0. MECO 6303 – Business Economics
Lesson 8
International Trade:
Trade and welfare, tariffs and quotas

1. International Trade
Who gains and who loses from free trade among countries?
What are the arguments that people use to advocate trade restrictions?
Countries do not trade individuals do!
The determinants of international trade are the same as the determinants of any trade – specialization and trade bring mutual gains.
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2. Comparative Advantage and differences in tastes
Why do people trade? Diversity among people and in nature.
Different Tastes
Different Abilities and Resources – comparative advantage
Comparative Advantage (CA) plays a big role in determining the pattern of trade – internal and international
CA refers to relative, rather than absolute, differences in costs (and prices)
Example: The Secretary and the Attorney – it pays to specialize.
The same principle applies in international trade.
Activity/Value
Typing
Words per minute
Legal Practice
$ per hour
Secretary 75
Attorney 90
300
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3. Viva la differance! It Pays to be different
Any difference is an opportunity for mutual gain
The more different you are, the more gains to be had
International Trade: small countries gain the most
Adam Smith
18th century economist
Described the way trade benefit all parties
Increased productivity through specialization
David Ricardo
19th century economist – c. 1830
First to recognize importance of comparative advantage
Analyzed consequences for mutually beneficial trade
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4. 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.
No one in the country is allowed to import or export steel.
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5. Equilibrium without International Trade
Price
of Steel
Domestic
demand
Consumer
surplus
Domestic price adjusts to balance demand and supply.
The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.
Domestic
supply
Equilibrium
price
quantity
Producer
surplus
Quantity
of Steel
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6. The 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.
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.
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7. How Free Trade Affects Welfare in an Exporting Country
Price of steel
Domestic
demand
Consumer surplus
before trade
Domestic
Supply
Domestic
supply
Exports
Price
after
trade
World
price
Exports D C B A PW
Price
before
trade PD
How would we show a situation where the domestic country can affect the world price?
Producer surplus
before trade
Domestic
Demand
Quantity
of Steel
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8. The Winners and Losers from Export Trade
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 – gains outweigh losses
These are partial and short term results.
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9. The Gains and Losses of an Importing Country
International Trade in an Importing Country
If the world price of steel is lower than the domestic price, the country will be an importer of steel when trade is permitted.
Domestic consumers will want to buy steel at the lower world price.
Domestic producers of steel will have to lower their output because the domestic price moves to the world price.
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10. International Trade in an Importing Country
Price
of Steel
Domestic
demand
Consumer surplus
before trade
Domestic
supply
Domestic
Supply
Price
before
trade C B D A PD
Price
after
trade
World
price PW
Domestic
quantity
supplied
Domestic
quantity
demanded
Producer surplus
before trade
Imports
Imports
Domestic
Demand
Quantity
of Steel
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11. The Winners and Losers from Import Trade
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.
Trade raises the economic well-being of the nation as a whole in the sense that the gains of consumers exceed the losses of producers.
These are partial and short term results.
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12. The Effects of a Tariff
A tariff is a tax on goods produced abroad and sold domestically.
Tariffs raise the price of imported goods above the world price by the amount of the tariff.
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13. Imposing a tariff Consumer surplus before tariff Producer surplus
Price
of Steel
Domestic
demand
Domestic
supply
Consumer surplus
before tariff
Domestic
Supply A
Producer surplus
before tariff
Tariff
revenue
Deadweight
Loss B
Price
with tariff C E
tariff
Tariff D F
Price
without tariff
World
price G
Imports
with tariff
Domestic
Demand
Imports
with tariff
Q1S
Q2S
Q2D
Q1D
Quantity
Imports
without tariff
of Steel
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14. The Effects of a 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.
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15. The 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.
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16. Imposing an Import Quota
Price
of Steel
Domestic
demand A
Domestic
Supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota B
Price with
quota
Equilibrium
with quota D Q S E' Q D C F
World
price
Price
without
quota =
E" Q S Q D G
Imports
with quota
Quantity
Imports
without quota
of Steel
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17. The Effects of an Import Quota
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.
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18. The Lessons for 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.
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19. The Arguments for Restricting Trade
Jobs
National Security
Infant Industry
Unfair Competition
Protection-as-a-Bargaining Chip
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20. Other Benefits of International Trade
Increased variety of goods
Lower costs through economies of scale
Increased competition enhanced flow of ideas,
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