INTERNATIONAL TRADE Principles of Microeconomic Theory, ECO 284 John Eastwood CBA 247 523-7353 John.Eastwood@nau.edu Harmonized tariff schedule (HTS) of the United States: http://www.usitc.gov/taffairs.htm#HTS

Learning Objectives Review the gains from trade Eastwood's ECO486 Notes Learning Objectives Review the gains from trade Become familiar with tariffs Analyze the welfare cost of tariffs Explain why the welfare effects of quotas are worse than those of tariffs Analyze the welfare effects of a domestic production subsidy Tariffs

Static Gains from Trade Eastwood's ECO486 Notes Static Gains from Trade Specialization along the lines of comparative advantage increases world output. Trade raises consumption beyond autarky. Greater variety of goods and services Imported resources Tariffs

Dynamic Gains from Trade Eastwood's ECO486 Notes Dynamic Gains from Trade Trade speeds economic growth When more K goods are imported than produced in autarky, PPF shifts out. Trade diffuses new technology. Trade raises real income. Savings rise. Free trade an effective anti-trust policy Trade expands the market; firms achieve economies of scale. Tariffs

Eastwood's ECO486 Notes Commercial Policy Governments action that may change the composition and volume of trade flows Tariffs Quotas Other non-tariff barriers Subsidies Tariffs

Tariffs Taxes on Components Imports Exports Ad valorem-- % of value Eastwood's ECO486 Notes Tariffs Taxes on Imports Exports Components Ad valorem-- % of value Specific -- flat fee per unit Compound -- both Tariffs

Positive Effects of Tariffs Eastwood's ECO486 Notes Positive Effects of Tariffs Revenue Effect -- provide tax revenue Protective Effect -- shelter domestic producers from foreign competition A pure-revenue tariff is one imposed on a good not produced domestically A tariff on bananas imported to Iceland A prohibitive tariff is one that is so high that none of the good is imported no revenue is collected Developing countries may rely on tariffs to provide tax revenue Developed countries impose tariffs for their protective effect Tariffs

Tariffs as tools of int’l policy Most Favored Nation status, MFN granted as a reward, withheld as a punishment Generalized System of Preferences, GSP Most developed countries have GSP as means of helping developing countries access to markets of developed countries

Non-tariff Barriers Voluntary export restraints (VER) Eastwood's ECO486 Notes Non-tariff Barriers Voluntary export restraints (VER) Tariff-rate quotas (TRQs), WTO members are replacing existing quotas with TRQs Quotas (on apparel and textiles) are to be phased out by 2005 Voluntary export restraints (VER) are agreements between two governments in which the government of the exporting country agrees to restrain the volume of its own exports. Met letter, but not spirit, of GATT prohibition of quotas Tariff-rate quotas (TRQs), allow quantities below the quota to enter at low tariff rates. Once the quota is exceeded a higher tariff applies. WTO members are beginning to replace existing quotas with TRQs Quotas (on apparel and textiles) are to be phased out by 2005 Exceptions are allowed Tariffs

Welfare Cost Analysis Use Supply and Demand One import or export good Measure Changes in Consumer Surplus and Producer Surplus Start with a small country Its trade is too small to affect terms of trade

Consumers’ Surplus Consumers’ Surplus is the difference between consumers’ maximum willingness-to-pay and the amount they actually paid. The amount actually paid equals PQ. Graphically, Consumers’ Surplus (CS) is the area under the demand curve above P.

Eastwood's ECO486 Notes Producer Surplus Producer surplus is the price of a good minus the opportunity cost of producing it. Graphically, Producers’ Surplus (PS) is the area under the Price line and above Supply. Tariffs

An Efficient Market for Pizza Eastwood's ECO486 Notes An Efficient Market for Pizza Consumer surplus S 25 Price (dollars per pizza) 20 15 10 At Pe, CS + PS is greatest. At a price below Pe, fewer units are sold. CS may be larger, but PS is smaller. Some surplus is transferred from producers to consumers. Some surplus is lost. At a price above Pe, fewer units are sold. PS may be larger, but CS is smaller. Producer surplus 5 D 0 5 10 15 20 Quantity (thousands of pizzas per day) Tariffs

Gains from free trade -- imports Eastwood's ECO486 Notes Gains from free trade -- imports Domestic Supply of grapes 10 Price ($ per bushel of grapes) 6 a b c 3 World price of grapes 2 Domestic demand for grapes 1 4 7 10 Quantity (millions bushels of grapes per year) Tariffs

Welfare of a Move to Free Trade A Small Country’s Imports Eastwood's ECO486 Notes Welfare of a Move to Free Trade A Small Country’s Imports Tariffs

Gains from free trade -- exports Eastwood's ECO486 Notes Gains from free trade -- exports Domestic Supply of honey 10 9 World price of honey Price ($ per jar of honey) g e f 6 2 Domestic demand for honey 1 4 7 10 Quantity (millions jars of honey per year) Tariffs

Welfare of a Move to Free Trade A Small Country’s Exports Eastwood's ECO486 Notes Welfare of a Move to Free Trade A Small Country’s Exports Tariffs

Pure Revenue Tariff Versus Free Trade Eastwood's ECO486 Notes Pure Revenue Tariff Versus Free Trade Domestic Supply of grapes lies along y-axis 10 Price ($ per bushel of bananas) a 5 World price + tariff $2/bu b c 3 World price of bananas 2 Iceland’s demand for bananas 1 3 5 7 10 Quantity (millions bushels of bananas per year) Tariffs

Welfare Cost of a Tariff on Imports -- Small Country Eastwood's ECO486 Notes Welfare Cost of a Tariff on Imports -- Small Country Domestic Supply of grapes 10 Price ($ per bushel of grapes) 5 World price + tariff $2/bu c a b d 3 World price of grapes 2 Domestic demand for grapes 1 3 5 7 10 Quantity (millions bushels of grapes per year) Tariffs

Welfare Cost of a Tariff on Imports -- Small Country Eastwood's ECO486 Notes Welfare Cost of a Tariff on Imports -- Small Country Loss = 0.5 x tariff x change in imports Tariffs

Exhibit 6: Effect of a Quota Eastwood's ECO486 Notes Exhibit 6: Effect of a Quota In panel a, D is the U.S. demand curve and S is the supply curve of U.S. producers. The world price of sugar is $0.10 (the price that would prevail in the U.S. market) and a total of 70 million pounds would be demanded  U.S. producers would supply 20 million pounds and importers 50 million pounds. (a) S Price per pound Now suppose that U.S. officials impose a quota of 30 million pounds per month 0.10 As long as the U.S. price is at or above the world price of $0.10 per pound, foreigners supply 30 million pounds  the total supply of sugar to the U.S. market is found by adding 30 million pounds of imported sugar to the amount supplied by U.S. producers D Sugar (millions of pounds per month) 20 70 Tariffs

Exhibit 6: Effect of a Quota Eastwood's ECO486 Notes Exhibit 6: Effect of a Quota Thus, the supply curve that sums domestic production and imports is horizontal at the world price of $0.10 per pound and remains so until the quantity supplied reaches 50 million pounds. (a) S S +30 For prices above $0.10, the new supply curve, S + 30, adds horizontally the 30 million pound quota to S, the supply curve of U.S. producers as shown by the dark red line. The U.S. price is found where this new supply curve intersects the domestic demand curve  point e  an effective quota, by limiting imports, raises the price of domestic sugar above the world price and reduces quantity below the free trade level. e Price per pound $0.15 0.10 D Sugar (millions of pounds per month) 20 50 70 Tariffs

Exhibit 6: Effect of a Quota Eastwood's ECO486 Notes Exhibit 6: Effect of a Quota (a) (b) The right panel shows the distribution and efficiency aspects of the quota. As a result of the quota, U.S. consumer surplus declines by the blue and pink shaded areas. Price per pound S S +30 S S +30 e $0.15 $0.15 a c b d 0.10 0.10 D D Sugar (millions of pounds per month) 20 50 70 Sugar (millions of pounds per month) 20 30 60 70 Area a becomes producer surplus  no loss of U.S. welfare. The blue rectangle, c, shows the increased profit to those permitted by the quota to sell Americans 30 million pounds at $0.15 per pound. To the extent that foreign exporters rather than U.S. importers reap this profit, area c reflects a net loss in domestic welfare. Tariffs

Exhibit 6: Effect of a Quota Eastwood's ECO486 Notes Exhibit 6: Effect of a Quota The pink triangle, b, shows by how much the marginal cost of producing another 10 million pounds in the U.S. exceeds the world price  a welfare loss to the U.S. economy because sugar could have been purchased abroad for $0.10 and the resources employed to increase sugar production could have been used more efficiently to produce other goods. (a) (b) Price per pound S S +30 S S +30 e $0.15 $0.15 a c b d 0.10 0.10 D D Sugar (millions of pounds per month) 20 50 70 Sugar (millions of pounds per month) 20 30 60 70 The pink triangle, d, is also a welfare loss, because it reflects a reduction in consumer surplus with no offsetting gain to anyone  the two pink shaded areas measure the minimum welfare cost imposed on the domestic economy by an effective quota. To the extent that the profit from quota rights, area c, accrues to foreigners, this increases the U.S. welfare loss resulting from the quota Tariffs

Welfare effects of a domestic production subsidy Eastwood's ECO486 Notes Welfare effects of a domestic production subsidy Domestic supply of small cars Domestic supply with subsidy 20 Subsidy = $T Price ($1000 per car) 12 10 World price + new equivalent tariff a b 6 World price of small cars 4 Domestic demand 2 4 6 8 10 14 18 Quantity (thousands of cars per year) Tariffs

Welfare effects of a domestic production subsidy Eastwood's ECO486 Notes Welfare effects of a domestic production subsidy Tariffs

Welfare Cost of Tariffs as a Percentage of GDP Eastwood's ECO486 Notes Welfare Cost of Tariffs as a Percentage of GDP Tariffs & NTBs often exclude new goods e.g., computers, just-in-time inventory processes GDP loss almost twice the tariff rate Ten percent tariff lowers GDP by 19.8% Twenty-five percent tariff lowers GDP by 47% Tariffs & NTBs often exclude new goods (e.g., computers, just-in-time inventory processes) Tariffs

Eastwood's ECO486 Notes Review homework Tariffs