international trade ratna k. shrestha

International Trade

Ratna K. Shrestha

Chapter 9

International Trade How does

international trade affect economic well-being?

Who gains and who loses (consumers or producers) from free trade among countries?

Overview

The Determinants of Trade The Winners and Losers From Trade The Welfare Effects of a Tariff The Arguments for Restricting Trade

The Principle of Comparative Advantage

Recall from Chapter 3 that trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.

The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

Determinants of International Trade

The effects of international trade can be shown as the difference between the domestic price of a good without trade and the world price of a good.

A country will either be an exporter of the good or an importer of the good.

If the domestic price (without trade) is higher, then the country becomes an importer.


International trade issues are no different from

trading as it applies to individuals within a community and

between provinces and regions within a country.

Equilibrium without TradeAssume:

– A country that is isolated from the rest of the world and produces steel.

– The market for steel consists of the buyers and sellers of the country.

In the absence of trade, the price adjusts to equilibrate domestic supply and demand.

The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive from the steel market.

Equilibrium Without Trade

DomesticSupply

Domestic Demand

Quantity

Pric

eSteel Market

Consumer Surplus

Producer Surplus

Impacts of International Trade

If the country decides to engage in international trade will it be an importer or exporter of steel?

Who will gain from free trade in steel and who would lose?

Would gains from trade exceed losses? To answer these questions..Start by

comparing market prices. . .


If a country has a comparative advantage, then the domestic price will be below the world price and the country will be an exporter of the good.

If the rest of the world has a comparative advantage, then the domestic price will be higher than the world price and the country will be an importer of the good.

International Trade: Exporter

If the world price of steel is higher than the domestic price, producers of steel will want to sell their steel at the world price, hence output would increase and domestic price would rise.

As domestic suppliers produce more steel and sell some of the additional output in the world market, the domestic price will increase to the world price. Domestic country becomes an Exporter!

International Trade: Exporter

DomesticSupply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

International Trade:ExporterDomestic

Supply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

International Trade:Exporter

The difference between domestic demand and domestic production at the world price is the amount exported!

It can be determined, graphically, that, exports will result in a net gain in surplus (welfare).


Supply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

QuantityExported!


Supply

Domestic Demand

Quantity

Pric

eSteel Market

World Price

Net Gain in Surplus! (CS = -B, PS = B+D)

A

B

C

D

Welfare of Exporting Country

International Trade:Importer

If the world price of steel is lower than the domestic price, the country would be an importer of steel, when trade is permitted.– Consumers will want to buy the lower priced

steel at the world price. Producers of steel will have to lower their

output until the supply price is equal to the world price.


DomesticSupply

Domestic Demand

Quantity

Pric

eSteel Market

World Price

International Trade: Importer

As a result of a lower world market price, the quantity demanded by the domestic consumers will increase but the domestic production decreases, hence the domestic country becomes an Importer!

The difference between domestic demand and domestic production at the world price is the amount imported!

It can be determined, graphically, that, Imports will result in a net gain in surplus (welfare).


DomesticSupply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

AmountImported!

International Trade:ImporterDomestic

Supply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

Net Gain in Surplus!(CS = B+D, PS = -B)

A

B

C

D

Welfare of an Importing Country

Winners and Losers When a country allows trade and becomes an

exporter of a good, domestic producers of the good are better off. They receive a higher price.

However, domestic consumers of the good are worse off. They pay a higher price.

When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off. They pay a lower price.

However, domestic producers of the good are worse off. They receive a lower price.

Winners and Losers From Free International Trade

No matter who losses or gains, trade raises the economic well-being of the nation as a whole.

The net change in total surplus is positive.

The Lessons for Trade Policy Enhanced flow of ideas, especially production

techniques. Increased variety of goods. We can enjoy

mangoes from Mexico, Papaya from the Philippines and a car from Japan.

Lower costs through economies of scale. Trade leads to specialization. As a country produces more for international market as well, it can enjoy economies of scale (lower average cost of production due to higher production).

Increased competition. With trade firms have to compete with foreign producers as well.

Other Benefits of International Trade

The Welfare Effects of a Tariff A tariff is a tax on imported goods. It raises the

price of imported goods, above the world price by the amount of the tariff.

Domestic suppliers of the tariffed goods are gainers while domestic consumers of the goods are losers.

The government gains from the tax revenue. Examples: U.S. tariff on Canadian lumber in

2001/2002. U.S. tariff on foreign steel. When we buys goods from across the border, we pay taxes if value of goods exceeds certain amount.

The Welfare Effects of a TariffDomestic

Supply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

$$ value ofImport


Supply

Domestic Demand

Quantity

Pric

e Steel Market

World Price

Tariff

}

Imports w/ Tariff


Supply

Quantity

Pric

e Steel Market

Tariff}

ReducedConsumption

IncreasedProduction

Govt. Revenue


Supply

Quantity

Pric

e Steel Market

Tariff}

Deadweight Losses From

Tariff

D F

A

BC E

G

Deadweight Losses Due to Tariff Like any tax on the sale of a good, it distorts

incentives and pushes the allocation of scarce resources away from the optimum. – Raises domestic prices and encourages more

domestic production (Loss = D). Notice this extra increased domestic production can be produced by foreign firms at a lower costs (than the domestic firms) and in that sense misallocation of resources.

– Higher domestic prices reduces the amount purchased by domestic consumers (Loss =F).

The Effects of a Tariff

The Effects of an Import Quota An import quotaimport quota is a limit on the quantity of a

good that is produced abroad and sold domestically.

It raises domestic price above the world price– domestic buyers are worse off– domestic sellers are better off.

Import license holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.

Example: Canada permits only two bottles of liquor import for individuals traveling across the border.

Figure 7 The Effects of an Import Quota

Copyright © 2004 South-Western

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticsupply

+Import supply

Domesticdemand

Isolandianprice with

quota

Importswithout quota

Equilibriumwith quota

Equilibriumwithout trade

Quota

Importswith quota

QD

Worldprice

Worldprice

Pricewithout

quota=

QS QDQS

Figure 7 The Effects of an Import Quota

Copyright © 2004 South-Western

A

E'C

B

G

D E" F

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticsupply

+Import supply

Domesticdemand

Isolandianprice with

quota

Importswithout quota

Equilibriumwith quota

Equilibriumwithout trade

Quota

Importswith quota

QD

Worldprice

Worldprice

Pricewithout

quota=

QS QDQS

The Effects of an Import Quota

Thailand Imports Quota for Japan Steel Set at 950,000 Tons (October 25th, 2007)Under the Japan-Thailand Economic Partnership Agreement (JTEPA), the quota for Thailand imports of Japan steel has been set at 950,000 tons according to the Bangkok Post.

Of the Thailand imports quota, the largest allocations of steel go to Siam United Steel and Thai Cold Rolled Sheet, both of which are part of joint ventures with Nippon Steel and Sahaviriya Steel Industries respectively.

The Japan-Thailand Economic Partnership Agreement (JTEPA) states that Thailand will eliminate the 15% Thailand import tariff for Japanese steel, and in return, Japan will reduce tariffs for farm goods.

Arguments for Restricting Trade Jobs: Trade leads to loss of jobs to countries with

lower wages or lax standards (such as environmental). During presidential election in 1992, Ross Perot argument was that NAFTA will lead to loss of US jobs to Mexico.

National Security: A country should not import militarily sensitive equipments from foreign nations.

Infant Industry: For many start up businesses, it takes time to be competitive with already established foreign businesses and so needs some protection in the form of trade (import) barriers.

Arguments for Restricting Trade Unfair-Competition: Another argument is unfair

competition from foreign firms. In 2002, US slapped 29% tax (on the average) on Canadian lumber arguing that Canadian lumber industry receives subsidies from the government (charge minimum fee for logging in public lands) which is unfair for US forest industry, where they don’t get any such help from the government.

Protection-as-a-Bargaining-Chip: When U.S. imposed tariff on Canadian lumber and band on beef (in the wake of BSE case in Alberta), there was a talk of restricting energy supply to U.S. The threat can be considered as a bargaining chip.

On the News: Japan threatens US with trade quotas

June 11, 2005: Japan has joined with six other countries including the EU in warning the US of their intention of imposing trade sanctions unless the US government abolishes the Byrd Amendment-an antidumping tariff amendment (if it does not eliminate the Continued Dumping and Subsidy Offset act of 2000)

The World Trade Organization (WTO) has termed the Byrd Amendment as violation of the WTO rules.

Two Approaches to Free Trade

Unilateral– Britain in 19th century and South Korea and

Chile in recent years. Multilateral

– NAFTA (North American Free Trade Agreement) among Canada, US and Mexico in 1993. This agreement is meant to lower the tariff and quota restriction on the flow of goods and services across these 3 nations.

Two Approaches to Free Trade Multilateral:

GATT (General Agreement on Trade and Tariff), a continuing series of trade agreements among many nations. The rules of GATT are enforced by World Trade Organization (WTO). GATT has reduced the average tariff from 40% before WW II to about 5% today.

On the news: WTO panel to rule on Canada-U.S. lumber dispute (Jan, 2005): The WTO has set up a panel to decide if the U.S. complied with its earlier rulings that favored Canada in the long-running dispute over softwood lumber.

Conclusion... Economists see the benefits of trade between

countries the same way as they see the benefits of trade between provinces, cities and people.

Any individual would have a much lower standard of living if she or he had to produce all of the goods that this individual planned to consume!

If there were no gains from trade, there would have been no trade across individuals or nations at all.

international trade ratna k. shrestha

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