Gains from Trade

The Gains from Trade Figure 8.2 At the free trade price of PW, Home supply will fall to S1 and Home demand will rise to D1. (b) Free Trade Price S PA PW Figure 8.2 (b) The Gains from Free Trade at Home With Home demand of D and supply of S, the no-trade equilibrium is at point A, at the price PA producing Q0. With free trade, the world price is PW, so quantity demanded increases to D1 and quantity supplied falls to S1. Since quantity demanded exceeds quantity supplied, Home imports D1 − S1. Consumer surplus increases by the area (b + d), and producer surplus falls by area b. The gains from trade are measured by area d. Imports will make up for the excess demand and will equal (D1 – S1) D S1 D1 Quantity Imports © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Trade Barriers Tariffs Quotas –or– Voluntary Export Restraints Subsidies Other types of barriers Licensing requirements Product standards Domestic buying rules Health and safety regulations Red tape Currency manipulation 4

Protectionism Tariff: A tax on a good coming into a country Increases the price of the good and makes it less competitive Quota: Physical restriction on the number of goods coming into a country

Tariffs

Import Tariffs for a Small Country Figure 8.4 Home price rises by the amount of the tariff. Home supply increases and Home demand decreases  Imports fall to M2 No-trade equilibrium Price Price S A M2 C X*+t PW+t S2 D2 Figure 8.4 Tariff for a Small Country Applying a tariff of t dollars will increase the import price from PW to PW + t. The domestic price of that good also rises to PW + t. This price rise leads to an increase in Home supply from S1 to S2, and a decrease in Home demand from D1 to D2, in panel (a). Imports fall due to the tariff, from M1 to M2 in panel (b). As a result, the equilibrium shifts from point B to C. B Foreign export supply, X* PW D M S1 D1 Quantity M1 Imports M2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Import Tariffs for a Small Country Figure 8.5 (a.3) The gain in government revenue due to the tariff is equal to the shaded area (c) This equals the tariff, t, times the quantity of imports, M2 (b+d) is deadweight loss No-trade equilibrium Price S A b d PW+t PW c Figure 8.5 (a) Effect of Tariff on Welfare The tariff increases the price from P W to P W + t. As a result, consumer surplus falls by (a + b + c + d). Producer surplus rises by area a, and government revenue increases by the area c. Therefore, the net loss in welfare, the deadweight loss to Home, is (b + d), which is measured by the two triangles b and d in panel (a). D S1 S2 D2 D1 Quantity M2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Globalization and Developing Countries Developing countries rely on “easy to collect” tariffs over “hard to collect” income and value-added taxes As globalization expands, we would expect these countries to move away from tariffs to the more “hard to collect” revenues According to one research study, the ratio of tax revenue to GDP obtained from “easy to collect” taxes fell by about 20% in developing countries between 1980’s and 1990’s

Quotas

Import Quotas Effect of the quota The import quota leads to an increase in the Home price, and a reduction in Home imports, just like the tariff We can see what the equivalent tariff, the tariff that would be set to give the same quantity and price as the quota, would be: t = P2 – PW For every level of import quota, there is an equivalent import tariff

Subsidy

Subsidy Effect of the Subsidy Consumers still pay Pw so there is no lost consumer surplus. However, since it is the consumer’s tax dollars that are paying to subsidize inefficient industry they may be worse off after the subsidy.