International Trade

International Trade Mr. BarnettUHSAP Microeconomics

Determinants of TradeEquilibrium without tradeOnly domestic buyers and sellersDomestic price in the textile market will balance supply and demandTotal BenefitsConsumer SurplusProducer Surplus

Determinants of TradeA new leader is elected to Latveria who is interested in pursuing trade. A committee of economists is organized to determine the following:

If the government allows trade, what will happen to the price of textiles and the quantity of textiles sold in the domestic market?

Who will gain from trade, who will lose, and will the gains exceed the losses?

Should a tariff (a tax on imported textiles) be part of the new trade policy?

Determinants of TradeThe first issue is to decide whether Latveria should import or export textiles.The answer depends on the relative price of textiles in Latveria compared with the price of textiles in other countries.Definition of world price: the price of a good that prevails in the world market for that good.Compare domestic price with world priceDetermine who has comparative advantageIf domestic price < world priceExport the goodThe country has comparative advantageIf domestic price > world priceImport the goodThe world has comparative advantage

Note that the domestic price represents the opportunity cost of producing textiles in Latveria, whereas the world price represents the opportunity cost of producing textiles abroad.

Competitive MarketsTextiles are generally part of a competitive marketthere are many firmsin the market, none of which is large in terms of sales Firms can enter and exit the market easilyEach firm in the market produces and sells a nondifferentiated orhomogeneous productAll firms and consumers in the market havecomplete informationabout prices, product quality, and production techniques

Winners and Losers from TradeLatveria will be price takers in textile world market (must buy or sell at that price)

If the world price is higher than the domestic price, Latveria will export textiles.

Once trade is allowedDomestic price rises to = world priceDomestic quantity supplied > domestic quantity demandedThe difference = exports

Exporting CountryWelfare without TradeConsumer surplus is equal to:Producer surplus is equal to:Total surplus is equal to:

Welfare with TradeConsumer surplus is equal to:Producer Surplus is equal to:Total surplus is equal to:

Changes in WelfareConsumer surplus changes by:Producer surplus changes by:Total surplus changes by:

Exporting CountryWhen a country exports a good:Domestic producers of the good are ______(better off/worse off) Domestic consumers of the good are _____(better off/worse off)

With international trade:Consumer surplus ______ (increases/decreases)Producer surplus _______(increases/decreases)Total surplus ________(increases/decreases)

The economic well-being of the country ______(rises/falls).

Importing CountryMeanwhile in WakandaWakandas domestic equilibrium price for textiles before trade is above the world price for textiles Once trade is allowedDomestic price ____ (rises/drops) to = world priceDomestic quantity supplied ____ ( ) domestic quantity demandedThe difference = _______ (imports/exports)

Importing CountryWelfare without TradeConsumer surplus is equal to:Producer surplus is equal to:Total surplus is equal to:

Welfare with TradeConsumer surplus is equal to:Producer Surplus is equal to:Total surplus is equal to:

Changes in WelfareConsumer surplus changes by:Producer surplus changes by:Total surplus changes by:

Importing CountryWhen a country imports a good:Domestic producers of the good are ______(better off/worse off) Domestic consumers of the good are _____(better off/worse off)

With international trade:Consumer surplus ______ (increases/decreases)Producer surplus _______(increases/decreases)Total surplus ________(increases/decreases)

The economic well-being of the country ______(rises/falls).

Trade can make everyone better off!

Tariffs and QuotasTariffTax on goods produced abroad and sold domesticallyFree tradeDomestic price = World priceTariff on importsRaises domestic price above world priceBy the amount of the tariff

TariffWelfare without TariffConsumer surplus is equal to:Producer surplus is equal to:Total surplus is equal to:

Welfare with TariffConsumer surplus is equal to:Producer Surplus is equal to:Total surplus is equal to:

Changes in Welfare after TariffConsumer surplus changes by:Producer surplus changes by:Total surplus changes by:

TariffsThe effects of a tariffPrice rises by _______________Domestic quantity demanded ______ (increases/decreases)Domestic quantity supplied ________(increases/decreases)_________(Increases/decreases) the quantity of importsMoves the domestic market _____(closer/farther away) to its equilibrium without tradeDomestic sellers are ______(better off/worse off)Domestic buyers are ______(better off/worse off)Consumer surplus is ______ (bigger/smaller)Producer surplus is ______(bigger/smaller)Government tax revenue is ______ (bigger/smaller)Total Surplus is _______(bigger/smaller)

Import Quotas: Another Way to Restrict TradeAn 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 foreign producers of the imported goods, who can sell them at higher price. Or, govt could auction licenses to import to capture this profit as revenue. Usually it does not. 01717total surplusproducer surplusconsumer surplusdirection of traderisesfallsrisesimportsPD > PWrisesrisesfallsexportsPD < PWSummary: The Welfare Effects of TradeWhether a good is imported or exported, trade creates winners and losers. But the gains exceed the losses. 01818Other benefits of international tradeConsumers enjoy increased variety of goods.Producers sell to a larger market, may achieve lower costs by producing on a larger scale.Competition from abroad may reduce market power of domestic firms, which would increase total welfare.Trade enhances the flow of ideas, facilitates the spread of technology around the world.

Then Why All the Opposition to Trade?Recall one of the Ten Principles from Chapter 1: 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. 0# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2020In 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 textbook website. You may need a username and password; you can get them from your Cengage/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. Arguments for Restricting Trade1. The jobs argumentTrade destroys jobs in industries that compete with imports. Economists response:Look at the data to see whether rising imports cause rising unemployment0# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2121U.S. Imports & Unemployment, Decade averages, 1961201001961-19701971-19801981-19901991-20002001-2010Imports (% of GDP)Unemployment (% of labor force)# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2222By using decade averages, the short-term noise and fluctuations average out, which makes the long-term trends easier to see.

Unemployment hovers around 6%, while imports keep trending up. Indeed, the period from 1981-2000 sees unemployment fall while imports rise.

Note: This data does not appear in the textbook. I include it here because I think it is effective. But it is not supported in the Test Bank or Study Guide, so please feel free to omit this and the preceding slide if you wish.

Data source: FRED database, St Louis Federal Reserve, http://research.stlouisfed.org/fred2/ and my calculations. (I constructed imports as a percentage of GDP, then computed simple averages of the two series over each of the decades shown in the graph.)

Arguments for Restricting Trade2. The national security argumentAn 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. 0

# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2323Arguments for Restricting Trade3. The infant-industry argumentA new industry argues for temporary protection until it is mature and can compete with foreign firms. Economists response:Difficult for govt 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. 0

# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2424Arguments for Restricting Trade4. The unfair-competition argumentProducers argue their competitors in another country have an unfair advantage, e.g. due to govt subsidies, regulationsEconomists response:Great! Then we can import extra-cheap products subsidized by the other countrys taxpayers. The gains to our consumers will exceed the losses to our producers. 0

# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2525Arguments for Restricting Trade5. The protection-as-bargaining-chip argumentExample: The U.S. can threaten to limit imports of French wine unless France lifts their quotas on American beef. Economists response:Suppose France refuses. Then the U.S. must choose between two bad options: A) Restrict imports from France, which reduces welfare in the U.S.B) Dont restrict imports, which reduces U.S. credibility. 0

# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2626Of 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. Trade AgreementsA country can liberalize trade with unilateral reductions in trade restrictionsmultilateral agreements with other nationsExamples of trade agreements: North American Free Trade Agreement (NAFTA), 1993General Agreement on Tariffs and Trade (GATT), ongoingSuccessfully reduced the average tariff among member countries from about 40% to 5%Enforced by the WTO153 countries; 97 % of world tradeWorld Trade Organization (WTO), est. 1995, enforces trade agreements, resolves disputes0

# 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.#2727The WTO website (http://www.wto.org) has useful information.

Especially worthwhile for students is the section 10 common misunderstandings about the WTO.