Application: International Trade: - What Determines Whether A Country Imports or Exports A Good?

06.09.
2011
What determines whether a country imports or

exports a good?
Application:
International Trade
Copyright2004 South-Western
Copyright 2004 South-Western/Thomson Learning
Who gains and who loses from free trade

among countries?
What are the arguments that people use to

advocate trade restrictions?
Figure 1The Equilibrium without International Trade
THE DETERMINANTS OF TRADE

Price
of Steel
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.
No one in the country is allowed to import or export
steel.
Domestic
supply
Consumer
surplus
Equilibrium
price
Producer
surplus
Domestic
demand
0
Equilibrium
quantity
Quantity
of Steel
Copyright 2004 South-Western
06.09.2011
The Equilibrium Without International Trade
The World Price and Comparative Advantage
Equilibrium Without Trade
If the country decides to engage in international

trade, will it be an importer or exporter of 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 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 pprice refers to the pprice that pprevails 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.
g
Figure 2 International Trade in an Exporting Country

If the country does not have a comparative
advantage, then the domestic price will be
higher than the world price, and the country
p
of the ggood.
will be an importer
Price
of Steel
Domestic
supply
Price
after
trade
World
price
i
Price
before
trade
Exports
0
Domestic
quantity
demanded
Domestic
demand
Domestic
quantity
supplied
Quantity
of Steel
06.09.2011
Figure 3 How Free Trade Affects Welfare in an Exporting

Country
Figure 3 How Free Trade Affects Welfare in an Exporting

Country
Price
of Steel
Price
of Steel
Price
after
trade
Domestic
supply
Exports
A
B
Price
before
trade
World
price
Consumer surplus
before trade
Price
after
trade
Quantity
of Steel
C
Producer surplus
before trade
Domestic
demand
Quantity
of Steel
How Free Trade Affects Welfare in

an Exporting Country
World
price
Domestic
demand
0
Exports
Price
before
trade
Domestic
supply
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.
The Gains and Losses of an Importing

Country
International Trade in an Importing Country
If the world price of steel is lower than the domestic
price, the country will be an importer of steel when
trade is permitted.
Domestic consumers will want to buy steel at the
lower world price.
Domestic producers of steel will have to lower their
output because the domestic price moves to the
world price.
Figure 4 International Trade in an Importing Country

Price
of Steel
Domestic
supply
Price
before
trade
Price
after
trade
Imports
0
World
price
Domestic
quantity
supplied
Domestic
quantity
demanded
Domestic
demand
Quantity
of Steel
06.09.2011
Figure 5 How Free Trade Affects Welfare in an Importing

Country
Price
of Steel

Country
Price
of Steel
Consumer surplus
before trade
Domestic
supply
A
Price
before trade
Price
after trade
B
C
Domestic
supply
A
Price
before trade
D
Imports
World
price
Price
after trade
Domestic
demand
0
Quantity
of Steel

Country
Price
of Steel
Consumer surplus
after trade
B
World
price
C
Producer surplus
before trade
Domestic
demand
Quantity
of Steel
How Free Trade Affects Welfare in

an Importing Country
Domestic
supply
A
Price
before trade
Price
after trade
B
C
Imports
Producer surplus
after trade
World
price
Domestic
demand
Quantity
of Steel

FROM TRADE
How Free Trade Affects Welfare in an
Importing Country
The analysis of an importing country yields two
conclusions:

FROM TRADE
The gains of the winners exceed the losses of
the losers.
The net change in total
surplus is positive.
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.
06.09.2011
Figure 6 The Effects of a Tariff
The Effects of a Tariff

Price
of Steel
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.
Domestic
supply
Equilibrium
without trade
Price
with tariff
Tariff
Price
without tariff
Imports
with tariff
S
World
price
Quantity
of Steel
Imports
without tariff
Domestic
demand
Price
of Steel
Price
of Steel
Consumer surplus
before tariff
Producer
surplus
before tariff
Consumer surplus
with tariff
Domestic
supply
Equilibrium
without trade
Domestic
supply
Equilibrium
without trade
B
Price
with tariff
Price
without tariff
Domestic
demand
QS
QD
World
price
Quantity
of Steel
Imports
without tariff
Tariff
Price
without tariff
Imports
with tariff
QS
QS
QD
QD
Price
of Steel
Price
of Steel
Domestic
supply
Producer
surplus
after tariff
Price
with tariff
Domestic
supply
Equilibrium
without trade
Tariff Revenue
Price
with tariff
Tariff
Price
without tariff G
World
price
Quantity
of Steel
Imports
without tariff
Domestic
demand
Imports
with tariff
QS
QS
Domestic
demand
QD
Imports
without tariff
QD
World
price
Quantity
of Steel
Tariff
E
Price
without tariff
Imports
with tariff
QS
QS
Domestic
demand
QD
Imports
without tariff
QD
World
price
Quantity
of Steel
06.09.2011

Price
of Steel
Domestic
supply
Deadweight Loss
B
Price
with tariff
Tariff
Price
without tariff G
Imports
with tariff
S
Domestic
demand
D
World
price
Quantity
of Steel
Imports
without tariff
The Effects of an Import Quota
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 amount referred to as a
deadweight loss.
An import quota is a limit on the quantity of a

good that can be produced abroad and sold
domestically.
Figure 7 The Effects of an Import Quota

Price
of Steel
Domestic
supply
Equilibrium
without trade
Quota
Isolandian
price with
quota
Equilibrium
with quota
Price
World
without =
price
quota
0
Domestic
supply
+
Import supply
Imports
with quota
S
Domestic
demand
D
Q
Imports
without quota
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.
g
License holders are better off because they
make a profit from buying at the world price
and selling at the higher domestic price.
World
price
Quantity
of Steel
06.09.2011
Figure 7 The Effects of an Import Quota

Price
of Steel
Domestic
supply
Equilibrium
without trade
Domestic
supply
+
Import supply
Quota
A
Isolandian
price with
quota
Price
World
without =
price G
quota
0
B
C
E'
Equilibrium
with quota
F
E"
Imports
with quota
S
Domestic
demand
D
Imports
without quota
World
price
Quantity
of Steel
The Lessons for Trade Policy
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.
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 . . .
Other Benefits of International Trade
raise domestic prices.

reduce the welfare of domestic consumers.
increase the welfare of domestic producers.
cause deadweight losses.
Increased variety of goods

Lower costs through economies of scale
Increased competition
Enhanced flow of ideas
06.09.2011
THE ARGUMENTS FOR

RESTRICTING TRADE
Jobs
National Security
Infant Industry
U f i Competition
Unfair
C
titi
Protection-as-a-Bargaining Chip
CASE STUDY: Trade Agreements and the

World Trade Organization
Unilateral
Unilateral: when a country removes its trade
restrictions on its own.
Multilateral
Multilateral: a country reduces its trade
restrictions while other countries do the same.

NAFTA

GATT
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.
The General Agreement on Tariffs and Trade

(GATT) refers to a continuing series of negotiations
among many of the worlds 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.
Summary
Summary
The effects of free trade can be determined by

comparing the domestic price without trade to
the world price.
A low domestic pprice indicates that the country
y has
a comparative advantage in producing the good and
that the country will become an exporter.
A high domestic price indicates that the rest of the
world has a comparative advantage in producing the
good and that the country will become an importer.
When a country allows trade and becomes an

exporter of a good, producers of the good are
better off, and consumers of the good are worse
off.
When a country allows trade and becomes an
importer of a good, consumers of the good are
better off, and producers are worse off.
06.09.2011
Summary
Summary
A tariffa tax on importsmoves a market

closer to the equilibrium than would exist
without trade, and therefore reduces the gains
from trade.
Import quotas will have effects similar to those
of tariffs.
There are various arguments for restricting

trade: protecting jobs, defending national
security, helping infant industries, preventing
unfair competition,
p
and responding
p
g to foreign
g
trade restrictions.
Economists, however, believe that free trade is
usually the better policy.

Application: International Trade: - What Determines Whether A Country Imports or Exports A Good?

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06.09.

What determines whether a country imports or

Who gains and who loses from free trade

What are the arguments that people use to

Copyright 2004 South-Western/Thomson Learning

Copyright 2004 South-Western/Thomson Learning

Figure 1The Equilibrium without International Trade

THE DETERMINANTS OF TRADE

Equilibrium Without Trade

The Equilibrium Without International Trade

The World Price and Comparative Advantage

Equilibrium Without Trade

If the country decides to engage in international

Copyright 2004 South-Western/Thomson Learning

Copyright 2004 South-Western/Thomson Learning

The World Price and Comparative Advantage

The World Price and Comparative Advantage

The effects of free trade can be shown by

If a country has a comparative advantage, then

Copyright 2004 South-Western/Thomson Learning

Copyright 2004 South-Western/Thomson Learning

Figure 2 International Trade in an Exporting Country

The World Price and Comparative Advantage

Copyright 2004 South-Western/Thomson Learning

Figure 3 How Free Trade Affects Welfare in an Exporting

Figure 3 How Free Trade Affects Welfare in an Exporting

Copyright 2004 South-Western

How Free Trade Affects Welfare in

Copyright 2004 South-Western

THE WINNERS AND LOSERS

Copyright 2004 South-Western/Thomson Learning

The Gains and Losses of an Importing

Copyright 2004 South-Western/Thomson Learning

Figure 4 International Trade in an Importing Country

Copyright 2004 South-Western/Thomson Learning

Figure 5 How Free Trade Affects Welfare in an Importing

Figure 5 How Free Trade Affects Welfare in an Importing

Figure 5 How Free Trade Affects Welfare in an Importing

How Free Trade Affects Welfare in

THE WINNERS AND LOSERS

Copyright 2004 South-Western/Thomson Learning

THE WINNERS AND LOSERS

Domestic producers of the good are worse off, and

Copyright 2004 South-Western/Thomson Learning

Copyright 2004 South-Western/Thomson Learning

Figure 6 The Effects of a Tariff

The Effects of a Tariff

A tariff is a tax on goods produced abroad and

Copyright 2004 South-Western/Thomson Learning

Figure 6 The Effects of a Tariff

Copyright 2004 South-Western

Figure 6 The Effects of a Tariff

Copyright 2004 South-Western

Figure 6 The Effects of a Tariff

Copyright 2004 South-Western

Figure 6 The Effects of a Tariff

Figure 6 The Effects of a Tariff

The Effects of a Tariff

Copyright 2004 South-Western/Thomson Learning

Copyright 2004 South-Western

The Effects of a Tariff

The Effects of an Import Quota

A tariff reduces the quantity of imports and