0. Chapter 9

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?
If policymakers restrict imports, who benefits? Who is harmed? Do the gains of the policy outweigh the losses?
What are some common arguments for restricting trade? Do they have merit?

2. Introduction
Recall from Chapter 3: A country has a comparative advantage in a good if it produces the good at lower opportunity cost than other countries.
Countries can gain from trade if each exports the goods in which it has a comparative advantage.
Now we apply the tools of welfare economics to see where these gains come from and who gets them.

3. 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 has comparative advantage in the good
under free trade, country exports the good
If PD > PW,
country does not have comparative advantage
under free trade, country imports the good

4. 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.

5. 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 (for the crop year):
Soybeans are grown primarily in the eastern provinces of Ontario and Quebec
Canadian farmers grew kilotons of soybeans.
The average price was $220/ton.
Canada exported kilotons.
Canada’s biggest foreign customer was Japan, which accounted for almost 25 percent of Canadian soybean exports.
The second largest importer of Canadian soybeans was The Islamic Republic of Iran, which imported about 12 percent of our exports.
Source: Canadian Soybean Exporters 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.

6. 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
Net gain from trade $4 C
Trade benefits soybean producers, because they can sell at a higher price. Producer surplus rises by the area B + D.
Trade makes domestic buyers worse off, because they have to pay a higher price. Consumer surplus falls by the area B.
The gains to producers are greater than the losses to consumers, so trade increases total welfare: total surplus rises by the amount D.

7. A C T I V E L E A R N I N G 1: Analysis of trade
Without trade, PD = $3000, Q = 400
In world markets, PW = $1500
Under free trade, how many TVs will the country import or export?
Identify CS, PS, and total surplus without trade, and with trade. P Q
Plasma TVs D S
$3000
400
$1500
The two preceding slides show students the analysis of trade when the country exports. The next step is to cover the analysis of trade when the country imports the good.
Instead of lecturing on this material, I suggest you have students work on this exercise, which students to do this analysis themselves. It’s an activity that breaks up the lecture and gives students a chance to apply the techniques you’ve just presented.
I suggest you have students work on it in pairs. Give them about 5 minutes, then go over the answers on the following two slides.
While students are working, circulate around the room and offer to assist any students that ask for help. This will also give you a sense of how well students are understanding the material.
If you prefer to lecture on the material instead, replace these slides with the two “hidden” slides that immediately follow the CHAPTER SUMMARY. You will then have to “unhide” those slides by unselecting “Hide Slide” from the “Slide Show” drop-down menu.
200
600 7

8. A C T I V E L E A R N I N G 1: Answers
Under free trade,
domestic consumers demand 600
domestic producers supply 200
imports = 400 P Q
Plasma TVs D S
$3000
$1500
PD > PW, so this country will import plasma TV sets from abroad.
The quantity of imports is simply the difference between the quantity demanded by domestic consumers and the quantity supplied by domestic firms at the world price.
200
600
imports 8

9. A C T I V E L E A R N I N G 1: Answers
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
Net gain from trade A
$3000 B D
$1500
Trade benefits consumers in this case, because it allows them to buy plasma TVs at lower prices, so more consumers can afford plasma TVs if imports are allowed. The gains to consumers appear on the graph as the area (B+D), which represents the increase in consumer surplus when the country allows trade.
In this example, trade harms domestic producers, because they now must sell their plasma TVs at a lower price. As a result, they produce a smaller quantity, earn less revenue, and likely let go of some of their workers. These losses are represented on the graph by the area B , which represents the fall in producer surplus resulting from trade.
As the graph shows, the gains to consumers outweigh the losses to producers: total surplus increases by the amount D, which represents the gains from trade in plasma TV sets. C
imports 9

10. 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.

11. 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.

12. Then Why All the Opposition to Trade?
Recall one of the Ten Principles: Trade can make everyone better off.
The winners from trade could compensate the losers and still be better off.
Yet, such compensation rarely occurs.
The losses are often highly concentrated among a small group of people, who feel them acutely.
The gains are often spread thinly over many people, who may not see how trade benefits them.
Hence, the losers have more incentive to organize and lobby for restrictions on trade.
In December 2005, thousands of protestors gathered outside the meeting place of the World Trade Organization talks in Hong Kong. Some protests turned violent, and police made 900 arrests.
Mankiw addresses the issue of opposition to trade very nicely in the “Ask the Author” video for Chapter 3.
The “Ask the Author” videos are available at the Mankiw Xtra website. You may need a username and password; you can get them from your Thomson/South-Western sales rep.
There is one “Ask the Author” video clip per chapter. Each video is about 2 minutes. In each, Mankiw addresses a question submitted by a student. I encourage you to check out these videos, and consider showing some of them in your class.
The videos for Chapter 3 and Chapter 9 both go very nicely with the material in this PowerPoint.

13. 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 ).

14. 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

15. 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
Cotton shirts
deadweight loss = D + F D S A B
$30 40 70
The tariff benefits domestic producers, by allowing them to sell for a higher price. Producer surplus increases by C.
The tariff makes consumers worse off, because they have to pay a higher price. Consumer surplus falls by C + D + E + F.
The tariff generates revenue for the government equal to E.
The losses from the tariff exceed the gains, so total welfare falls. The tariff reduces total surplus by (D + F). C E D F
$20 25 80 G

16. 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
Cotton shirts
deadweight loss = D + F D S A B
$30 40 70
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. C E D F
$20 25 80 G

17. 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:
raise the domestic price of the good
reduce the quantity of imports
reduces buyers’ welfare
increases sellers’ welfare
cause a deadweight losses
A tariff creates revenue for the govt. A quota creates profits the holder of the import license who sells the good at domestic price which is higher than the world price.
Or, the govt could charge a fee for the import license. In this case, the import quota works exactly like a tariff.
The 4th edition of the textbook replaces the graphical analysis of a quota with an FYI box. This slide is based on that box.

18. Arguments for Restricting Trade
1. The jobs argument
Trade destroys jobs in the industries that compete against imports.
Economists’ response:
Total unemployment does not rise as imports rise, because job losses from imports are offset by job gains in export industries.
Even if all goods could be produced more cheaply abroad, the country need only have a comparative advantage to have a viable export industry and to gain from trade.

19. Arguments for Restricting Trade
2. The national security argument
An industry vital to national security should be protected from foreign competition, to prevent dependence on imports that could be disrupted during wartime.
Economists’ response:
Fine, as long as we base policy on true security needs.
But producers may exaggerate their own importance to national security to obtain protection from foreign competition.

20. Arguments for Restricting Trade
3. The infant-industry argument
A new industry argues for temporary protection until it is mature and can compete with foreign firms.
Economists’ response:
Difficult for gov’t to determine which industries will eventually be able to compete, and whether benefits of establishing these industries exceed cost to consumers of restricting imports.
Besides, if a firm will be profitable in the long run, it should be willing to incur temporary losses.

21. Arguments for Restricting Trade
4. The unfair-competition argument
Producers argue their competitors in another country have an unfair advantage, e.g. due to gov’t subsidies.
Economists’ response:
Great! Then we can import extra-cheap products subsidized by the other country’s taxpayers.
The gains to our consumers will exceed the losses to our producers.

22. Arguments for Restricting Trade
5. The protection-as-bargaining-chip argument
Example: In the mid- to late 90s, Canada threatened to limit the import of certain Australian products (e.g, fruits, wine, lamb, and beef) in retaliation of Australia’s prohibition of imports of fresh salmon from Canada.
Economists’ response:
Suppose Australia refuses. Then Canada must choose between two bad options:
A) Restrict imports from Australia, which reduces welfare in Canada.
B) Don’t restrict imports, lose face and suffer a loss of credibility.
The example comes from:
Trade war looms over Tasmanian salmon
Of course, this argument and response are meant to apply more generally than in the specific example described. But most non-economics majors more easily learn a general concept if they start with a specific, graspable example than with the general concept itself.

23. 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
The WTO website ( has useful information.
Especially worthwhile for students is the section “Common misunderstandings about the WTO.”

24. 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.
A tariff benefits producers and generates revenue for the gov’t, but the losses to consumers exceed these gains.

25. CHAPTER SUMMARY
Common arguments for restricting trade include: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
Some of these arguments have merit in some cases, but economists believe free trade is usually the better policy.

26. End: Chapter 9