Chapter 9: International Trade

world price

the price prevailing in other countries

world price > domestic price

a country will export that good

world price < domestic price

import that good

small economy assumption

most countries’ actions have a negligible effect on world markets, they’re said to be price takers and therefore cannot affect world prices

gains and losses of the exporting country

producers: gain surplus
consumers: lose surplus

**producers better off, consumers worse off

trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers
horizontal line at world price represents demand of textiles from the rest of the world. this supply is perfectly elastic bc the world can demand as much as it wants

the gains and losses of an importing country

producers: lose surplus

consumers: gain surplus

**gains of consumers > losses of producers so trade raises the economic well-being of a nation

*horizontal world price is elastic, represents world supply, and it’s elastic bc the country is a small economy and can buy as much as it wants at the world price

does trade always make everyone better off?

according to theory, it should but in practice, it probably won’t. technically whoever gains more could give that surplus back to the other group but in practice, this doesn’t happen. trade expands the size of the economic pie but can leave some people with a smaller pie

tariff

tax on imported goods

when are tariffs relevant?

only on imported goods, not on exported goods.

what does a tariff do to the price of an imported good?

without the tariff, the price is much lower, at world price. with the tariff, the price is raised higher towards domestic price, so domestic suppliers who compete with foreign suppliers can now sell their goods for world price + tariff

what effect does a tariff have in general

reduces the quantity of imports and increases the price of goods and services

gains and losses from a tariff

domestic sellers: better off bc price is raised

domestic buyers: worse off bc price is raised
government: gets tax revenue

**however, there is deadweight loss

why do tariffs cause deadweight loss

like taxes, it distorts incentives and pushes the allocation of scarce resources away from the optimum. there’s DWL from overproduction of textiles (next to supply curve), and DWL from underconsumption of textiles (next to demand curve)

quotas

limit on how much of a good can be imported

are import quotas similar to tariffs?

yes, both reduce quantity of imports, raise the domestic price of a good, decrease the welfare of domestic consumers, increase the welfare of domestic producers, and cause DWL.

One difference: tariff raises revenue for the government while an import quota generates surplus for those who obtain the permits to import. the profit for holders of import permits is the difference between the domestic price and the world price

benefits of international trade (5)

increased variety of goods

lower costs through economies of scale

increased competition

increased productivity

enhanced flow of ideas

economies of scale

some goods can only be produced at a low cost if they’re produced in large quantities. a firm can’t take full advantage of economies of scale if it can sell only in a small domestic market. free trade gives firms access to world markets, allowing them to realize economies of scale more fully

arguments for restricting trade

(1) jobs

(2) national security

(3) infant-industry

(4) unfair competition

(5) protection as a bargaining chip

the jobs argument

opponents of free trade say it destroys jobs i.e. free trade in fruit could cause the price to fall, reducing quant produced domestically and slashing employment in the fruit industry. HOWEVER free trade creates new jobs even as it destroys some old ones. displaced fruit workers can move to industries in which the country has a comparative advantage. in the long run, the country will enjoy a higher standard of living.

the national security argument

ex. a country’s steel companies might point out that steel is used to make guns and tanks. free trade in steel could lead the country to become dependent on foreign countries to supply steel. if a war interrupted the foreign supply, the country might be unable to quickly produce enough steel and weapons to defend itself.

**pay attention to who is making the national security argument. companies have a financial incentive to exaggerate their role in national defense bc protection from foreign competition can be lucrative. a country’s generals may see things differently as when the military buys an industry’s output, it is a consumer and benefits from imports, allowing them to stockpile steel and make weapons at a lower cost

infant-industry argument

new industries sometimes ask for temporary trade restrictions to get them started, but after the period of protection, they should be strong enough to compete with foreign firms.

**economists are skeptical bc it’s hard to pick winners and decide which industries to support. also, if an industry that is young is unable to compete against foreign rivals but there’s reason to believe it can be profitable in the long run, the firm owners should be willing to take temp losses to obtain eventual profits. protection isn’t needed

unfair competition

some say free trade is only desirable if all countries play by the same rules. if companies in different countries are subject to different laws and regulations, then it’s unfair to expect them to compete globally.

it might hurt domestic producers but it benefits domestic consumers

protection as a bargaining chip

trade restrictions can be a bargaining chip, and can be useful in obtaining concesions from trading partners. however, the threat may not work, leaving the country w/ two bad options:

(1) implement the trade restriction and reduce its own economic welfare

(2) back down from the threat and lose prestige and future bargaining power

unilateral approach

remove trade restrictions on its own

multilateral approach

reducing trade restrictions in concert with other countries

ex. North American Free Trade Agreement (NAFTA), in 1991 lowered trade barriers among the US, Mexico, and Canada.

ex. General Agreement on Tariffs and Trade (GATT), a series of negotiations among many of the world’s countries with the goal of promoting free trade. the US helped to found GATT after WWII in response to high tariffs imposed during great depression. rules established under GATT are enforced yb World Trade Organization (WTO), which serves to administer trade agreements, provide a forum for negotiations, and handle disputes among member countries

pros and cons of multilateral approach

potential to result in freer trade than a unilateral approach bc it can reduce trade restrictions abroad as well as at home. however, if internaitonal negotiations fail, the result could be more restricted trade than under a unilateral approach

multilateral approach may have a political advantage - in most markets, producers are fewer and better organized than consumers —> have better political clout

North American Free Trade Agreement (NAFTA)

multilateral approach, in 1993 lowered trade barriers among the US, Mexico, and Canada
**new updated NAFTA known as the United States-Mexico-Canada agreement went into effect in 2020.

General Agreement on Tariffs and Trade (GATT)

multilateral approach, series of negotations amony many of world’s countries with goal of promoting free trade. US helped ofund GATT after WWII in response to high tariffs imposed during Great Depression
**Gatt was successful, reducing avg tariff among member countries from over 20% after WWII to less than 5% in 2000

who enforces GATT

World Trade Organization (WTO

WTO

established 1995, headquarters in Geneva, Switzerland, 164 countries have joined, accounting for 98% of world trade

functions of WTO

administer trade agreements, provide a forum for negotiations, handle disputes among member countries