Transcript APPLYING SUPPLY AND DEMAND

APPLYING SUPPLY AND
DEMAND
International Trade
Major Issues
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Why trade with other nations (regions)?
Recognizing comparative advantage
Benefits and costs
Effects of tariffs, quotas, and other
impediments to trade
Why Trade?
• Take advantage of specialization and
division of labor
• Not much controversy among economists
over the benefits of free trade in the long
run. Consider the U.S or the European
Union.
• Controversy arises about moving to freer
trade or more restrictions on trade because
there are winners and losers.
The Principle of
Comparative Advantage
• Comparative Advantage describes the comparison
among producers of a good according to their
opportunity cost.
The producer who has the smaller opportunity cost of
producing a good is said to have a comparative
advantage in producing that good.
A Classic Case: The Corn Laws
• United Kingdom passed a law in 1815
banning the importation of grain (corn)
from North America.
• The law was repealed in 1846. In effect.
Britain and the U.S went from autarky to
free trade in the grain markets. We will look
at the effects of this change in the wheat
market.
Determinants of International
Trade
• The effects of international trade are shown
as the difference between the domestic price
of a good without trade and the world price
of a good.
• A country will either be an exporter of the
good or an importer of the good.
Equilibrium without Trade
(Autarky)
Assume:
– A country that is isolated from rest of the world
and produces wheat.
– The market for wheat consists of the buyers and
sellers of the country.
– Domestic Price adjusts to balance Demand and
Supply.
UnitedStatesMarket
inWheat
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Price
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United States
United Kingdom
Quantity
Demanded Supplied
Demanded Supplied
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90.0
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82.5
30
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75.0
25
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67.5
20
70
60.0
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90
52.5
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110
45.0
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130
37.5
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150
30.0
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170
22.5
0
190
15.0
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210
7.5
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230
0.0
World
Supplied
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Demanded
90.0
82.5
75.0
62.5
50.0
37.5
25.0
12.5
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-12.5
-25.0
-37.5
-50.0
UnitedKingdomMarket
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Equilibrium Without Trade
• When an economy cannot trade in world
markets, the price adjusts to equilibrate
domestic supply and demand.
Impacts of International Trade,
example
• If the country decides to engage in
international trade will it be an importer or
exporter of wheat?
• Who will gain from free trade in wheat and
who would lose?
• Would gains from trade exceed losses?
• Start by comparing market prices. . .
Determinants of International Trade
• 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.
• If the rest of the world has a comparative
advantage, then the domestic price will be higher
than the world price and the country will be an
importer of the good.
International Trade Example Exporter
• If the U.K. price of wheat is higher than
the U.S. price, the U.S. would be an
exporter of wheat, when trade is permitted.
• U.S. producers of wheat will want to sell
their wheat at the higher price, hence output
would increase and domestic price would
rise.
International Trade Example Importer
• Since the U.S. price of wheat is lower than the U.K.
price, the U.K would be an importer of wheat,
when trade is permitted.
– U.K consumers will want to buy the lower priced wheat
at the world price.
• U.K producers of wheat will have to lower their
output until the supply price is equal to the world
price.
Equilibrium with Free Trade
• In our example, the world demand consists
of U.K demand for imports and U.S. supply
of exports. Equilibrium price is the one at
which both are equal.
WorldMarket
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Winners and Losers From
Free International Trade
• When a country allows trade and becomes
an exporter of a good, domestic producers
of the good are better off. They receive a
higher price.
• However, domestic consumers of the good
are worse off. They pay a higher price.
Winners and Losers From
Free International Trade
• When a country allows trade and becomes
an importer of a good, domestic consumers
of the good are better off. They pay a
lower price.
• However, domestic producers of the good
are worse off. They receive a lower price.
Winners and Losers From
Free International Trade
• Trade raises the economic well-being of the
nation.
• The net change in total surplus is positive.
• The total surplus is the sum of the consumer
surplus and the producer surplus. How do we
figure out the total surplus?
Consumer Surplus
• The consumer surplus from purchase of a
unit of an item is the difference between
what the unit is worth to the consumer and
the price the consumer has to pay for the
unit. If I buy a car for $5,000 but its value
to me is $7,000 then my surplus is $2,000.
More generally if the tenth unit of wheat is
worth $6 but the price is $2, then the
consumer’s surplus for that unit is $4.
Computing Consumer Surplus
• When looking at the market demand,
consumer surplus is the distance between
the demand curve and the price line. In
order, to compute the consumer surplus
accruing from all units at the current price,
we compute the area under the demand
curve and above the price line. In our
graph, (8-2)x30/2 = $90
Computing the Surpluses
UnitedStatesMarket
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Producer Surplus
• The producer surplus from sale of a unit of
an item is the difference between the price
received for the unit and the opportunity
cost of the unit. If I sell a car for $5,000 but
its value to me is $4,000 then my surplus is
$1,000. More generally, if the opportunity
cost of the tenth unit of wheat is $1 but the
price is $2, then the producer’s surplus for
that unit is $1.
Computing Producer Surplus
• When looking at the market demand,
producer surplus is the distance between
the supply curve and the price line. In order,
to compute the producer surplus accruing
from all units at the current price, we
compute the area above the supply curve
and below the price line. In our graph, (2.5)x30/2 = $22.5
Gains from Free Trade in the U.S
• The total surplus under autarky is the $90 + $22.5 =
$112.5, that is the sum of consumer and producer
surpluses.
• Under free trade, with a price of $4 and quantity
consumed of 20, consumer surplus is (8-4)x20/2=$40.
The quantity supplied is 70 and producer surplus is (4.5)x70/2=$122.5. Therefore, the total surplus under
free trade is $162.5
• The net change in the U.S. is $162.5-$112.5=$50
Gains from Free Trade in U.K.
• At a price of $8 per unit, consumer surplus
is (12-8)x30/2=60 and producer surplus is
(8-2)x30/2=90 for a total surplus of $150.
• At $4, consumer surplus is (12-4)x60/2=240
while producer surplus is (4-2)x10/2=20 for
a total of $260.
• The net gain is $90.
• Evaluate the gains and losses to producers
and consumers in both countries.
The Welfare Effects of a Tariff
• A tariff is a tax on imported goods.
• A tariff raises the price of imported goods, above the
world price by the amount of the tariff.
• Domestic suppliers of the good with the tariff are
gainers while domestic consumers of the good are
losers.
Graphing the Effects of a Tariff
• Use the U.K graph but add import supply to
domestic supply to total supply in U.K.
Under free trade, the equilibrium is at $4
with 60 units consumed, imports of 50, and
U.K production of 10.
• Impose a tariff of $1 per unit on imports.
This shifts the total supply up. It increases
price in U.K. and U.K. production while
decreasing imports.
U.K. Market inWheat
Effect of aTariff
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The Welfare Effects of a Tariff
Deadweight Losses
• Like any tax on the sale of a good, it distorts
incentives and pushes the allocation of
scarce resources away from the optimum.
– Raises domestic prices and encourages more
domestic production of the good.
– Higher domestic prices reduces the amount
purchased by domestic consumers
An Import Quota
• A quota is a quantitative restriction on
imports in the sense that a limited quantity
of the good is allowed into the country.
• Qualitative effect of a quota is the same as
that of a tariff. However, the difference in
price between the domestic market and the
world market accrues to the holder of the
import license. (Can lead to corruption!)
U.K. Market inWheat
Effect of aQuota
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Effects of Quota
• In our example, quota restricts imports to
20. This appears as a horizontal addition to
the domestic supply curve.
• Relative to free trade, price in importing
country is increased to $6.4, imports are
reduced to 20, and domestic output is
increased from 10 to 22. (Effect on U.S.?)
• Value of an import license $2.4 times
quantity authorized
Arguments for Restricting Trade
Arguments Against Free Trade
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Jobs
National Security
Infant Industry
Unfair-Competition
Protection-as-a-Bargaining-Chip
Conclusion...
A Parable of Free Trade
• Throughout its history, the United States has
allowed unrestricted trade among the states,
and the country as a whole has benefited
from the specialization that trade allows.