Chapter 9 Application: International Trade
• The determinants of Trade
• The winners and losers from trade
• The arguments for restricting trade
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The Determinants of Trade
• Consider the market for steel
– Steel market is well suited for examining the gains and
losses from trade.
• Produced in many countries and is much traded.
• Trade restrictions are often implemented in this
market.
• The Equilibrium without Trade
• Assume:
– 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. See Figure 9-1
– No one in the country is allowed to import or export
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steel.
• Results:
– Domestic price adjusts to balance demand and supply.
– The sum of consumer and producer surplus measures the
total benefits that buyers and sellers receive.
• The World Price and Comparative Advantage
• If the country decides to engage in international trade, will it
be an importer or exporter of steel?
• The effects of free 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.
• 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.
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• If the country does not have a comparative advantage, then
the domestic price will be higher than the world price, and
the country will be an importer of the good.
THE WINNERS AND LOSERS FROM TRADE
• The gains and losses of an exporting country
• To analyze the welfare effects of free trade, the economists
begin with the assumption that the country is a small
economy.
– The country is a price taker.
– Price taker means that the country takes the world price
of steel as given. They can sell steel at this price and be
exporters or buy steel at this price and be importers.
• Figure 9-2 shows that the domestic equilibrium price is
below the world price of steel.
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• Once free trade is allowed, the domestic price will rise to
equal the world price.
• The domestic quantity demanded is smaller than the
domestic quantity supplied and the country becomes an
exporter of steel.
• Figure 9-3 show the gains and losses from trade by looking
at changes in consumer and producer surplus.
• These gains and losses are also summarized in Table 9-1.
• 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
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whole.
• The Gains and Losses of an Importing Country
• Figure 9-4 shows that the domestic equilibrium price is
above the world price of steel.
• Once free trade is allowed, the domestic world price must
equal the world price.
• The domestic quantity demanded is greater than the
domestic quantity supplied and the country becomes an
importer of steel.
• Figure 9-5 show the gains and losses from trade by looking
at changes in consumer and producer surplus.
• These changes are also summarized in Table 9-2.
• 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.
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– Trade raises the economic well-being of the nation as a
whole because the gains of consumers exceed the losses
of producers.
• The Effects of a Tariff
• A tariff is a tax on goods produced abroad and sold
domestically.
• See Figure 9-6
• Tariffs raise the price of imported goods above the world
price by the amount of the tariff.
• A tariff reduces the quantity of imports and moves the
domestic market closer to its equilibrium without trade.
• With a tariff, total surplus in the market decreases by an
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amount referred to as a deadweight loss.
• The Effects of an Import Quota
• An import quota is a limit on the quantity of a good that can
be produced abroad and sold domestically.
• See Figure 9-7
• Because the quota raises the domestic price above the world
price, domestic buyers of the good are worse off, and
domestic sellers of the good are better off.
• License holders are better off because they make a profit
from buying at the world price and selling at the higher
domestic price.
• With a quota, total surplus in the market decreases by an
amount referred to as a deadweight loss.
• The quota can potentially cause an even larger deadweight
loss, if a mechanism such as lobbying is employed to
allocate the import licenses.
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• The Lessons for Free Trade Policy
• If government sells import licenses for full value, revenue
equals that of an equivalent tariff and the results of tariffs
and quotas are identical.
• Both tariffs and import quotas . . .
– raise domestic prices.
– reduce the welfare of domestic consumers.
– increase the welfare of domestic producers.
– cause deadweight losses.
• Other Benefits of International Trade
– Increased variety of goods.
– Lower costs through economies of scale.
– Increased competition.
– Enhanced flow of ideas.
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THE ARGUMENTS FOR RESTRICTING TRADE
• The jobs argument:
– Opponents(of free trade) argue: trade with other countries
destroys domestic jobs.
• The National-Security argument:
– Opponents argue: the industry is vital for national
security when an industry is threatened with competition
form other countries.
• The infant-industry argument: new industries sometimes
argue for temporary trade restrictions to help them get
started
• The unfair-competition argument: free trade is desirable
only if all countries play by the same rule. If firms in
different countries are subject to different laws and
regulations, then it is unfair to expect the firms to compete
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in the international marketplace.
• The protection-as-a-bargaining chip argument: the
strategy of bargaining. The threat of a trade restriction can
help remove a trade restriction already imposed by a foreign
government.
• CASE STUDY: Trade Agreements and the WTO
• Unilateral: when a country removes its trade restrictions on
its own.
• Multilateral: a country reduces its trade restrictions while
other countries do the same.
• 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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• 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.
• WTO
• The rules established under GATT are now enforced by an
international institution called the World Trade Organization
(WTO).
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