1. LECTURE #8: MICROECONOMICS CHAPTER 9
Determinants of Trade
Arguments for Restricting Trade

2. Determinants of Trade Objective: Increase the standard of living
Key Factor: Comparative advantage
Local Price vs. World Price
If LP < WP, we export, else we import.
Eventually LP = WP
Winners and Losers
If LP < WP, local consumers will suffer welfare losses.
If LP > WP, local producers will suffer welfare losses.
Regardless, trade raises the total economic wellbeing

3. International Trade Exporting Country Impact on LP and LQ when WP > LP
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 3

4. International Trade Importing Country Impact on LP and LQ when WP < LP
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 4

5. Determinants of Trade Impact of Tariffs
Tariffs effectively raise price of imports above the world price (WP)
Purpose of tariff: protect local producers if LP > WP
Imposing tariff reduces imports and helps local market move to equilibrium
Tariffs impose deadweight loses in the same manner as taxes

6. Determinants of 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 6

7. Determinants of Trade The effects of a tariff Before the tariff
Consumer surplus = Producer surplus
Government tax revenue = 0
With a tariff
Consumer surplus - smaller
Producer surplus - bigger
Government tax revenue
Total surplus - smaller 7

8. Imports without tariff
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) 8

9. Determinants of Trade Benefits of international trade
Increased variety of goods
Lower costs through economies of scale
Increased competition
Enhanced flow of ideas 9

10. Arguments For Restricting Trade
Potential for loss of jobs
Potential for harm to national security
The need to protect young/new industries
Possibility of unfair competition (subsidies by foreign governments)
Protection as bargaining chip
Unilateral vs. Bilateral vs. Multilateral trade agreements

11. Trade Agreements & Organizations
NAFTA (North American Free Trade Assoc.) US, Canada, Mexico
GATT (General Agreement on Trade & Tariffs (multi-lateral)
WTO (World Trade Organization) administer trade agreements, settle disputes

12. Homework
Questions for Review: 1, 2, 4
Problems and Applications: 1, 2