1 Government and Trade

2 At the end of this section you should be able to: Evaluate the gains and losses from exporting and importing countries Evaluate the gains and losses from exporting and importing countries Evaluate and define the effect of an import quota and tariff Evaluate and define the effect of an import quota and tariff We are going to apply trade theory to determine welfare for exporting and importing countries. We will use aspects from the world market for each good.

3 Exporting Country Without trade our exporting country has a market for airplanes as described in the graph. Without trade our exporting country has a market for airplanes as described in the graph. P (in millions) Q S D Q*=400 P*=80 Recall, Q* is not only where the exporting country is producing but also where they are consuming.

4 Exporting Country Suppose the world market determines a world price of 100 million for an airplane. Suppose the world market determines a world price of 100 million for an airplane. This world price is where world supply = world demand. This world price is where world supply = world demand. P (in millions) Q S D 400 Pd=80 Pw=100 Qwd=300Qws=800 -At P=100 million, domestic suppliers are willing to supply 800 planes but domestic demand is only 300 planes. -There exists a surplus of 500 planes. This surplus will be exported.

5 Exporting Country Exporting plane makers have a comparative advantage in making planes. Exporting plane makers have a comparative advantage in making planes. This means the opportunity cost (the cost of producing the next best alternative) of the exporting country to make planes is < that of the rest of the world. This means the opportunity cost (the cost of producing the next best alternative) of the exporting country to make planes is < that of the rest of the world.

6 Exporting Country Gains from trade for Exporting Country exporting airplanes. Gains from trade for Exporting Country exporting airplanes. P (in millions) Q S D 400 Pd=80 Pw=100 Qwd=300Qws=800 A B C D Domestic Welfare for Exporting Country Before Trade Welfare Domestically: CS=A+B PS=D TS=A+B+D After Trade Welfare Domestically: CS=A PS=B+C+D TS=A+B+C+D Net Welfare increase with Trade=C Note: while some will lose with trade, the loser’s losses are less than the winner’s gains.

7 Importing Country Without trade our importing country has a market for airplanes as described in the graph. Without trade our importing country has a market for airplanes as described in the graph. P (in millions) Q S D Q*=200 P*=120 Recall, Q* is not only where the importing country is producing but also where they are consuming.

8 Importing Country Recall the world market price is 100 million (where Qws=Qwd) Recall the world market price is 100 million (where Qws=Qwd) P (in millions) Q S D 200 Pd=120 Notice no domestic supplier can make air planes at this price so it is beneficial to the exporting country (it maximizes their total surplus) to import all of the airplanes they will consume. Suppose they import 500 planes. Pw=

9 Importing Country Gains from trade for importing country importing airplanes Gains from trade for importing country importing airplanes P (in millions) Q S D 200 Pd=120 Pw= A B CD Domestic Welfare for Importing Country Before Trade Welfare Domestically: CS=A PS=B TS=A+B After Trade Welfare Domestically: CS=A+B+C+D PS=0 TS=A+B+C+D Net Welfare increase with Trade=C+D Note: while some will lose with trade, the producer’s losses are less than the consumer’s gains.

10 Tariffs A Tariff is a tax on a good that is imposed by the importing country when an imported good crosses the international boundary. A Tariff is a tax on a good that is imposed by the importing country when an imported good crosses the international boundary. Why Would a Country do this? Why Would a Country do this? Provide revenue to the government Provide revenue to the government Promote domestic industry Promote domestic industry Restricting free trade hurts overall welfare of importing country. Restricting free trade hurts overall welfare of importing country.

11 B Losses from Tariffs Suppose the government of the importing country imposes a tariff of 15 million, thus the world price increases to 115 million. Suppose the government of the importing country imposes a tariff of 15 million, thus the world price increases to 115 million. P (in millions) Q S D 200 Pd=120 Pw= Before Tariff on Trade Welfare: CS=A+B+C+D+E+F PS=0 TS=A+B+C+D+E+F After Tariff on Trade Welfare: CS=A+B PS=C TS=A+B+C+D Net Welfare loss due to Tariff=E+F Note: Tariffs are thought to help the importing country but actually the total welfare decreased. Pt= A C D EF Tariff= =15 Govt Revenue=D Domestic Welfare for Importing Country

12 Quotas A quota is a specified maximum amount of a good that may be imported in a given period of time. A quota is a specified maximum amount of a good that may be imported in a given period of time. Quotas are intended to help the importing country for reasons similar to tariffs. Quotas are intended to help the importing country for reasons similar to tariffs. Restricting free trade hurts overall welfare of importing country. Restricting free trade hurts overall welfare of importing country.

13Quotas Suppose the importing country sets a quota of 200 airplanes Suppose the importing country sets a quota of 200 airplanes The quota is represented by shifting supply curve. The quota is represented by shifting supply curve. The shift in the supply curve sets a new equilibrium where Qs+q=Qd. The shift in the supply curve sets a new equilibrium where Qs+q=Qd. P (in millions) Q S D 200 Pd=120 Pw= Domestic Welfare for Importing Country Before Quota with Free Trade: CS=A+B+C+D+E+F PS=0 TS=A+B+C+D+E+F After Quota Welfare Domestically: CS=A+F PS=B TS=A+B+F Net Welfare decrease with Quota=C+D+E S+Q 275 Pq= Quota=200= A B C D E F Note: Quotas are thought to help the importing country but actually the total welfare decreased.