1. International Trade and Tariff1
International Trade
and Tariff

2. What determines whether a country imports or exports a good?

3. Who gains and who loses from free trade among countries?

4. What are the arguments that people use to advocate trade restrictions?

5. THE DETERMINANTS OF TRADE
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.

6. Figure 1The Equilibrium without International Trade
Price
of Steel
Domestic
demand
Consumer
surplus
Domestic
supply
Equilibrium
price
quantity
Producer
surplus
Quantity
of Steel

7. Consumer and Producer Surplus
Consumer surplus
It measures the amount a consumer gains from a purchase by the difference between the price he actually pays and the price he would have been willing to pay.
It can be derived from the market demand curve.
Graphically, it is equal to the area under the demand curve and above the price.
Example: Suppose a person is willing to pay $20 per packet of pills, but the price is only $5. Then, the consumer surplus gained by the purchase of a packet of pills is $15.

8. Consumer Surplus Deriving Consumer Surplus from the Demand Curve
Price, P
Quantity, Q D
$12 9 8
$10 10 $9 11

9. Consumer Surplus Geometry of Consumer Surplus Price, P Quantity, Q a Db P2 Q2

10. Producer surplus
It measures the amount a producer gains from a sale by the difference between the price he actually receives and the price at which he would have been willing to sell.
It can be derived from the market supply curve.
Graphically, it is equal to the area above the supply curve and below the price.
Example: A producer willing to sell a good for $2 but receiving a price of $5 gains a producer surplus of $3.

11. Producer Surplus Geometry of Producer Surplus Price, P Quantity, Q S

12. Measuring the Cost and Benefits
Is it possible to add consumer and producer surplus?
We can (algebraically) add consumer and producer surplus because any change in price affects each individual in two ways:
As a consumer
As a worker
We assume that at the margin a dollar’s worth of gain or loss to each group is of the same social worth.

13. The Equilibrium Without International Trade
Equilibrium Without Trade
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.

14. The World Price and Comparative Advantage
If the country decides to engage in international trade, will it be an importer or exporter of steel?

15. The World Price and Comparative Advantage
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.

16. The World Price and Comparative Advantage
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.

17. The World Price and Comparative Advantage
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.

18. Figure 2 International Trade in an Exporting Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Domestic
quantity
demanded
Domestic
quantity
supplied
Price
before
trade
Exports
Quantity
of Steel

19. Figure 3 How Free Trade Affects Welfare in an Exporting Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Exports D C B A
Price
before
trade
Quantity
of Steel

20. Figure 3 How Free Trade Affects Welfare in an Exporting Country
Price
of Steel
Domestic
demand
Consumer surplus
before trade
Domestic
supply
Price
after
trade
World
price
Exports D C B A
Price
before
trade
Producer surplus
before trade
Quantity
of Steel
Copyright © South-Western

21. How Free Trade Affects Welfare in an Exporting Country

22. THE WINNERS AND LOSERS FROM 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.

23. 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.

24. Figure 4 International Trade in an Importing Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
before
trade
Price
after
trade
World
price
Domestic
quantity
supplied
Domestic
quantity
demanded
Imports
Quantity
of Steel

25. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price
Domestic
demand
of Steel
Domestic
supply C B D A
Price
before trade
Price
after trade
World
price
Imports
Quantity
of Steel

26. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price A
Domestic
demand
of Steel
Consumer surplus
before trade
Domestic
supply
Price
before trade C B
Producer surplus
before trade
Price
after trade
World
price
Quantity
of Steel

27. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price
Domestic
demand
of Steel
Consumer surplus
after trade
Domestic
supply C B D A
Price
before trade
Price
after trade
World
price
Imports
Producer surplus
after trade
Quantity
of Steel

28. How Free Trade Affects Welfare in an Importing Country

29. THE WINNERS AND LOSERS FROM TRADE
How Free Trade Affects Welfare in an Importing Country
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 because the gains of consumers exceed the losses of producers.

30. THE WINNERS AND LOSERS FROM TRADE
The gains of the winners exceed the losses of the losers.
The net change in total surplus is positive.

31. 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.

32. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Equilibrium
without trade
Price
with tariff Q S Q D
Tariff
Price
without tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
without tariff
of Steel

33. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Consumer surplus
before tariff
Domestic
supply
Producer surplus
before tariff
Equilibrium
without trade
Price
without tariff
World
price Q S Q D
Quantity
Imports
without tariff
of Steel

34. Figure 6 The Effects of a Tariff
Price
of Steel A B
Domestic
demand
Consumer surplus
with tariff
Domestic
supply
Equilibrium
without trade
Price
with tariff Q S Q D
Tariff
Price
without tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
without tariff
of Steel

35. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Producer surplus
after tariff
Equilibrium
without trade
Price
with tariff C G
Imports
with tariff Q S D
Tariff
Price
without tariff
World
price Q S Q D
Quantity
Imports
without tariff
of Steel

36. Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Tariff Revenue
Price
with tariff
Imports
with tariff Q S D E
Tariff
Price
without tariff
World Q S Q D
price
Quantity
Imports
without tariff
of Steel

37. Figure 6 The Effects of a Tariff
Price
of Steel A
Domestic
demand
Domestic
supply
Deadweight Loss B
Price
with tariff C G D F Q S E Q D
Tariff
Price
without tariff
World Q S Q D
Imports
with tariff
price
Quantity
Imports
without tariff
of Steel

38. The Effects of a Tariff

39. 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.

40. Export subsidy Export subsidy
A payment by the government to a firm or individual that ships a good abroad
When the government offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy.
It can be either specific or ad valorem.

41. Effects of an Export Subsidy
Price, P
Quantity, Q S D PS
Subsidy a b c d
= producer gain
(a + b + c)
= consumer loss (a + b)
= cost of
government subsidy
(b + c + d ) PW
Welfare loss = b + d
Exports

42. Effects of an Export Subsidy
An export subsidy raises prices in the exporting country.
An export subsidy leads to costs that exceed its benefits.

43. Export Subsidy: an Example
Europe’s Common Agricultural Program
Price, P
Quantity, Q S D
Support price
EU price without imports
= cost of
government
subsidy
World price
Exports

44. 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.

45. Figure 7 The Effects of an Import Quota
Price
of Steel
Domestic
demand
Domestic
supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota
Isolandian
price with
quota
Equilibrium
with quota Q S Q D
World
price
Price
without
quota = Q S Q D
Imports
with quota
Quantity
Imports
without quota
of Steel

46. 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.

47. Figure 7 The Effects of an Import Quota
Price
of Steel A
Domestic
demand
Domestic
supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota B
Isolandian
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

48. The Effects of an Import Quota

49. The Effects of an Import Quota
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.

50. Import Quota: an Example
Effects of the U.S. Import Quota on Sugar
Price, $/ton
Quantity of sugar,
million tons
Supply
Demand
= consumer loss
(a + b + c + d)
= producer gain (a)
= quota rents (c)
Price in
U.S. Market 466 a
8.45
6.32 b c d
World Price 280
5.14
9.26
Import quota:
2.13 million tons

51. 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.

52. The Lessons for Trade Policy
Both tariffs and import quotas . . .
raise domestic prices.
reduce the welfare of domestic consumers.
increase the welfare of domestic producers.
cause deadweight losses.

53. The Lessons for Trade Policy
Other Benefits of International Trade
Increased variety of goods
Lower costs through economies of scale
Increased competition
Enhanced flow of ideas

54. Other Instruments of Trade Policy
Voluntary Export Restraints
A voluntary export restraint (VER) is an export quota administered by the exporting country.
It is also known as a voluntary restraint agreement (VRA).
VERs are imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions.

55. Voluntary Export Restraints
A VER is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country.
A VER is always more costly to the importing country than a tariff that limits imports by the same amount.
The tariff equivalent revenue becomes rents earned by foreigners under the VER.
Example: About 2/3 of the cost to consumers of the three major U.S. voluntary restraints in textiles and apparel, steel, and automobiles is accounted for by the rents earned by foreigners.
A VER produces a loss for the importing country.

56. THE ARGUMENTS FOR RESTRICTING TRADE
Jobs
National Security
Infant Industry
Unfair Competition
Protection-as-a-Bargaining Chip

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

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

59. Summary
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.
Import quotas will have effects similar to those of tariffs.

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