Lecture Notes: Econ 203 Introductory Microeconomics
Lecture/Chapter 9: International Trade
M. Cary Leahey
Manhattan College
Fall 2012
Goals
• This is another applications chapter looking at international trade.
• This chapter reviews many of the concepts introduced in earlier
classes, particularly the tradeoff between efficiency and equity.
• This chapter will examine the determinants of trade-why and how
much does a country import or export.
• We also look at who benefits and loses from trade. Do the gains
outweigh the benefits
• At the end, we review the merits of a number of well-known
arguments for restricting trade.
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Comparative advantage and the “world price”
• Comparative advantage unfolds if a country produces the good at a
lower opportunity cost than other countries.
• Nations gains from trade by exporting the goods that they have a
comparative advantage.
• Armed with this knowledge, let us make some assumptions:
•
Pw = the world price of a good, one that prevails in world markets
•
Pd = domestic price without trade
• If Pd < Pw, then the country has a comp advantage and exports
• If Pd > Pw, then the country imports the goods
• Assuming all countries are “small,” they are price takers and for
them Pw is the only relevant price
•
No seller would accept less than Pw
•
No buyer would pay more than Pw
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Example 1: a country that exports soybeans
P
Without trade,
PD = $4
Q = 500
PW = $6
Under free trade,
– domestic
consumers
demand 300
– domestic producers
supply 750
– exports = 450
Soybeans
S
exports
$6
$4
D
300 500 750
Q
Example 1: a country that exports soybeans
CS = A + B
PS = C
Total surplus
=A+B+C
With trade,
CS = A
PS = B + C + D
Total surplus
=A+B+C+D
Soybeans
P
Without trade,
S
exports
A
$6
B
$4
C
D
gains
from trade
D
Q
Example 2, a country that imports TVs
Without trade,
PD = $3000, Q = 400
P
Plasma TVs
In world markets,
PW = $1500
Under free trade,
how many TVs
will the country
import or export?
S
$3000
What about the gains from$1500
trade?
D
200
400
600
Q
Example 2, a country that imports TVs
Under free trade,
 domestic
consumers
demand 600
 domestic
producers
supply 200
 imports = 400
P
Plasma TVs
S
$3000
$1500
D
imports
200
600
Q
Example 2, a country that imports TVs
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
Summary of the welfare effects from trade
PD < P W
PD > PW
direction of trade
exports
imports
consumer surplus
falls
rises
producer surplus
rises
falls
total surplus
rises
rises
Whether a good is imported or exported,
trade creates winners and losers.
But the gains exceed the losses.
International trade: other benefits and costs
• Other benefits:
• Consumers enjoy increased access to more and different goods.
• Producers can target a large market and achieve lower costs
working at a larger scale.
• Foreign competition may reduce domestic firms’ market power,
increasing total societal welfare.
• Trade enhances information flow and the spread of technology.
• Costs:
• While the winners can compensate the losers and everyone can be
better off, this rarely happens in the “real world.”
• This is an example of the iron triangle. The gains are spread thinly
across many people but the losses are large and highly
concentrated among a small group.
• So the losers have more incentive to act than the winners.
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Trade restriction example 1: tariffs
• Tariff is a tax on imports.
• Example: a tariff on cotton shirts.
•
Tariff (T) is $10/shirt
•
Pw is $20/shirt
• Consumers pay $30 for an imported shirt so that domestic
producers charge $30 as well.
• In general the domestic price Pd = Pw + T
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Example 1, tariff on cotton shirts
P
PW = $20
Free trade:
buyers demand 80
sellers supply 25
imports = 55
T = $10/shirt
price rises to $30
buyers demand 70
sellers supply 40
imports = 30
Cotton shirts
S
$30
$20
imports
25
40
70 80
D
Q
Example 1, tariff on cotton shirts
P
Cotton
shirts
deadweight
loss = D + F
Free trade
CS = A + B + C
+D+E+F
PS = G
Total surplus = A + B
+C+D+E+F+G
Tariff
CS = A + B
PS = C + G
Revenue = E
Total surplus = A + B
+C+E+G
S
A
B
$30
$20
C
D
E
F
G
25
40
70 80
D
Q
Example 1, tariff on cotton shirts
P
Cotton
shirts
deadweight
loss = D + F
D = deadweight loss from the
overproduction
of shirts
F = deadweight loss from the
under-consumption
of shirts
S
A
B
$30
$20
C
D
E
F
G
25
40
70 80
D
Q
Trade restriction example 2: quotas
• Import quotas an quantifiable limits on imports.
• They work like a tariff, but no tax revenue is raised.
•
Quotas lift prices, reducing Q demanded
•
Quotas reduce buyers welfare but increase producers welfare
• While quotas raise no revenues that increase profits for foreign
producers who sell at a higher price.
• The revenue lost to the govt could be “captured” by auctioning
import licenses.
•
This process happens in carbon taxes-the “pay to pollute” notion I
environmental economics.
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Reviewing the arguments for restricting trade
• 1. The jobs argument: trade destroys jobs in industries that
compete against imports.
• Analysis:
• Trade does not directly cause unemployment from the empirical
data. Trade implicitly creates more jobs in the US than it destroys.
• The literature points out that trade has benefit more highly skilled
positions and hurt less highly skilled positions—”skills-based” trade.
• While this skills-based explanation cites “technological change”
rather than “trade,” there is a increasing sense that jobs losses are
more trade than technology related. So the results are becoming
more mixed.
• 2. National security. An industry vital to national security should be
protected from foreign competition, to prevent dependence during
wartime “to uncertain sources.”
• Analysis:
• Acceptable argument but producers may exaggerate their national
security characteristics.
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Reviewing the arguments for restricting trade
• 3. Infant-industry argument: a new industry needs support until it
can grow and be competitive.
• Analysis
• Hard to determine who needs help and/or establish if the costs to
consumer is less than benefits to the industry.
• In addition, it is eventually profitable to grow, the industry can do it
on its own.
• Mild case for helping “key” industry for a new nation.
• 4. Unfair competition: producer abroad have a unfair advantage due
to govt subsidies, etc.
• Analysis
• No consumer ever died in a price war, so lower prices are great.
We get ultra cheap products.
• The gains from consumer would outweigh the losses to producers.
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Reviewing the arguments for restricting trade
• 5. Protection as bargaining chip: threaten to retaliate to force the
other nation to cut their trade restriction on our stuff.
• Analysis
• If bluff is taken, either we back down (reducing credibility) or retaliate
which (reducing welfare).
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Trade agreements
• A country can liberalize trade with:
•
unilateral reduction (with one country)
•
multilateral agreements with more than one nation
• Examples:
• GATT, 1962 and on
• NAFTA, 1993
• The World trade office (WTO) enforces trade agreements and helps
settle disputes.
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Summary
• Exporting country. A country will export if the world price is above
the domestic price without trade. Trade raises the producer surplus,
reduces consumer surplus, and raises total surplus.
• Importing country. A country will import a good is the world price is
below the domestic price without trade. Trader lower the producer
surplus but raises consumer surplus and the total surplus.
• Tariff. A tariff benefits producers and produces revenue for the govt.
but the overall economy loses as the gains are less than the losses
to consumers.
• Common arguments for restricting trade including: protecting jobs,
defending national security, helping infant industries, preventing
unfair competition, and responding to foreign trade restrictions. Only
a few (and under restrictive assumptions) have much merit.
• Free trade is usually the better policy, particularly if the winners can
compensate the losers.
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