Transcript free trade

Unit IV
International Trade (Chapter 8)
In this chapter, look for the
answers to these questions:
 What determines how much of a good a country
will import or export?
 Who benefits from trade? Who does trade harm?
Do the gains outweigh the losses?
 How do tariffs and import quotas cause inefficiency
and reduce total surplus?
 Why do governments often engage in trade
protection to shelter domestic industries from
imports and how do international trade agreements
counteract this?
The World Price and
Comparative Advantage
• PW = the world price of a good,
the price that prevails in world markets
• PD = domestic price without trade
• If PD > PW,
– country does not have comparative advantage
– under free trade, country imports the good
– There are overall gains from trade because consumer
gains exceed the producer losses.
• If PD < PW,
– country has comparative advantage in the good
– under free trade, country exports the good
– There are overall gains from trade because producer gains
exceed the consumer losses.
The Small Economy Assumption
• A small economy is a price taker in world markets:
Its actions have no affect on PW.
• Not always true – especially for the U.S. – but
simplifies the analysis without changing its lessons.
• When a small economy engages in free trade,
PW is the only relevant price:
– No seller would accept less than PW, because
she could sell the good for PW in world markets.
– No buyer would pay more than PW, because
he could buy the good for PW in world markets.
A Country That Exports Soybeans
Without trade,
PD = $4
Q = 500
P
– domestic
consumers
demand 300
$6
$4
– domestic producers
supply 750
– exports = 450
S
exports
PW = $6
Under free trade,
Soybeans
D
300 500 750
Q
A Country That Exports Soybeans
Without trade,
CS = A + B
PS = C
Total surplus
=A+B+C
S
exports
A
$6
B
With trade,
CS = A
PS = B + C + D
Total surplus
=A+B+C+D
Soybeans
P
$4
C
D
gains
from trade
D
Q
Summary: The Welfare Effects of Trade
PD < P W
PD > PW
direction of trade
exports
imports
consumer surplus
falls
rises
producer surplus
rises
falls
total surplus
rises
rises
Whether a good is imported or exported,
trade creates winners and losers.
But the gains exceed the losses.
Other Benefits of International
Trade
• Consumers enjoy increased variety of goods.
• Producers sell to a larger market and may achieve
lower costs through economies of scale.
• Competition from abroad may reduce market
power of some firms, which would increase
total welfare.
• Trade enhances the flow of ideas, facilitates the
spread of technology around the world
• PROBLEM -- there are losers in free trade
– SOLUTION -- winners compensate the losers
(seldom done)
Effects of Trade Protection
• An economy has free trade when the
government does not attempt either to reduce or
to increase the levels of exports and imports that
occur naturally as a result of supply and
demand. Policies that limit imports are known as
trade protection or simply as protection.
• Most economists advocate free trade, although
many governments engage in trade protection
of import-competing industries. The two most
common protectionist policies are tariffs and
import quotas. In rare instances, governments
subsidize export industries.
Effects of a Tariff
• A tariff is a tax levied on imports.
• It raises the domestic price above the
world price, leading to a fall in trade and
total consumption and a rise in domestic
production.
• Domestic producers and the government
gain, but consumer losses more than
offset this gain, leading to deadweight loss
in total surplus.
Tariff: An Example of a Trade
Restriction
• Tariff: a tax on imports
• Example: Cotton shirts
PW = $20
Tariff: T = $10/shirt
Consumers must pay $30 for an imported shirt.
So, domestic producers can charge $30 per shirt.
• In general, the price facing domestic buyers &
sellers equals (PW + T ).
Analysis of a Tariff on Cotton Shirts
P
PW = $20
free trade:
Cotton shirts
buyers demand 80
sellers supply 25
imports = 55
S
T = $10/shirt
price rises to $30
buyers demand 70
sellers supply 40
imports = 30
$30
$20
imports
imports
25
40
70 80
D
Q
Analysis of a Tariff on Cotton Shirts
P
free trade
Cotton
shirts
deadweight
loss = D + F
CS = A + B + C
+D+E+F
PS = G
Total surplus = A + B
+C+D+E+F+G
S
tariff
CS = A + B
PS = C + G
Revenue = E
Total surplus = A + B
+C+E+G
A
B
$30
$20
C
D
E
F
G
25
40
70 80
D
Q
Analysis of a Tariff on Cotton Shirts
P
D = deadweight
loss from the
overproduction
of shirts
F = deadweight loss
from the underconsumption
of shirts
$30
$20
Cotton
shirts
deadweight
loss = D + F
S
A
B
C
D
E
F
G
25
40
70 80
D
Q
Import Quotas:
Another Way to Restrict Trade
• An import quota is a quantitative limit on
imports of a good.
• Mostly, has the same effects as a tariff:
– raises price, reduces quantity of imports
– reduces buyers’ welfare
– increases sellers’ welfare
• A tariff creates revenue for the govt. A
quota creates profits for the license holder
Trade Protection in the United
States



The United States today generally follows a policy of free trade.
Most manufactured goods are subject either to no or a low
tariff.
There are two areas where imports are limited:
 Agriculture: A certain amount of imports are subject to low a
tariff rate and this acts like an import quota because only
importers that are license holders are allowed to pay the low
rate. Any additional imports are subject to a higher tariff.
 Clothing and Textiles: A surge of clothing from China led to a
partial re-imposition of import quotas which had otherwise been
removed at the start of 2005.
In most cases, quota licenses are assigned to foreign
governments. Quota rents greatly go overseas, increasing the
cost to the U.S. of foreign imports.
Trade Protection in the United
States


There isn’t much U.S. trade protection.
According to official U.S. estimates, the total
economic cost of all quantifiable restrictions on
imports is about $3.7 billion a year, or around
one-fortieth of a percent on national income. Of
this, about $1.9 billion comes from restrictions
on clothing imports, $0.8 billion from restrictions
on sugar, and $0.6 billion from restrictions on
dairy. Everything else is small change.
Arguments for Trade Protection
• Advocates of tariffs and import quotas
offer a variety of arguments. Three
common arguments are:
– national security
– job creation
– the infant industry argument
• Despite the deadweight losses, import
protections are often imposed because
groups representing import-competing
industries are smaller and more cohesive
than groups of consumers.
Trade Agreements
• A country can liberalize trade with
– unilateral reductions in trade restrictions
– multilateral agreements with other nations
• Examples of trade agreements:
– North American Free Trade Agreement (NAFTA),
1993
– General Agreement on Tariffs and Trade (GATT),
ongoing
• World Trade Organization (WTO) est. 1995,
enforces trade agreements, resolves disputes
New Challenges to Globalization
• There are two concerns shared by
economists:
– Worries about the effects of globalization on
inequality.
– Worries that new developments, in particular
the growth in offshore outsourcing, are
increasing economic insecurity.
Offshore outsourcing takes place when
businesses hire people in another country to
perform various tasks.
CHAPTER SUMMARY
 A country will export a good if the world price of the good is higher than the domestic
price without trade. Trade raises producer surplus, reduces consumer surplus, and
raises total surplus.
 A country will import a good if the world price
is lower than the domestic price without trade. Trade lowers producer surplus, but
raises consumer and total surplus.
 International trade leads to expansion in exporting industries and contraction in
import-competing industries.
 Most economists advocate free trade, but in practice many governments engage in
trade protection.
 A tariff is a tax levied on imports. An import quota is a legal limit on the quantity of a
good that can be imported.
 Although several popular arguments have been made in favor of trade protection, in
practice the main reason for protection is probably political: import-competing
industries are well-organized and well-informed about how they gain from trade
protection, while consumers are unaware of the costs they pay.
 Many concerns have been raised about the effects of globalization:
• Income inequality due to the surge in imports from relatively poor countries
• Offshore outsourcing