International Trade Mr. Barnett

UHS

AP Microeconomics

Determinants of Trade

Equilibrium without trade Only domestic buyers and sellers

Domestic price in the textile market will balance supply and demand

Total Benefits Consumer Surplus

Producer Surplus

Determinants of Trade

A 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 Trade

The 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 price Determine who has comparative advantage

If domestic price < world price

Export the good

The country has comparative advantage

If domestic price > world price

Import the good

The 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 Markets

Textiles are generally part of a competitive market there are many firms in the

market, none of which is large in terms of sales

Firms can enter and exit the market easily

Each firm in the market produces and sells a nondifferentiated or homogeneous product

All firms and consumers in the market have complete information about prices, product quality, and production techniques

Winners and Losers from Trade

Latveria 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 allowed Domestic price rises to = world

price

Domestic quantity supplied > domestic quantity demanded

The difference = exports

Exporting Country Welfare without Trade

Consumer surplus is equal to:

Producer surplus is equal to:

Total surplus is equal to:

Welfare with Trade Consumer surplus is equal to:

Producer Surplus is equal to:

Total surplus is equal to:

Changes in Welfare Consumer surplus changes by:

Producer surplus changes by:

Total surplus changes by:

Exporting Country

When 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 Country Meanwhile in Wakanda…

Wakanda’s domestic equilibrium price for textiles before trade is above the world price for textiles

Once trade is allowed… Domestic price ____ (rises/drops) to = world price

Domestic quantity supplied ____ ( </>) domestic quantity demanded

The difference = _______ (imports/exports)

Importing Country Welfare without Trade

Consumer surplus is equal to:

Producer surplus is equal to:

Total surplus is equal to:

Welfare with Trade Consumer surplus is equal to:

Producer Surplus is equal to:

Total surplus is equal to:

Changes in Welfare Consumer surplus changes by:

Producer surplus changes by:

Total surplus changes by:

Importing Country

When 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 Quotas

Tariff

Tax on goods produced abroad and sold domestically

Free trade

Domestic price = World price

Tariff on imports

Raises domestic price above world price

By the amount of the tariff

Tariff Welfare without Tariff

Consumer surplus is equal to:

Producer surplus is equal to:

Total surplus is equal to:

Welfare with Tariff Consumer surplus is equal to:

Producer Surplus is equal to:

Total surplus is equal to:

Changes in Welfare after Tariff Consumer surplus changes by:

Producer surplus changes by:

Total surplus changes by:

Tariffs

The effects of a tariff Price rises by _______________

Domestic quantity demanded ______ (increases/decreases)

Domestic quantity supplied ________(increases/decreases)

_________(Increases/decreases) the quantity of imports

Moves the domestic market _____(closer/farther away) to its equilibrium without trade

Domestic 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 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 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.

total surplus

producer surplus

consumer surplus

direction of trade

rises

falls

rises

imports

PD > PW

rises

rises

falls

exports

PD < PW

Summary: The Welfare Effects of Trade

Whether a good is imported or exported, trade creates winners and losers. But the gains exceed the losses.

Other benefits of international trade Consumers 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.

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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.

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Arguments for Restricting Trade

1. The jobs argument

Trade destroys jobs in industries that compete with imports.

Economists’ response:

Look at the data to see whether rising imports cause rising unemployment…

U.S. Imports & Unemployment, Decade averages, 1961–2010

0%

2%

4%

6%

8%

10%

12%

14%

16%19

61-

1970

1971

-19

80

1981

-19

90

1991

-20

00

2001

-20

10

Imports (% of GDP)

Unemployment (% of labor force)

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Arguments for Restricting Trade

2. 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.

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Arguments for Restricting Trade

3. 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.

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Arguments for Restricting Trade

4. The unfair-competition argument

Producers argue their competitors in another country have an unfair advantage, e.g. due to govt subsidies, regulations

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.

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Arguments for Restricting Trade

5. The protection-as-bargaining-chip argument

Example: 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) Don’t restrict imports, which reduces

U.S. credibility.

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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 Successfully reduced the average tariff

among member countries from about 40% to 5%

Enforced by the WTO 153 countries; 97 % of world trade

World Trade Organization (WTO), est. 1995, enforces trade agreements, resolves disputes