1 Chapter 9 Application: International Trade The determinants of Trade The winners and losers from trade The arguments for restricting trade

2 The Determinants of Trade Consider the market for steel –Steel market is well suited for examining the gains and losses from trade. Produced in many countries and is much traded. Trade restrictions are often implemented in this market. The Equilibrium without TradeThe Equilibrium without Trade Assume: –A country is isolated from rest of the world and produces steel. –The market for steel consists of the buyers and sellers in the country. See Figure 9-1 –No one in the country is allowed to import or export steel.

3 Results: –Domestic price adjusts to balance demand and supply. –The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive. The World Price and Comparative AdvantageThe World Price and Comparative Advantage If the country decides to engage in international trade, will it be an importer or exporter of steel? The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good. 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.

4 If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good. THE WINNERS AND LOSERS FROM TRADE The gains and losses of an exporting country To analyze the welfare effects of free trade, the economists begin with the assumption that the country is a small economy. –The country is a price taker. –Price taker means that the country takes the world price of steel as given. They can sell steel at this price and be exporters or buy steel at this price and be importers. Figure 9-2 shows that the domestic equilibrium price is below the world price of steel.

5 Once free trade is allowed, the domestic price will rise to equal the world price. The domestic quantity demanded is smaller than the domestic quantity supplied and the country becomes an exporter of steel. Figure 9-3 show the gains and losses from trade by looking at changes in consumer and producer surplus. These gains and losses are also summarized in Table 9-1. The analysis of an exporting country yields two conclusions: –Domestic producers of the good are better off, and domestic consumers of the good are worse off. –Trade raises the economic well-being of the nation as a whole.

6 The Gains and Losses of an Importing CountryThe Gains and Losses of an Importing Country Figure 9-4 shows that the domestic equilibrium price is above the world price of steel. Once free trade is allowed, the domestic world price must equal the world price. The domestic quantity demanded is greater than the domestic quantity supplied and the country becomes an importer of steel. Figure 9-5 show the gains and losses from trade by looking at changes in consumer and producer surplus. These changes are also summarized in Table 9-2. The analysis of an importing country yields two conclusions: –Domestic producers of the good are worse off, and domestic consumers of the good are better off.

7 –Trade raises the economic well-being of the nation as a whole because the gains of consumers exceed the losses of producers. The Effects of a TariffThe Effects of a Tariff A tariff is a tax on goods produced abroad and sold domestically. See Figure 9-6 Tariffs raise the price of imported goods above the world price by the amount of the tariff. A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.

8 The Effects of an Import QuotaThe Effects of an Import Quota An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically. See Figure 9-7 Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off. License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price. With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss. The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.

9 The Lessons for Free Trade PolicyThe Lessons for Free Trade Policy If government sells import licenses for full value, revenue equals that of an equivalent tariff and the results of tariffs and quotas are identical. Both tariffs and import quotas... –raise domestic prices. –reduce the welfare of domestic consumers. –increase the welfare of domestic producers. –cause deadweight losses. Other Benefits of International Trade –Increased variety of goods. –Lower costs through economies of scale. –Increased competition. –Enhanced flow of ideas.

10 THE ARGUMENTS FOR RESTRICTING TRADE The jobs argument: –Opponents(of free trade) argue: trade with other countries destroys domestic jobs. The National-Security argument: –Opponents argue: the industry is vital for national security when an industry is threatened with competition form other countries. The infant-industry argument: new industries sometimes argue for temporary trade restrictions to help them get started The unfair-competition argument: free trade is desirable only if all countries play by the same rule. If firms in different countries are subject to different laws and regulations, then it is unfair to expect the firms to compete in the international marketplace.

11 The protection-as-a-bargaining chip argument: the strategy of bargaining. The threat of a trade restriction can help remove a trade restriction already imposed by a foreign government. CASE STUDY: Trade Agreements and the WTOCASE STUDY: Trade Agreements and the WTO UnilateralUnilateral: when a country removes its trade restrictions on its own. MultilateralMultilateral: a country reduces its trade restrictions while other countries do the same. NAFTA –The North American Free Trade Agreement (NAFTA) is an example of a multilateral trade agreement. –In 1993, NAFTA lowered the trade barriers among the United States, Mexico, and Canada.

12 GATT –The General Agreement on Tariffs and Trade (GATT) refers to a continuing series of negotiations among many of the world’s countries with a goal of promoting free trade. –GATT has successfully reduced the average tariff among member countries from about 40 percent after WWII to about 5 percent today. WTO The rules established under GATT are now enforced by an international institution called the World Trade Organization (WTO).