Chapter 9
Application: International trade
Outline
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Trade can make everyone better off
Principle of comparative advantage
Gains and losses from trade
Effects of a tariff and import quota on
trade
• Implications for trade policy
• Arguments for restricting trade
Recap: Gains from Trade
• The gains from trade are less obvious
when one person/country is better at
producing both goods.
• Principle of absolute advantage
compares producers of a good according
to their productivity
• Principle of comparative advantage
compares producers of a good according
to their opportunity cost
• With trade, both countries can produce
more of one commodity and consume
more of both commodities (founded upon
principle of comparative advantage)
Gains from Trade
• It is impossible for a producer to
have a comparative advantage in
the production of both the goods.
Why?
• If two producers have different
opportunity costs they gain from
trade as the price of the good they
buy is less than their opportunity
cost for that good
Interdependence and the gains from
trade
• To summarize:
Comparative advantage
Specialization
Economic well-being Increase in production
Gains from trade
Trade
The Determinants of Trade
• Equilibrium with out trade:
– Economy is closed.
– Domestic supply and domestic demand
determine equilibrium price.
• Equilibrium with trade:
– Principle of comparative advantage involves
comparison of domestic price and world price
for the traded good.
– If domestic price is less than world price, then
the country becomes an exporter of the good.
– If domestic price is greater than world price
then country becomes and importer of the
good.
Winners and losers from trade
• Gains and losses of an exporting country
– The country is a price taker in the world
economy.
– Exports= domestic supply at world pricedomestic demand at world price.
– Increase in domestic producer surplus
– Decrease in domestic consumer surplus
– However trade raises the total surplus in the
economy
Winners and losers from trade
• Gains and losses of an importing country
– The country is a price taker in the world
economy.
– Imports= domestic demand at world pricedomestic supply at world price.
– Decrease in domestic producer surplus
– Increase in domestic consumer surplus
– However trade raises the total surplus in the
economy