply + Import supply E’E” Equilibrium without trade Equilibrium with quota Quota

Changes in Welfare From an Import Quota (Table 9-4)

Arguments for Restricting Trade Arguments Against Free Trade u Jobs u National Security u Infant Industry u Unfair-Competition (Dumping) u Protection-as-a-Bargaining-Chip u Trade Imbalances

Other Benefits of International Trade u Increased variety of goods u Lower costs through economies of scale u Increased competition u Enhanced flow of ideas

Summary... A Parable of Free Trade u Throughout its history, the United States has allowed unrestricted trade among the states, and the country as a whole has benefited from the specialization that trade allows. u Parable of Isoland...

Summary u The effects of free trade can be determined by comparing the domestic price without trade to the world price. u A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter. u A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.

Summary u When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off. u When a country allows trade and becomes an importer of a good, consumers of the good are better off, and producers are worse off.

Summary u A tariff – a tax on imports – moves a market closer to the equilibrium than would exist without trade, and therefore reduces the gains from trade. u Import quotas will have effects similar to those of tariffs.

Summary u There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions. u Economists, however, believe that free trade is usually the better policy.