International Trade
• What determines whether a country imports or
exports a good?
• Who gains and who loses from free international
trade between countries?
• What are the arguments that people use to
advocate international trade restrictions?
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Interdependence & Gains from Trade
• Remember, economics is the study of how
societies produce and distribute goods in an
attempt to satisfy the wants and needs of its
members.
• Voluntary trade creates wealth!
• Bag Game, Movies, Other Stuff…
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THE DETERMINANTS OF TRADE
• Equilibrium Without International Trade
• A country is isolated from rest of the world and
produces steel.
• The market for steel consists of the buyers and
sellers in the country (domestic).
• There is no import or export of steel.
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Figure 1The Equilibrium without International Trade
Price
of Steel
Domestic
supply
Consumer
surplus
Equilibrium
price
Producer
surplus
Domestic
demand
0
Equilibrium
quantity
Quantity
of Steel
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The World Price and Comparative
Advantage
• The effects of free international trade can be
shown by comparing the domestic price of a good
without trade and the world price of the good.
• The world price refers to the price that prevails in
the world market for that good.
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The World Price and Comparative
Advantage
• With international trade, will a country be an importer
or exporter of steel?
• If a country has a comparative advantage, the
domestic price will be below the world price, and the
country will be an exporter of the good.
• If the country has a comparative disadvantage, the
domestic price will be higher than the world price, and
the country will be an importer of the good.
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The Gains and Losses of an Exporting
Country
• International Trade in an Exporting Country
• World price of steel > domestic price of steel.
• Domestic producers increase production as the price
moves up to the world price.
• Domestic consumers decrease consumption as the price
moves up to the world price.
• The excess supply (surplus) will be exported to willing
buyers in another country.
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Figure 3 How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Consumer surplus
before trade
Price
after
trade
Exports
A
B
Price
before
trade
World
price
D
C
Producer surplus
before trade
0
Domestic
supply
Domestic
demand
Quantity
of Steel
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How Free Trade Affects Welfare in an
Exporting Country
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THE WINNERS AND LOSERS FROM
TRADE
• The analysis of an exporting country yields two
conclusions:
• Domestic producers of the good are better off, and
domestic consumers of the good are worse off.
• Trade raises the economic well-being of the nation as a
whole because the gains of producers exceed the losses
of consumers.
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The Gains and Losses of an Importing
Country
• International Trade in an Importing Country
• World price of steel < domestic price of steel.
• Domestic producers decrease production as the price
moves down to the world price.
• Domestic consumers increase consumption as the price
moves down to the world price.
• The excess demand (shortage) will be satisfied by
imports from willing sellers in another country.
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Figure 5 How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
Consumer surplus
after trade
Domestic
supply
A
Price
before trade
Price
after trade
0
B
C
D
Imports
Producer surplus
after trade
World
price
Domestic
demand
Quantity
of Steel
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How Free Trade Affects Welfare in an
Importing Country
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THE WINNERS AND LOSERS FROM
TRADE
• The analysis of an importing country yields two
conclusions
• Domestic producers of the good are worse off, and
domestic consumers of the good are better off.
• Trade raises the economic well-being of the nation as a
whole because the gains of consumers exceed the losses
of producers.
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The Effects of a Tariff
• A tariff is a tax on goods produced abroad and
sold domestically.
• Tariffs raise the price of imported goods above the
world price by the amount of the tariff.
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Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
A
Deadweight Loss
B
Price
with tariff
Price
without tariff
0
C
D
E
G
Tariff
F
Imports
with tariff
Q
S
Q
S
Domestic
demand
Q
Imports
without tariff
D
Q
D
World
price
Quantity
of Steel
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The Effects of a Tariff
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The Effects of a Tariff
• Tariffs reduce imports and move the domestic
market closer to its equilibrium before trade.
• Domestic production increases while domestic
consumption decreases.
• Tariffs reduce total well-being (total surplus) in
the market by an amount called deadweight loss.
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The Lessons for Trade Policy
• Import quotas limit the quantity of a good that
can be produced abroad and sold domestically.
• In the domestic market both tariffs and quotas ....
• raise prices and reduce imports.
• increase production and decrease consumption.
• increase welfare of producers and reduce welfare of
consumers.
• cause deadweight loss.
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The Lessons for Trade Policy
• Other Benefits of International Trade
• Increased variety of goods
• Increased competition
• Enhanced flow of ideas
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THE ARGUMENTS FOR
RESTRICTING TRADE
•
•
•
•
Jobs
National Security
Infant Industry
Unfair Competition
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Trade Agreements and the World Trade
Organization
• Unilateral: when a country removes its trade
restrictions on its own.
• Multilateral: a country reduces its trade
restrictions while other countries do the same.
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Trade Agreements and the World Trade
Organization
• NAFTA
• The North American Free Trade Agreement (NAFTA) is
an example of a multilateral trade agreement.
• In 1993, NAFTA lowered the trade barriers among the
United States, Mexico, and Canada.
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Trade Agreements and the World Trade
Organization
• GATT
• The General Agreement on Tariffs and Trade (GATT)
refers to a continuing series of negotiations among many
of the world’s countries with a goal of promoting free
trade.
• GATT has successfully reduced the average tariff
among member countries from about 40 percent after
WWII to about 5 percent today.
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Punch Line
• If you care about someone’s well-being, trade
with them.
• Why?
• Because trade creates well-being!
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Summary
• The effects of free international trade can be
determined by comparing the domestic price
without trade to the world price.
• A low domestic price indicates that the country has a
comparative advantage in producing the good and the
country will become an exporter.
• A high domestic price indicates that the country has a
comparative disadvantage in producing the good and
the country will become an importer.
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Summary
• If a country moves to international trade and
exports a good, producers of the good are better
off, while consumers are worse off.
• When a country moves to international trade and
imports a good, consumers of the good are better
off, while producers are worse off.
• In each case, the gains outweigh the losses.
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Summary
• A tariff—a tax on imports—moves a market
closer to the equilibrium than would exist before
trade, and thus reduces well-being (total surplus).
• Import quotas will generally have effects similar
to those of tariffs.
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Summary
• There are various arguments for restricting trade:
protecting jobs, defending national security,
helping infant industries, preventing unfair
competition, and responding to foreign trade
restrictions (retaliation).
• However, most economists believe that free
international trade is generally the better policy.
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