International TradeInternational TradeInternational TradeInternational Trade

GlobalizationGlobalizationGlobalizationGlobalization

Consider what determines whether a Consider what determines whether a country imports or exports a good.country imports or exports a good.

Examine who wins and who loses from Examine who wins and who loses from international trade.international trade.

Learn that the gains from to winners Learn that the gains from to winners from international trade exceed the from international trade exceed the losses to losers.losses to losers.

Analyze the welfare effects of tariffs and Analyze the welfare effects of tariffs and import quotas.import quotas.

Examine the arguments people use to Examine the arguments people use to advocate trade restrictions.advocate trade restrictions.

In this chapter you will…In this chapter you will…

Consider the market for steelConsider the market for steel• Steel market is well suited for Steel market is well suited for

examining the gains and losses examining the gains and losses from trade.from trade. Produced in many countries and is Produced in many countries and is

much traded.much traded. Trade restrictions are often Trade restrictions are often

implemented in this market.implemented in this market.

THE DETERMINANTS OF TRADETHE DETERMINANTS OF TRADE

Assume:Assume:• A country is isolated from the world A country is isolated from the world

and produces steel.and produces steel.• The market for steel consists of the The market for steel consists of the

buyers and sellers in the country. buyers and sellers in the country. (See Figure 9-1)(See Figure 9-1)

• No one in the country is allowed to No one in the country is allowed to import or export steel.import or export steel.

The Equilibrium without TradeThe Equilibrium without Trade

Quantity of steel

Price of steel

0

Consumer surplus

Equilibrium price

Equilibrium quantity

E

Producer surplus

Domestic demand

Domestic supply

Figure 9-1: The Equilibrium without Figure 9-1: The Equilibrium without International TradeInternational Trade

Results:Results:• Domestic price adjusts to balance Domestic price adjusts to balance

demand and supply.demand and supply.• The sum of consumer and producer The sum of consumer and producer

surplus measures the total benefits surplus measures the total benefits that buyers and sellers receive.that buyers and sellers receive.

The Equilibrium without TradeThe Equilibrium without Trade

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

The effects of free trade can be shown The effects of free trade can be shown by comparing the domestic price of a by comparing the domestic price of a good without trade and the good without trade and the world priceworld price of the good. of the good.

The The world priceworld price refers to the price that refers to the price that prevails in the world market for that prevails in the world market for that good.good.

The World Price and Comparative The World Price and Comparative AdvantageAdvantage

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

If the country does not have a If the country does not have a comparative advantage, then the comparative advantage, then the domestic price will be higher than the domestic price will be higher than the world price, and the country will be an world price, and the country will be an importerimporter of the good.of the good.

The World Price and Comparative The World Price and Comparative AdvantageAdvantage

To analyze the welfare effects of free To analyze the welfare effects of free trade, the economists begin with the trade, the economists begin with the assumption that the country is a small assumption that the country is a small economy.economy.• The country is a The country is a price takerprice taker.. • Price takerPrice taker means that the country takes means that the country takes

the world price of steel as given. They can the world price of steel as given. They can sell steel at this price and be exporters or sell steel at this price and be exporters or buy steel at this price and be importers. buy steel at this price and be importers.

THE WINNERS AND LOSERS THE WINNERS AND LOSERS FROM TRADEFROM TRADE

0 Quantity of Steel

Price of Steel

Price before trade

Exports

Price after trade

World price

Domestic quantity

Demanded

Domestic quantity Supplied

Domestic demand

Domestic supply

Figure 9-2: International Trade in an Figure 9-2: International Trade in an Exporting CountryExporting Country

Exporting CountryExporting Country

Domestic demand

Domestic supply

0 Quantity of Steel

Price of Steel

Exports

Exporting CountryExporting Country

Price after trade

World price

A

B

C

D

Price before trade

Figure 9-3: How Free Trade affects Figure 9-3: How Free Trade affects Welfare in an Exporting CountryWelfare in an Exporting Country

Table 9-1: Changes in Welfare from a Free Table 9-1: Changes in Welfare from a Free Trade: The Case of an Exporting CountryTrade: The Case of an Exporting Country

The analysis of an exporting The analysis of an exporting country yields two conclusions:country yields two conclusions:• Domestic producers of the good are Domestic producers of the good are

better off, and domestic consumers of better off, and domestic consumers of the good are worse off.the good are worse off.

• Trade raises the economic well-being Trade raises the economic well-being of the nation as a whole.of the nation as a whole.

The Gains and Losses of an Exporting The Gains and Losses of an Exporting CountryCountry

0 Quantity of Steel

Price of Steel

Imports

Price after trade

World price

Price before trade

Domestic quantity Supplied

Importing CountryImporting Country

Domestic demand

Domestic supply

Domestic quantity

Demanded

Figure 9-4: International trade in an Figure 9-4: International trade in an Importing CountryImporting Country

Domestic demand

Domestic supply

0 Quantity of Steel

Price of Steel

Imports

Importing CountryImporting Country

D

C

B

A

Price after trade

World price

Price before trade

Figure 9-5: How Free Trade affects Figure 9-5: How Free Trade affects Welfare in an Importing CountryWelfare in an Importing Country

Table 9-2: Changes in Welfare from Free Table 9-2: Changes in Welfare from Free Trade: The Case of an Importing CountryTrade: The Case of an Importing Country

The analysis of an importing The analysis of an importing country yields two conclusions:country yields two conclusions:• Domestic producers of the good are Domestic producers of the good are

worse off, and domestic consumers of worse off, and domestic consumers of the good are better off.the good are better off.

• Trade raises the economic well-being Trade raises the economic well-being of the nation as a whole because the of the nation as a whole because the gains of consumers exceed the losses gains of consumers exceed the losses of producers.of producers.

The Gains and Losses of an Importing The Gains and Losses of an Importing CountryCountry

A A tarifftariff is a tax on goods produced is a tax on goods produced abroad and sold domestically.abroad and sold domestically.

Tariffs raise the price of imported Tariffs raise the price of imported goods above the world price by the goods above the world price by the amount of the tariff.amount of the tariff.

The Effects of a TariffThe Effects of a Tariff

Domestic supply

0 Quantity of Steel

Price of Steel

Imports without tariffs

Tariff

Equilibrium without trade

Imports with tariffs

D E F

B

C

G

A

Price with tariff

Price without tariff

World price

QS1 QS

2 QD2 QD

1

Domestic demand

Figure 9-6: The Effects of a TariffFigure 9-6: The Effects of a Tariff

Table 9-3: Changes in Welfare from a Table 9-3: Changes in Welfare from a TariffTariff

A tariff reduces the quantity of A tariff reduces the quantity of imports and moves the imports and moves the domestic market closer to its domestic market closer to its equilibrium without trade.equilibrium without trade.

With a tariff, total surplus in the With a tariff, total surplus in the market decreases by an market decreases by an amount referred to as a amount referred to as a deadweight loss.deadweight loss.

The Effects of a TariffThe Effects of a Tariff

An An import quotaimport quota is a limit on the is a limit on the quantity of a good that can be quantity of a good that can be produced abroad and sold produced abroad and sold domestically.domestically.

The Effects of an Import QuotaThe Effects of an Import Quota

Domestic supply

0 Quantity of Steel

Price of Steel

Imports without quotas

Equilibrium without trade

Imports with quota

D E F

B

C

G

A

Isolandian price with

quota

Price without quota = World

price

World price

QS1 QS

2 QD1

Domestic demand

E’

Domestic supply + Import supply

Equilibrium with quota

QD2

Quota

Figure 9-7: The Effects of an Import Figure 9-7: The Effects of an Import QuotaQuota

Table 9-4: Changes in Welfare from an Table 9-4: Changes in Welfare from an Import QuotaImport Quota

Because the quota raises the Because the quota raises the domestic price above the world domestic price above the world price, domestic buyers of the good price, domestic buyers of the good are worse off, and domestic sellers are worse off, and domestic sellers of the good are better off.of the good are better off.

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

The Effects of an Import QuotaThe Effects of an Import Quota

With a quota, total surplus in the With a quota, total surplus in the market decreases by an amount market decreases by an amount referred to as a deadweight loss.referred to as a deadweight loss.

The quota can potentially cause an The quota can potentially cause an even larger deadweight loss, if a even larger deadweight loss, if a mechanism such as lobbying is mechanism such as lobbying is employed to allocate the import employed to allocate the import licenses.licenses.

The Effects of an Import QuotaThe Effects of an Import Quota

If a government sells import licenses for If a government sells import licenses for full value, revenue equals that of an full value, revenue equals that of an equivalent tariff and the results of tariffs equivalent tariff and the results of tariffs and quotas are identical.and quotas are identical.

Both tariffs and import quotas . . .Both tariffs and import quotas . . .• raise domestic prices.raise domestic prices.• reduce the welfare of domestic reduce the welfare of domestic

consumers.consumers.• increase the welfare of domestic increase the welfare of domestic

producers.producers.• cause deadweight losses.cause deadweight losses.

The Lessons for Free Trade PolicyThe Lessons for Free Trade Policy

Other Benefits of International TradeOther Benefits of International Trade• Increased variety of goods.Increased variety of goods.• Lower costs through economies of scale.Lower costs through economies of scale.• Increased competition.Increased competition.• Enhanced flow of ideas.Enhanced flow of ideas.

The Lessons for Free Trade PolicyThe Lessons for Free Trade Policy

The jobs argument. The jobs argument. The National-Security argument. The National-Security argument. The infant-industry argument. The infant-industry argument. The unfair-competition argument. The unfair-competition argument. The protection-as-a-bargaining chip The protection-as-a-bargaining chip

argument. argument.

THE ARGUMENTS FOR THE ARGUMENTS FOR RESTRICTING TRADERESTRICTING TRADE

UnilateralUnilateral: when a country removes its : when a country removes its trade restrictions on its own.trade restrictions on its own.

MultilateralMultilateral: a country reduces its trade : a country reduces its trade restrictions while other countries do the restrictions while other countries do the same.same.

NAFTANAFTA• The North American Free Trade Agreement The North American Free Trade Agreement

(NAFTA) is an example of a multilateral trade (NAFTA) is an example of a multilateral trade agreement.agreement.

• In 1993, NAFTA lowered the trade barriers In 1993, NAFTA lowered the trade barriers among the United States, Mexico, and Canada.among the United States, Mexico, and Canada.

CASE STUDY:CASE STUDY: Trade Agreements and the Trade Agreements and the WTOWTO

GATTGATT• TheThe General Agreement on Tariffs and General Agreement on Tariffs and

Trade (GATT) refers to a continuing Trade (GATT) refers to a continuing series of negotiations among many of series of negotiations among many of the world’s countries with a goal of the world’s countries with a goal of promoting free trade.promoting free trade.

• GATT has successfully reduced the GATT has successfully reduced the average tariff among member countries average tariff among member countries from about 40 percent after WWII to from about 40 percent after WWII to about 5 percent today.about 5 percent today.

CASE STUDY:CASE STUDY: Trade Agreements and the Trade Agreements and the WTOWTO

The effects of free trade can be The effects of free trade can be determined by comparing the determined by comparing the domestic price without trade to the domestic price without trade to the world price.world price.• A low domestic price indicates that the country A low domestic price indicates that the country

has a comparative advantage in producing the has a comparative advantage in producing the good and that the country will become an good and that the country will become an exporter.exporter.

• A high domestic price indicates that the rest of A high domestic price indicates that the rest of the world has a comparative advantage in the world has a comparative advantage in producing the good and that the country will producing the good and that the country will become an importer.become an importer.

SummarySummary

When a country allows trade and When a country allows trade and becomes an exporter of a good, becomes an exporter of a good, producers of the good are better off, producers of the good are better off, and consumers of the good are and consumers of the good are worse off.worse off.

When a country allows trade and When a country allows trade and becomes an importer of a good, becomes an importer of a good, consumers of the good are better off, consumers of the good are better off, and producers are worse off.and producers are worse off.

SummarySummary

A tariff—a tax on imports—moves a A tariff—a tax on imports—moves a market closer to the equilibrium than market closer to the equilibrium than would exist without trade, and therefore would exist without trade, and therefore reduces the gains from trade.reduces the gains from trade.

Import quotas will have effects similar Import quotas will have effects similar to those of tariffs.to those of tariffs.

SummarySummary

There are various arguments for There are various arguments for restricting trade: protecting jobs, restricting trade: protecting jobs, defending national security, helping defending national security, helping infant industries, preventing unfair infant industries, preventing unfair competition, and responding to competition, and responding to foreign trade restrictions.foreign trade restrictions.

Economists, however, believe that Economists, however, believe that free trade is usually the better policy.free trade is usually the better policy.

SummarySummary

The EndThe End