Application: International Trade 9 Application: International Trade

International Trade: issues What determines whether a country imports or exports a good? Who gains and who loses from free trade among countries? What are the arguments that people use to advocate trade restrictions? CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

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 domestic buyers and sellers. No one in the country is allowed to import or export steel. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

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

The World Price and Comparative Advantage If the country decides to engage in international trade, will it be an importer or exporter of steel? CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

The World Price and Comparative Advantage The effects of free trade can be shown by comparing the domestic price of a good (in the absence of trade) and the world price of the good. The world price is the price that prevails in the world market for that good. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

The World Price and Comparative Advantage If a country has a comparative advantage in steel production, then its domestic price will be less than the world price In this case, the country will be an exporter of the good. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

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 this country will be an importer of the good. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

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

Figure 2 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

The Gains and Losses from trade for 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 buyers will want to buy steel at the lower world price. Domestic producers of steel will have to reduce their output because the domestic price will fall to the world price. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

Figure 3 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

Figure 3 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

The Gains and Losses from trade for an Importing Country Domestic producers of the imported good are worse off Domestic consumers of the imported good are better off. Trade raises the economic well-being of the nation as a whole That is, the gains of consumers exceed the losses of producers. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

The Winners And Losers From Trade Irrespective of whether a country exports a good or imports it, the gains of those who gain exceed the losses of those who lose. That is, the net change in total surplus is always positive. And yet, tariffs/taxes on imported goods are quite popular. Why? CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Tariffs CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 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. Domestic price = World price + Tariff This reduces trade and, therefore, the benefits of trade CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

Figure 4 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

Figure 4 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

Figure 4 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

Figure 4 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

Figure 4 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

Figure 4 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

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE The Effects of a Tariff A tariff reduces the quantity of imports and moves the domestic market closer to the no-trade equilibrium. Buyers of the imported good are worse off Domestic sellers are better off Total surplus decreases by an amount referred to as a deadweight loss. That is, the loss to the nation’s buyers of the import-competing good exceed the gains to the nation’s sellers of that good CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

The Lessons for Trade Policy Tariffs raise domestic prices. reduce the welfare of domestic consumers. increase the welfare of domestic producers. cause deadweight losses. Free trade maximizes total surplus CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

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 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

The Arguments For Restricting Trade Jobs are shipped abroad National Security is endangered Infant Industries need to be shielded Unfair Competition Cheap labor Lax environmental standards Hard for domestic regulators to keep out defective or harmful imported goods Protection-as-a-Bargaining Chip Increasing inequality

CASE STUDY: Trade Agreements and the World Trade Organization Unilateral: when a country removes its trade restrictions on its own. Multilateral: a country reduces its trade restrictions while other countries do the same. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CASE STUDY: Trade Agreements and the World Trade Organization Unilateral: politically difficult to achieve Negative terms-of-trade effect for a large country Multilateral: politically easier to achieve because exporters can be mobilized to oppose the import-competing industries that oppose free trade Less risk of negative terms-of-trade effect

CASE STUDY: Trade Agreements and the World Trade Organization 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. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CASE STUDY: Trade Agreements and the World Trade Organization 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. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 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. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 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. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 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. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE

CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 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. CHAPTER 9 APPLICATION: INTERNATIONAL TRADE