Trade Activities

world equilibrium

quantity exported = quantity imported

“Theory of Comparative Advantage”

specialization that results from free trade will benefit in all parties including a rise in real wages

absolute advantage

one country can produce a product using fewer resources than another country

comparative advantage

one country can produce at lower opportunity cost

endowment of resources

educated people, labor, land, other natural resources

assumptions of Ricardian Model

• all agents in the economy are rational

• there are only 2 countries

• there are only 2 goods

• labor is the only input

• labor is mobile domestically, immobile across country

• labor is fully employed

• markets are perfectly competitive

nominal price

price of a good in terms of money

relative price

ratio of one goods price relative to another

autarky price

price without trade

gains from trade

net benefits of trade; consumption/overall welfare

L

total labor

a_Lx

hours needed to produce one unit of the good

Q_Lx

a_Lx / a_Ly

wage

P_x/a_Lx

opportunity cost for good x

a_Lx / a_Ly

Hecksher-Ohlin Theorum

since countries aren’t mobile between economies, countries that are well-endowed with certain factors have comparative advantage in goods produced with those factors

H-O theorum inputs

K = capital

L = labor

K/L ratio

K_x / L_x

Gravity Model of Trade

predicts likelihood of trade between 2 countries

Gravity Model Equation

T_IJ = (Y_i + Y_j ) / D_ij

import demand

excess of what consumers demand over what producers supply

export supply curve

excess of what producers supply over what consumers demand

tariff

tax levied when a good is imported

specific tariffs

levied as a fixed charge for each unit of goods imported

ad valorem tariffs

taxes levied as a fraction of the value of imported goods

quotas

limits on the quantity of imports

impact of tariff on importers

• raises the price to P_T

• allows more government revenue

• shippers only willing to import unless importer price > exporter by at least the amount of the tariff

• import demand goes down

• increase in P is less than the amount of the tariff because part of the tariff is reflected in a decline in foreign’s export price

impact of tariff on exporter

• lowers price to P*_T (P*_t - t)

• reduced supply

• increased demand

• smaller export supply

trade volume Q_T

home import demand = foreign export demand when P_T - P*_T = t

Small country case

• small countries don’t affect the foreign export prices

• price raises to P_W+T

• production of imported goods rise, consumption falls

consumer surplus

• measures amount a consumer gains form a purchase

• ½ (P₂ = P₁) * Q_D

producer surplus

amount a producer gains from a sale

Gain to Domestic Producers

Higher Producer Surplus

Domestic Consumers

Lower Consumer Surplus

government revenue (domestic)

tariff rate t (P_T = P*_T) * (D₂ - S₂)

Net cost of a tariff

consumer loss - producer gain - government revenue (b + d - e)

efficiency loss

reduction in welfare that arises due to higher price with the tariff distorting incentive to consume and produce

terms of trade

increase in welfare that arises due to a tariff lowering foreign price

export subsidy

payment to a firm or individual that ships a good abroad

Voluntary Export Restraint

quota on trade imposed from the exporting country instead of importer

local content requirement

regulation that requires some specific fraction of a final good to be produced domestically