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Application: International Trade
9 Application: International Trade
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Analyzing the Impact of Trade
Compare Market without trade – “closed economy” Market where international trade is permitted – “open economy” Examine Equilibrium price/quantity before/after Consumer/producer surplus before/after Determine which group benefits and how; and which group “loses”
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Analyzing the Impact of Trade
Impact of Tariffs and Quotas Compare Market without tariffs – “free trade” Market with tariffs (taxes on imports) or quotas Examine Equilibrium price/quantity before/after Consumer/producer surplus before/after Determine which group benefits and how; and which group “loses”
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The Determinants of Trade
The equilibrium without trade Only domestic buyers and sellers Produced here/consumed here Equilibrium price and quantity Determined on the domestic market Total benefits Consumer surplus Producer surplus
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The equilibrium without international trade
1 The equilibrium without international trade Price of textiles Consumer surplus Domestic Supply Domestic Demand Equilibrium price Producer surplus Equilibrium quantity Quantity of textiles When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. This figure shows consumer and producer surplus in an equilibrium without international trade for the textile market in the imaginary country of Isoland.
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The Determinants of Trade
Allow for international trade? Questions to ask: What happens to price and quantity sold – in the domestic market? (With and without trade) Who will gain from free trade; who will lose, and will the gains exceed the losses? Should a tariff be part of the new trade policy?
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The Determinants of Trade
The world price and comparative advantage World price Price of a good that prevails in the world market for that good Assume US consumers relatively small part of world market -> do not affect the world price Domestic price Opportunity cost of the good to domestic market (US producers or US consumers)
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The Determinants of Trade
The world price and comparative advantage Compare domestic price with world price Determine who has comparative advantage If domestic price < world price Export the good Country – has comparative advantage If domestic price > world price Import the good World – comparative advantage
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The Winners and Losers From Trade
The gains and losses of an exporting country domestic equilibrium price before trade is below world price Once trade is allowed Domestic price rises to = world price Domestic quantity supplied > domestic quantity demanded The difference = exports
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International trade in an exporting country
2 International trade in an exporting country Price of textiles Domestic Demand Domestic Supply A Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of textiles produced domestically, and the demand curve shows the quantity consumed domestically. Exports from Isoland equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. Sellers are better off (producer surplus rises from C to B + C + D), and buyers are worse off (consumer surplus falls from A + B to A). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole. Exports Price after trade World B D Price before trade C Exports Domestic Quantity Demanded Domestic Quantity Supplied Quantity of textiles The area D shows the increase in total surplus and represents the gains from trade Before trade After trade Change Consumer Surplus Producer Surplus Total Surplus A+B C A+B+C A B+C+D A+B+C+D -B +(B+D) +D
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The Winners and Losers From Trade
The gains and losses of an importing country domestic equilibrium price before trade above world price Once trade is allowed Domestic price drops to = world price Domestic quantity supplied < domestic quantity demanded The difference = imports
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International trade in an importing country
3 International trade in an importing country Price of textiles Domestic Demand Domestic Supply A Once trade is allowed, the domestic price falls to equal the world price. The supply curve shows the amount produced domestically, and the demand curve shows the amount consumed domestically. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off (consumer surplus rises from A to A + B + D), and sellers are worse off (producer surplus falls from B + C to C). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole Price before trade B D Price after trade World C Imports Domestic Quantity Supplied Domestic Quantity Demanded Quantity of textiles The area D shows the increase in total surplus and represents the gains from trade Before trade After trade Change Consumer Surplus Producer Surplus Total Surplus A B+C A+B+C A+B+D C A+B+C+D +(B+D) -B +D
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The Winners and Losers From Trade
The effects of a tariff Tariff Tax on goods produced abroad (foreign producers) and sold domestically Free trade Domestic price = world price Tariff on imports Raises domestic price above world price By the amount of the tariff (just like a tax)
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Imports without tariff
4 The effects of a tariff Price of textiles Domestic Demand Domestic Supply A A tariff reduces the quantity of imports and moves a market closer to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area D + F. These two triangles represent the deadweight loss from the tariff. Tariff B Price with tariff Q2S Q2D C D E F Price without tariff World Price Q1S Q1D G Imports with tariff Quantity of textiles Imports without tariff The area D + F shows the fall in total surplus and represents the deadweight loss of the tariff Before tariff After tariff Change Consumer Surplus Producer Surplus Government Revenue Total Surplus A+B+C+D+E+F G None A+B+C+D+E+F+G A+B C+G E A+B+C+E+G -(C+D+E+F) +C +E -(D+F)
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The Winners and Losers From Trade
The effects of a tariff Price – rises by the amount of the tariff Domestic quantity demanded – decrease Domestic quantity supplied – increase Reduces the quantity of imports Moves the domestic market closer to its equilibrium without trade Domestic sellers – better off Domestic buyers – worse off
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The Arguments For Restricting Trade
The jobs argument “Trade with other countries destroys domestic jobs” Free trade creates jobs at the same time that it destroys them The national-security argument “The industry is vital for national security” When there are legitimate concerns over national security
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The Arguments For Restricting Trade
The unfair-competition argument “Free trade is desirable only if all countries play by the same rules” Increase in total surplus for the country The protection-as-a-bargaining-chip argument “Trade restrictions can be useful when we bargain with our trading partners” The threat may not work
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Trade agreements and the World Trade Organization
Multilateral approach to achieve free trade Reduce its trade restrictions while other countries do the same Bargain with its trading partners in an attempt to reduce trade restrictions around the world North American Free Trade Agreement (NAFTA) lowered trade barriers among the United States, Mexico, and Canada General Agreement on Tariffs and Trade (GATT) Continuing series of negotiations among many of the world’s countries with the goal of promoting free trade
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