Introduction. The Small Economy Assumption. Application: International Trade. The World Price and Comparative Advantage

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1 9 pplication: International Trade R I N I L E O F EONOMI F O U R T H E I T I O N N. G R E G O R Y M N K I W remium oweroint lides by Ron ronovich 2008 update Modified by Joseph Tao-yi Wang 2008 outh-western, a part of engage Learning, all rights reserved 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? o the gains outweigh the losses? If policymakers restrict, who benefits? Who is harmed? o the gains from restricting outweigh the losses? What are some common arguments for restricting trade? o they have merit? 1 Introduction Recall from hapter 3: country has a comparative advantage in a good if it produces the good at lower opportunity cost than other countries. ountries can gain from trade if each the goods in which it has a comparative advantage. Now we apply the tools of welfare economics to see where these gains come from and who gets them. 2 The World rice and omparative dvantage W = the world price of a good, the price that prevails in world markets = domestic price without trade If < W, country has comparative advantage in the good under free trade, country the good If > W, country does not have comparative advantage under free trade, country the good 3 The mall Economy ssumption small economy is a price taker in world markets: Its actions have no effect on W. Not always true especially for the U.. but simplifies the analysis without changing its lessons. When a small economy engages in free trade, W is the only relevant price: No seller would accept less than W, since she could sell the good for W in world markets. No buyer would pay more than W, since he could buy the good for W in world markets. 4 ountry That Exports oybeans = $4 = 500 W = $6 consumers demand 300 producers supply 750 = 450 $6 $4 300 oybeans

2 ountry That Exports oybeans = + = = + + With trade, = = + + = $6 $4 oybeans gains from trade 6 T I V E L E R N I N G 1: nalysis of trade = 00, = 400 In world markets, W = $1500 how many TVs will the country import or export? Identify,, and total surplus without trade, and with trade. 00 $ lasma TVs T I V E L E R N I N G 1: nswers T I V E L E R N I N G 1: nswers consumers demand 600 producers supply 200 = $1500 lasma TVs = = + = With trade, = + + $1500 = = lasma TVs gains from trade 8 9 ummary: The Welfare Effects of Trade direction of trade consumer surplus producer surplus total surplus < W falls > W falls Whether a good is imported or exported, trade creates winners and losers. ut the gains exceed the losses. Other enefits of International Trade onsumers enjoy increased variety of goods. roducers sell to a larger market, may achieve lower costs by producing on a larger scale. ompetition from abroad may reduce market power of domestic firms, which would increase total welfare. Trade enhances the flow of ideas, facilitates the spread of technology around the world

3 Then Why ll the Opposition to Trade? Recall one of the Ten rinciples: Trade can make everyone better off. The winners from trade could compensate the losers and still be better off. Yet, such compensation rarely occurs. The losses are often highly concentrated among a small group of people, who feel them acutely. The gains are often spread thinly over many people, who may not see how trade benefits them. Hence, the losers have more incentive to organize and lobby for restrictions on trade. 12 Tariff: n Example of a Trade Restriction Tariff: a tax on Example: otton shirts W = Tariff: T = $10/shirt onsumers must pay for an imported shirt. o, domestic producers can charge per shirt. In general, the price facing domestic buyers & sellers equals ( W + T ). 13 nalysis of a Tariff on otton hirts nalysis of a Tariff on otton hirts W = free trade: buyers demand 80 sellers supply = 55 T = $10/shirt price to buyers demand 70 sellers supply 40 = 30 otton shirts free trade = E + F = G = E + F + G tariff = + = + G Revenue = E = E + G G otton deadweight shirts loss = + F 40 E F nalysis of a Tariff on otton hirts = deadweight loss from the overproduction of shirts F = deadweight loss from the underconsumption of shirts G otton deadweight shirts loss = + F 40 E F Import uotas: nother Way to Restrict Trade n import quota is a quantitative limit on of a good. Mostly, has the same effects as a tariff: raises price, reduces quantity of reduces buyers welfare increases sellers welfare tariff creates revenue for the govt. quota creates profits for the foreign producers of the imported goods, who can sell them at higher price. Or, govt could auction licenses to import to capture this profit as revenue. Usually it does not. 17

4 In the News: Textile Imports from hina On 12/31/2004, U.. quotas on apparel & textile products expired. uring Jan 2005: The U.. U.. textile of industry these & labor products unions from fought hina for new increased trade restrictions. over 70%. November 2005: The Loss National of 12,000 Retail ush administration agreed jobs Federation in U.. textile opposed industry. any to limit growth in restrictions. from hina. 1. The jobs argument Trade destroys jobs in industries that compete with. Look at the data to see whether rising cause rising unemployment % 14% 12% 10% 8% 6% 4% 2% 0% U.. & unemployment, decade averages, (% of G) unemployment (% of labor force) 1. The jobs argument Trade destroys jobs in the industries that compete against. Total unemployment does not rise as rise, because job losses from are offset by job gains in export industries. Even if all goods could be produced more cheaply abroad, the country need only have a comparative advantage to have a viable export industry and to gain from trade The national security argument n industry vital to national security should be protected from foreign competition, to prevent dependence on that could be disrupted during wartime. Fine, as long as we base policy on true security needs. ut producers may exaggerate their own importance to national security to obtain protection from foreign competition. 3. The infant-industry argument new industry argues for temporary protection until it is mature and can compete with foreign firms. ifficult for govt to determine which industries will eventually be able to compete, and whether benefits of establishing these industries exceed cost to consumers of restricting. esides, if a firm will be profitable in the long run, it should be willing to incur temporary losses

5 4. The unfair-competition argument roducers argue their competitors in another country have an unfair advantage, e.g. due to govt subsidies. Great! Then we can import extra-cheap products subsidized by the other country s taxpayers. The gains to our consumers will exceed the losses to our producers. 5. The protection-as-bargaining-chip argument Example: The U.. can threaten to limit of French wine unless France lifts their quotas on merican beef. uppose France refuses. Then the U.. must choose between two bad options: ) Restrict from France, which reduces welfare in the U.. ) on t restrict, and suffer a loss of credibility. 24 Trade greements country can liberalize trade with unilateral reductions in trade restrictions multilateral agreements with other nations Examples of trade agreements: North merican Free Trade greement (NFT), 1993 General greement on Tariffs and Trade (GTT), ongoing World Trade Organization (WTO) est. 1995, enforces trade agreements, resolves disputes 26 HTER UMMRY 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. 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. tariff benefits producers and generates revenue for the govt, but the losses to consumers exceed these gains. 27 HTER UMMRY ommon arguments for restricting trade include: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions. ome of these arguments have merit in some cases, but economists believe free trade is usually the better policy. pplication: International Trade Imports benefit consumers Exports benefit producers Trade benefit the entire economy Read Mankiw, ch., p.567, In the News Homework:Mankiw, ch. 9, pp , roblem 5, 10, 12 28