I NTERNATIONAL T RADE Economics 101

E QUILIBRIUM W ITHOUT T RADE 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.

F IGURE 1T HE E QUILIBRIUM WITHOUT I NTERNATIONAL T RADE Copyright © 2004 South-Western Consumer surplus Producer surplus Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Equilibrium price Equilibrium quantity

I MPORTER OR E XPORTER ? If the country decides to engage in international trade, will it be an importer or exporter of steel? 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.

E XPORTER 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.

F IGURE 2 I NTERNATIONAL T RADE IN AN E XPORTING C OUNTRY Copyright © 2004 South-Western Price of Steel 0 Quantity of Steel Domestic supply Price after trade World price Domestic demand Exports Price before trade Domestic quantity demanded Domestic quantity supplied

F IGURE 3 H OW F REE T RADE A FFECTS W ELFARE IN AN E XPORTING C OUNTRY Copyright © 2004 South-Western D C B A Price of Steel 0Quantity of Steel Domestic supply Price after trade World price Domestic demand Exports Price before trade

F IGURE 3 H OW F REE T RADE A FFECTS W ELFARE IN AN E XPORTING C OUNTRY Copyright © 2004 South-Western D C B A Price of Steel 0Quantity of Steel Domestic supply Price after trade World price Domestic demand Exports Price before trade Producer surplus before trade Consumer surplus before trade

W INNERS AND L OSERS 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.

I MPORTER 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.

F IGURE 4 I NTERNATIONAL T RADE IN AN I MPORTING C OUNTRY Copyright © 2004 South-Western Price of Steel 0 Quantity Price after trade World price of Steel Domestic supply Domestic demand Imports Domestic quantity supplied Domestic quantity demanded Price before trade

F IGURE 5 H OW F REE T RADE A FFECTS W ELFARE IN AN I MPORTING C OUNTRY Copyright © 2004 South-Western C B D A Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price after trade World price Imports Price before trade

F IGURE 5 H OW F REE T RADE A FFECTS W ELFARE IN AN I MPORTING C OUNTRY Copyright © 2004 South-Western C B A Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price after trade World price Price before trade Consumer surplus before trade Producer surplus before trade

F IGURE 5 H OW F REE T RADE A FFECTS W ELFARE IN AN I MPORTING C OUNTRY Copyright © 2004 South-Western C B D A Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price after trade World price Imports Price before trade Producer surplus after trade Consumer surplus after trade

W INNERS AND L OSERS 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

T ARIFF 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.

F IGURE 6 T HE E FFECTS OF A T ARIFF Copyright © 2004 South-Western Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Equilibrium without trade Price without tariff World price Imports with tariff Q S Q S Q D Q D

F IGURE 6 T HE E FFECTS OF A T ARIFF Copyright © 2004 South-Western Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports without tariff Equilibrium without trade Price without tariff World price Q S Q D Producer surplus before tariff Consumer surplus before tariff

F IGURE 6 T HE E FFECTS OF A T ARIFF Copyright © 2004 South-Western A B Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Equilibrium without trade Price without tariff World price Imports with tariff Q S Q S Q D Q D Consumer surplus with tariff

F IGURE 6 T HE E FFECTS OF A T ARIFF Copyright © 2004 South-Western C G Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Equilibrium without trade Price without tariff World price Q S Imports with tariff Q S Q D Q D Producer surplus after tariff

F IGURE 6 T HE E FFECTS OF A T ARIFF Copyright © 2004 South-Western E Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Price without tariff World price Q S Imports with tariff Q S Q D Q D Tariff Revenue

F IGURE 6 T HE E FFECTS OF A T ARIFF Copyright © 2004 South-Western C G A EDF B Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Price without tariff World price Imports with tariff Q S Q S Q D Q D Deadweight Loss

E FFECTS OF T ARIFF 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.

I MPORT Q UOTA An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

F IGURE 7 T HE E FFECTS OF AN I MPORT Q UOTA Copyright © 2004 South-Western Price of Steel 0 Quantity of Steel Domestic supply Domestic supply + Import supply Domestic demand Isolandian price with quota Imports without quota Equilibrium with quota Equilibrium without trade Quota Imports with quota Q D World price World price Price without quota = Q S Q D Q S

E FFECTS OF I MPORT Q UOTA 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.

F IGURE 7 T HE E FFECTS OF AN I MPORT Q UOTA Copyright © 2004 South-Western A E' C B G D E" F Price of Steel 0 Quantity of Steel Domestic supply Domestic supply + Import supply Domestic demand Isolandian price with quota Imports without quota Equilibrium with quota Equilibrium without trade Quota Imports with quota Q D World price World price Price without quota = Q S Q D Q S

D EADWEIGHT L OSS OF Q UOTA 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.

L ESSONS FROM T RADE P OLICY Both tariffs and import quotas... raise domestic prices. reduce the welfare of domestic consumers. increase the welfare of domestic producers. cause deadweight losses.