0. International Trade (Chapter 8)
Unit IV
International Trade (Chapter 8)

1. In this chapter, look for the answers to these questions:
What determines how much of a good a country will import or export?
Who benefits from trade? Who does trade harm? Do the gains outweigh the losses?
How do tariffs and import quotas cause inefficiency and reduce total surplus?
Why do governments often engage in trade protection to shelter domestic industries from imports and how do international trade agreements counteract this?

2. The World Price and Comparative Advantage
PW = the world price of a good, the price that prevails in world markets
PD = domestic price without trade
If PD > PW,
country does not have comparative advantage
under free trade, country imports the good
There are overall gains from trade because consumer gains exceed the producer losses.
If PD < PW,
country has comparative advantage in the good
under free trade, country exports the good
There are overall gains from trade because producer gains exceed the consumer losses.

3. The Small Economy Assumption
A small economy is a price taker in world markets: Its actions have no affect on PW.
Not always true – especially for the U.S. – but simplifies the analysis without changing its lessons.
When a small economy engages in free trade, PW is the only relevant price:
No seller would accept less than PW, because she could sell the good for PW in world markets.
No buyer would pay more than PW, because he could buy the good for PW in world markets.

4. A Country That Exports Soybeans
Without trade, PD = $4 Q = 500
PW = $6
Under free trade,
domestic consumers demand 300
domestic producers supply 750
exports = 450 P Q
Soybeans D S
exports $6
300
750 $4
500
Fun soybean facts (all for 2004):
U.S. farmers grew 3.1 billion bushels of soybeans.
The average price was $5.65/bushel, for a total of nearly $18 billion.
The U.S. exported 1.1 billion bushels, comprising nearly half of international trade in soybeans.
China purchased $2.3 billion worth of U.S. soybean exports, making China the U.S. soybean farmer’s biggest foreign customer.
Japan was second with $1.0 billion in purchases.
Source: American Soybean Association,
You might alert your students that, in just a moment, they will be asked to do some analysis very similar to this analysis. This will make them pay close attention.
In this case, PD < PW, so this country will export soybeans.
The quantity of exports is simply the difference between the domestic quantity supplied and the domestic quantity demanded at the world price.

5. A Country That Exports Soybeans
Without trade,
CS = A + B
PS = C
Total surplus = A + B + C
With trade,
CS = A
PS = B + C + D
Total surplus = A + B + C + D P Q
Soybeans D S
exports A $6 D B
gains from trade $4 C

6. A Country That Imports Plasma TVs
Without trade, PD = $3000 Q = 400
PW = $1500
Under free trade,
domestic consumers demand 600
domestic producers supply 200
imports = 400 P Q
Plasma TVs D S
$3000
400
$1500
200
600
imports

7. A Country That Imports Plasma TVs
Without trade,
CS = A
PS = B + C
Total surplus = A + B + C
With trade,
CS = A + B + D
PS = C
Total surplus = A + B + C + D P Q
Plasma TVs D S
gains from trade A
$3000 B D
$1500 C
imports

8. Summary: The Welfare Effects of Trade
rises
falls
exports
PD < PW
rises
falls
imports
PD > PW
direction of trade
consumer surplus
producer surplus
total surplus
Whether a good is imported or exported, trade creates winners and losers.
But the gains exceed the losses.

9. Other Benefits of International Trade
Consumers enjoy increased variety of goods.
Producers sell to a larger market and may achieve lower costs through economies of scale.
Competition from abroad may reduce market power of some firms, which would increase total welfare.
Trade enhances the flow of ideas, facilitates the spread of technology around the world
PROBLEM -- there are losers in free trade
SOLUTION -- winners compensate the losers (seldom done)

10. Effects of Trade Protection
An economy has free trade when the government does not attempt either to reduce or to increase the levels of exports and imports that occur naturally as a result of supply and demand. Policies that limit imports are known as trade protection or simply as protection.
Most economists advocate free trade, although many governments engage in trade protection of import-competing industries. The two most common protectionist policies are tariffs and import quotas. In rare instances, governments subsidize export industries.

11. Effects of a Tariff A tariff is a tax levied on imports.
It raises the domestic price above the world price, leading to a fall in trade and total consumption and a rise in domestic production.
Domestic producers and the government gain, but consumer losses more than offset this gain, leading to deadweight loss in total surplus.

12. Tariff: An Example of a Trade Restriction
Tariff: a tax on imports
Example: Cotton shirts
PW = $20
Tariff: T = $10/shirt
Consumers must pay $30 for an imported shirt.
So, domestic producers can charge $30 per shirt.
In general, the price facing domestic buyers & sellers equals (PW + T ).

13. Analysis of a Tariff on Cotton ShirtsP Q
PW = $20
free trade:
buyers demand 80
sellers supply 25
imports = 55
T = $10/shirt
price rises to $30
buyers demand 70
sellers supply 40
imports = 30
Cotton shirts D S
$30 40 70
$20 25 80
imports
imports

14. Analysis of a Tariff on Cotton Shirts
free trade
CS = A + B + C D + E + F
PS = G
Total surplus = A + B + C + D + E + F + G
tariff
CS = A + B
PS = C + G
Revenue = E
Total surplus = A + B + C + E + G P Q
deadweight loss = D + F
Cotton shirts D S A B
$30 40 70 C E D F
$20 25 80 G

15. Analysis of a Tariff on Cotton ShirtsP Q
D = deadweight loss from the overproduction of shirts
F = deadweight loss from the under-consumption of shirts
deadweight loss = D + F
Cotton shirts D S A B
$30
A tariff is a tax. Like the taxes we studied in the preceding chapter, the tariff causes a deadweight loss because it distorts incentives.
Here, the tariff causes the economy to devote more resources to a good that could be produced at lower opportunity cost in other countries. This causes a deadweight loss, represented on the graph by the area D.
Also, the tariff gives consumers an incentive to purchase a smaller quantity. The result is a deadweight loss, area F on the graph. 40 70 C E D F
$20 25 80 G

16. Import Quotas: Another Way to Restrict Trade
An import quota is a quantitative limit on imports of a good.
Mostly, has the same effects as a tariff:
raises price, reduces quantity of imports
reduces buyers’ welfare
increases sellers’ welfare
A tariff creates revenue for the govt. A quota creates profits for the license holder

17. Trade Protection in the United States
The United States today generally follows a policy of free trade. Most manufactured goods are subject either to no or a low tariff.
There are two areas where imports are limited:
Agriculture: A certain amount of imports are subject to low a tariff rate and this acts like an import quota because only importers that are license holders are allowed to pay the low rate. Any additional imports are subject to a higher tariff.
Clothing and Textiles: A surge of clothing from China led to a partial re-imposition of import quotas which had otherwise been removed at the start of 2005.
In most cases, quota licenses are assigned to foreign governments. Quota rents greatly go overseas, increasing the cost to the U.S. of foreign imports.

18. Trade Protection in the United States
There isn’t much U.S. trade protection.
According to official U.S. estimates, the total economic cost of all quantifiable restrictions on imports is about $3.7 billion a year, or around one-fortieth of a percent on national income. Of this, about $1.9 billion comes from restrictions on clothing imports, $0.8 billion from restrictions on sugar, and $0.6 billion from restrictions on dairy. Everything else is small change.

19. Arguments for Trade Protection
Advocates of tariffs and import quotas offer a variety of arguments. Three common arguments are:
national security
job creation
the infant industry argument
Despite the deadweight losses, import protections are often imposed because groups representing import-competing industries are smaller and more cohesive than groups of consumers.

20. Trade Agreements A country can liberalize trade with
unilateral reductions in trade restrictions
multilateral agreements with other nations
Examples of trade agreements:
North American Free Trade Agreement (NAFTA), 1993
General Agreement on Tariffs and Trade (GATT), ongoing
World Trade Organization (WTO) est. 1995, enforces trade agreements, resolves disputes

21. New Challenges to Globalization
There are two concerns shared by economists:
Worries about the effects of globalization on inequality.
Worries that new developments, in particular the growth in offshore outsourcing, are increasing economic insecurity.
Offshore outsourcing takes place when businesses hire people in another country to perform various tasks.

22. CHAPTER SUMMARY
A country will export a good if the world price of the good is higher than the domestic price without trade. Trade raises producer surplus, reduces consumer surplus, and raises total surplus.
A country will import a good if the world price is lower than the domestic price without trade. Trade lowers producer surplus, but raises consumer and total surplus.
International trade leads to expansion in exporting industries and contraction in import-competing industries.
Most economists advocate free trade, but in practice many governments engage in trade protection.
A tariff is a tax levied on imports. An import quota is a legal limit on the quantity of a good that can be imported.
Although several popular arguments have been made in favor of trade protection, in practice the main reason for protection is probably political: import-competing industries are well-organized and well-informed about how they gain from trade protection, while consumers are unaware of the costs they pay.
Many concerns have been raised about the effects of globalization:
Income inequality due to the surge in imports from relatively poor countries
Offshore outsourcing