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7
International Trade
Introduction to Economics
ETH Zürich, Prof. Dr. Jan-Egbert Sturm
Winter Term 2006/07
Exam
• Date:
Tuesday, February 13, 2007
• Time:
15:15 – 16:45 (90 minutes)
• Place:
HG E 7
• For those who canNOT register via eDoz,
please register via email:
• [email protected]
• Deadline: Thursday, 21. December 2006
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General Information
24.10.
Introduction; Transformation Curve, Opportunity Cost
Mankiw ch.1,2
31.10.
Markets: Demand and Supply
Ch. 4
7.11.
Elasticities
Ch. 5
14.11.
Costs, Production Function
Ch. 13
21.11.
Markets with perfect competiton
Ch. 7, 14
28.11.
Taxation
Ch. 8
5.12.
International Trade
Ch. 9 (, 3)
12.12.
Imperfect competition: Monopoly, and Oligoploy
Ch. 15, 16
19.12.
Public Goods, Externalities
Ch. 10,11
9.1.
National Accounting, Gross Domestic Product, Growth
Ch. 23, 25
16.1.
Money and Inflation
Ch. 24, 29, 30
23.1.
Business Cycles
Ch. 33, 34
30.1.
Open Economy Macro
Ch. 31
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• What determines whether a country imports or exports a
good?
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• Who gains and who loses from free trade among countries?
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• What are the arguments that people use to advocate trade
restrictions?
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THE DETERMINANTS OF TRADE
• 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.
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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
The Equilibrium Without International Trade
• Equilibrium Without Trade
• 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.
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The World Price and Comparative Advantage
• If the country decides to engage in international trade, will it be
an importer or exporter of a good?
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Comparative Advantage
• Differences in the costs of production determine the following:
• Who should produce what?
• How much should be traded for each product?
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Comparative Advantage
• Differences in Costs of Production
• Two ways to measure differences in costs of production:
• The number of hours required to produce a unit of output.
• The opportunity cost of sacrificing one good for another.
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Absolute Advantage
• The comparison among producers of a good according to their
productivity—absolute advantage
• Describes the productivity of one person, firm, or nation compared
to that of another.
• The producer that requires a smaller quantity of inputs to produce a
good is said to have an absolute advantage in producing that good.
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Absolute Advantage
• Labour Cost of Production
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Tomatoes
Cheese
Switzerland
60
15
Netherlands
20
10
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Absolute Advantage
• The Dutch need only 10 units of labor to produce one kilo of
cheese, whereas the Swiss need 15 minutes.
• The Dutch need only 20 units of labor to produce a kilo of
tomatoes, whereas the Swiss need 60 units of labor.
The Dutch have an absolute advantage in
the production of both tomatoes and
cheese.
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Opportunity Cost and Comparative Advantage
• Compares producers of a good according to their opportunity
cost.
• Whatever must be given up to obtain some item
• The producer who has the smaller opportunity cost of
producing a good is said to have a comparative advantage in
producing that good.
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Comparative Advantage and Trade
• Who has the absolute advantage?
• The Swiss or the Dutch?
• Who has the comparative advantage?
• The Swiss or the Dutch?
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Comparative Advantage
• Labour Cost of Production
Tomatoes
Cheese
Switzerland
60
15
Netherlands
20
10
Tomatoes
Cheese
Switzerland
4kg cheese
¼ kg tom.
Netherlands
2kg cheese
½ kg tom.
• Opportunity Cost
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Comparative Advantage and Trade
• The Swiss opportunity cost of a kilo of cheese is a ¼ kg of
tomatoes, whereas the Dutch opportunity cost of a kilo of
cheese is ½ a kg of tomatoes.
• The Swiss opportunity cost of a kilo of tomatoes is 4 kilos of
cheese, while the Dutch opportunity cost of a kilo of tomatoes
is 2 kilos of cheese...
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Comparative Advantage and Trade
…so, the Swiss have a
comparative advantage in the
production of cheese but the
Dutch have a comparative
advantage in the production of
tomatoes.
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Comparative Advantage and Trade
• Comparative advantage and differences in opportunity costs
are the basis for specialized production and trade.
• Whenever potential trading parties have differences in
opportunity costs, they can each benefit from trade.
• Hence, the Swiss will export cheese to the Netherlands, and the
Dutch will export tomatoes to Switzerland.
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Comparative Advantage and Trade
• Benefits of Trade
• Trade can benefit everyone in a society because it allows people to
specialize in activities in which they have a comparative advantage.
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The World Price and Comparative Advantage
• 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.
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The World Price and Comparative Advantage
• 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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The World Price and Comparative Advantage
• 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.
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Figure 2 International Trade in an Exporting Country
Price
of Steel
Domestic
supply
Price
after
trade
World
price
Price
before
trade
Exports
0
Domestic
quantity
demanded
Domestic
demand
Domestic
quantity
supplied
Quantity
of Steel
Figure 3 How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Price
after
trade
Domestic
supply
Exports
A
B
Price
before
trade
World
price
D
C
Domestic
demand
0
Quantity
of Steel
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
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.
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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.
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Figure 4 International Trade in an Importing Country
Price
of Steel
Domestic
supply
Price
before
trade
Price
after
trade
World
price
Imports
0
Domestic
quantity
supplied
Domestic
quantity
demanded
Domestic
demand
Quantity
of Steel
Figure 5 How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
Domestic
supply
A
Price
before trade
Price
after trade
B
C
D
Imports
World
price
Domestic
demand
0
Quantity
of Steel
Figure 5 How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
Consumer surplus
before trade
Domestic
supply
A
Price
before trade
Price
after trade
B
World
price
C
Producer surplus
before trade
0
Domestic
demand
Quantity
of Steel
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
How Free Trade Affects Welfare in an Importing
Country
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THE WINNERS AND LOSERS FROM TRADE
• How Free Trade Affects Welfare in an Importing Country
• 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 WINNERS AND LOSERS FROM TRADE
• The gains of the winners exceed the losses of the losers.
• The net change in total
surplus is positive.
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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
Equilibrium
without trade
Price
with tariff
Tariff
Price
without tariff
0
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity
of Steel
Figure 6 The Effects of a Tariff
Price
of Steel
Consumer surplus
before tariff
Producer
surplus
before tariff
Domestic
supply
Equilibrium
without trade
Price
without tariff
0
Domestic
demand
S
D
Q
Q
Imports
without tariff
World
price
Quantity
of Steel
Figure 6 The Effects of a Tariff
Price
of Steel
Consumer surplus
with tariff
A
Domestic
supply
Equilibrium
without trade
B
Price
with tariff
Tariff
Price
without tariff
0
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity
of Steel
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Producer
surplus
after tariff
Price
with tariff
Equilibrium
without trade
Tariff
C
Price
without tariff G
0
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity
of Steel
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Tariff Revenue
Price
with tariff
Tariff
E
Price
without tariff
0
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity
of Steel
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
A
Deadweight Loss
B
Price
with tariff
Tariff
C
D
Price
without tariff G
0
E
F
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity
of Steel
The Effects of a Tariff
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The Effects of a 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
amount referred to as a deadweight loss.
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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.
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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
Q
S
Domestic
demand
D
Q
Q
Imports
without quota
D
Q
World
price
Quantity
of Steel
The Effects of an Import 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.
• License holders are better off because they make a profit from
buying at the world price and selling at the higher domestic
price.
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Figure 7 The Effects of an Import Quota
Price
of Steel
Domestic
supply
Equilibrium
without trade
Quota
A
Isolandian
price with
quota
Price
World
without =
price G
quota
0
B
C
E'
D
Equilibrium
with quota
F
E"
Imports
with quota
S
Q
Domestic
supply
+
Import supply
S
Domestic
demand
D
Q
Q
Imports
without quota
D
Q
World
price
Quantity
of Steel
The Effects of an Import Quota
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The Effects of an Import Quota
• 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 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.
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The Lessons for Trade Policy
• Both tariffs and import quotas . . .
•
•
•
•
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raise domestic prices.
reduce the welfare of domestic consumers.
increase the welfare of domestic producers.
cause deadweight losses.
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The Lessons for Trade Policy
• Other Benefits of International Trade
•
•
•
•
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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
•
•
•
•
•
Jobs
National Security
Infant Industry
Unfair Competition
Protection-as-a-Bargaining Chip
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CASE STUDY: 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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CASE STUDY: 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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CASE STUDY: 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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Summary
• The effects of free 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 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.
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Summary
• 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.
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Summary
• A tariff—a tax on imports—moves 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.
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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.
• Economists, however, believe that free trade is usually the
better policy, at least in the long run.
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