PowerPoint Presentations for
Principles of Microeconomics
Sixth Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the
Sixth Canadian Edition by
Marc Prud’homme
University of Ottawa
APPLICATION:
INTERNATIONAL
TRADE
Chapter 9
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INTERNATIONAL TRADE
 Chapter 3 introduced the study of international
trade by applying the principle of comparative
advantage.
 According to this principle, all countries can
benefit from trading with one another because
trade allows each country to specialize in doing
what it does best.
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INTERNATIONAL TRADE
 But the analysis in Chapter 3 was incomplete. It did
not explain how the international marketplace
achieves these gains from trade or how the gains
are distributed among various economic
participants.
 The effects of international trade on economic wellbeing will be examined with the analytical tools
developed in the previous chapters.
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THE DETERMINANTS OF TRADE
 Consider the market for textiles, which is well suited to
examining the gains and losses from international trade:
 Textiles are made in many countries around the
world, and there is much world trade in textiles.
 The textile market is one in which policymakers often
consider trade restrictions to protect domestic
producers from foreign competitors.
 The textile market in the imaginary country of Isoland will
be studied here.
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The Equilibrium without Trade
 Lets start with the case of no international
trade.
 The market for textiles in Isoland consists solely
of Isolandian buyers and sellers.
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FIGURE 9.1:
The Equilibrium without International Trade
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The Equilibrium without Trade
 Following an election, the new president wants answers to
the following three questions in order to evaluate a
possible change in trade policy:
1. If the government allowed Isolandians to import and
export textiles, what would happen to the price of
textiles and the quantity of textiles sold in the
domestic textile market?
2. Who would gain from free trade in textiles and who
would lose, and would the gains exceed the losses?
3. Should a tariff (a tax on textile imports) or an import
quota (a limit on textile imports) be part of the new
trade policy?
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The World Price and Comparative Advantage
 The first issue to tackle is to find out that if free trade
was allowed, would Isolandians end up buying or
selling textiles in world markets?
 To answer this question, the economists compare the
current Isolandian price of textiles to the price of
textiles in other countries.
 World price: the price of a good that prevails in the
world market for that good
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The World Price and Comparative Advantage
 If the world price of textiles is higher than the domestic price,
then Isoland would become an exporter of textiles once
trade is permitted.
 If the world price of textiles is lower than the domestic price,
then Isoland would become an importer of textiles.
 By comparing the world price and the domestic price
before trade, we can determine whether Isoland is better or
worse at producing textiles than the rest of the world.
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QuickQuiz
The country Autarka does not allow
international trade. In Autarka, you can buy a
wool suit for 100 grams of gold. Meanwhile, in
neighbouring countries, you can buy the same
suit for 60 grams of gold.
If Autarka was to allow free trade, would it
import or export suits?
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THE WINNERS AND LOSERS FROM TRADE
 To analyze the welfare effects of free trade, the
Isolandian economists begin with the assumption
that Isoland is a small economy compared to the
rest of the world.
 The Isolandians are said to be price takers in the
world economy.
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The Gains and Losses
of an Exporting Country
 Figure 9.2 shows the Isolandian textile
market when the domestic equilibrium
price before trade is below the world
price.
 Once free trade is allowed, the
domestic price rises to equal the world
price.
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Ribah /Shutterstock
 No seller of textiles would accept less
than the world price, and no buyer
would pay more than the world price.
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FIGURE 9.2:
International Trade in an Exporting Country
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FIGURE 9.2 (continued)
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The Gains and Losses
of an Exporting Country
 This analysis of an exporting country yields two
conclusions:
1. When a country allows trade and becomes
an exporter of a good, domestic producers of
the good are better off and domestic
consumers of the good are worse off.
2. Trade raises the economic well-being of a
nation in the sense that the gains of the
winners exceed the losses of the losers.
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The Gains and Losses
of an Importing Country
 Now suppose that the domestic price before
trade is above the world price.
 Once again, after free trade is allowed, the
domestic price must equal the world price.
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The Gains and Losses
of an Importing Country
 Figure 9.3 shows that the domestic quantity
supplied is less than the domestic quantity
demanded.
 The difference between the domestic quantity
demanded and the domestic quantity
supplied is bought from other countries, and
Isoland becomes a textile importer.
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FIGURE 9.3:
International Trade in an Importing Country
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FIGURE 9.3 (continued)
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The Gains and Losses
of an Importing Country
 This analysis of an importing country yields two
conclusions parallel to those for an exporting
country:
 When a country allows trade and becomes an
importer of a good, domestic consumers of the
good are better off, and domestic producers of
the good are worse off.
 Trade raises the economic well-being of a nation
in the sense that the gains of the winners exceed
the losses of the losers.
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The Gains and Losses
of an Importing Country
 We can now see why the debate over trade policy is
so often contentious.
 Whenever a policy creates winners and losers, the
stage is set for a political battle.
 Nations sometimes fail to enjoy the gains from trade
simply because the losers lobby for trade restrictions,
such as tariffs and import quotas.
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Active Learning
Analysis of Trade
Without trade,
PD = $3000, Q = 400
P
Plasma TVs
In world markets,
PW = $1500
S
Under free trade,
how many TVs
will the country
import or export?
$3000
$1500
Identify CS, PS, and
total surplus without
trade, and with trade.
D
200
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400
600
Q
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Active Learning
Answers
Under free trade,
P
 domestic consumers
demand 600
 domestic producers
supply 200
 imports = 400
$3000
Plasma TVs
S
$1500
D
imports
200
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600
Q
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Active Learning
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
Plasma TVs
S
gains
from trade
A
$3000
B
$1500
C
D
imports
D
Q
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The Effects of a Tariff
 The Isolandian economists next consider the
effects of a tariff.
 Tariff: a tax on goods produced abroad and
sold domestically
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The Effects of a Tariff
 The tariff matters only if Isoland becomes a textile
importer.
 Concentrating their attention on this case, the
economists compare welfare with and without
the tariff.
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FIGURE 9.4:
The Effects of a Tariff
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FIGURE 9.4:
The Effects of a Tariff
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The Effects of a Tariff
 A tariff causes a deadweight loss because a tariff is a
type of tax.
 Like most taxes, it distorts incentives and pushes the
allocation of scarce resources away from the optimum.
 In this case, we can identify two effects.
1. The tariff raises the domestic price of textiles above
the world price.
2. The tariff raises the price that domestic textile
consumers have to pay, it encourages them to
reduce consumption of textiles.
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The Lessons for Trade Policy
 Question: If the government allowed Isolandians to
import and export textiles, what would happen to the
price of textiles and the quantity of textiles sold in the
domestic textile market?
 Answer: Once trade is allowed, the Isolandian price of
textiles would be driven to equal the price prevailing
around the world.
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The Lessons for Trade Policy
 Question: Who would gain from free trade in textiles
and who would lose, and would the gains exceed
the losses?
 Answer: The answer depends on whether the price
rises or falls when trade is allowed. If the price rises,
producers of textiles gain, and consumers of textiles
lose. If the price falls, consumers gain, and producers
lose. In both cases, the gains are larger than the
losses.
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The Lessons for Trade Policy
 Question: Should a tariff or an import quota be part
of the new trade policy?
 Answer: A tariff, like most taxes, has deadweight
losses. The best policy, from the standpoint of
economic efficiency, would be to allow trade
without a tariff or an import quota.
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QuickQuiz
Draw the supply and demand curves for wool
suits in the country of Autarka. When trade is
allowed, the price of a suit falls from 100 to 60
grams of gold.
In your diagram, what is the change in
consumer surplus, the change in producer
surplus, and the change in total surplus?
How would a tariff on suit imports alter these
effects?
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Other Benefits of International Trade
 Increased variety of goods
 Lower costs through
economies of scale
 Enhanced flow of ideas
Ribah /Shutterstock
 Increased competition
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THE ARGUMENTS FOR
RESTRICTING TRADE
 The Jobs Argument
 The National-Security Argument
 The Infant-Industry Argument
 The Unfair-Competition Argument
 The Protection-as-a-Bargaining-Chip Argument
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QuickQuiz
The textile industry of Autarka advocates a
ban on the import of wool suits.
Describe five arguments its lobbyists might
make.
Give a response to each of these arguments.
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Classroom Activity
Free Trade or Protection?
1. Which to do you favour, free trade or protection?
Explain why.
2. Assume you are voting on a request before the ministry
called International Trade Canada to raise the tariff on
imports of rubber thread. Rubber thread is made from
latex and is a relatively small industry. It is used in the
manufacture of elastic in items like socks, underwear,
and bungee cords. Increasing the tariff would allow
Canadian producers to avoid layoffs and to invest in
technology. Would you vote for the tariff increase, or
against it?
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Classroom Activity
Free Trade or Protection? (continued)
3. More generally, what are the benefits of keeping a job
in Canada?
4. The costs of protectionism are paid by consumers in
the form of higher prices. The obvious question is “At
what point do these costs exceed the benefits?” In your
opinion, how much extra should consumers pay to
keep a job in Canada? (Express this figure in
dollars/per job.)
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THE END
Chapter 9
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