International Trade Notes

International Trade

Introduction

• Comparative Advantage:
  • A country possesses a comparative advantage in producing a good if it can do so at a lower opportunity cost than other nations.
  • Countries engaging in trade can benefit if each specializes in exporting goods for which they hold a comparative advantage.
• Welfare Economics:
  • The principles of welfare economics are applied to understand the sources of gains from trade and their distribution.

The World Price and Comparative Advantage

• $P_W$ = World Price:
  • This is the prevailing price of a good in the global market.
• $P_D$ = Domestic Price:
  • This represents the price of a good within a country, absent of international trade.
• If $P<em>D < P</em>W$:
  • The country has a comparative advantage in producing the good.
  • Under conditions of free trade, the country will export the good.
• If $P<em>D > P</em>W$:
  • The country does not have a comparative advantage.
  • Under free trade, the country will import the good.

The Small Economy Assumption

• Price Taker:
  • A small economy is considered a price taker, meaning its actions do not influence the world price, $P_W$.
  • This assumption simplifies analysis without altering its fundamental lessons.
• Free Trade:
  • When a small economy engages in free trade, $P_W$ becomes the relevant price.
  • Sellers won't accept less than $P_W$, as they can sell at that price in world markets.
  • Buyers won't pay more than $P_W$, as they can purchase at that price in world markets.

A Country That Exports Soybeans

• Without Trade:
  • P_D = $4, Quantity = 500
• With Free Trade:
  • P_W = $6
  • Domestic consumers demand 300 units.
  • Domestic producers supply 750 units.
  • Exports = 450 units.
• Welfare Effects:
  • Without Trade:
    • Consumer Surplus (CS) = A + B
    • Producer Surplus (PS) = C
    • Total Surplus = A + B + C
  • With Trade:
    • CS = A
    • PS = B + C + D
    • Total Surplus = A + B + C + D
    • Gains from trade = D

Active Learning 1: Analysis of Trade

• Without Trade:
  • P_D = $3000, Quantity = 400
• With Free Trade:
  • P_W = $1500
  • Domestic consumers demand 600 units.
  • Domestic producers supply 200 units.
  • Imports = 400 units.
• Welfare Effects:
  • Without Trade:
    • CS = A
    • PS = B + C
    • Total Surplus = A + B + C
  • With Trade:
    • CS = A + B + D
    • PS = C
    • Total Surplus = A + B + C + D
    • Gains from trade = D

Summary: The Welfare Effects of Trade

• Imports:
  • Consumer surplus rises.
  • Producer surplus falls.
  • Total surplus rises.
  • $P<em>D > P</em>W$
• Exports:
  • Consumer surplus falls.
  • Producer surplus rises.
  • Total surplus rises.
  • $P<em>D < P</em>W$
• Whether a good is imported or exported, trade creates winners and losers, but the gains always exceed the losses.

Other Benefits of International Trade

• Increased Variety:
  • Consumers have access to a broader range of goods.
• Economies of Scale:
  • Producers can sell to larger markets, potentially lowering costs through economies of scale.
• Increased Competition:
  • Competition from abroad can reduce the market power of domestic firms, enhancing total welfare.
• Enhanced Flow of Ideas:
  • Trade facilitates the spread of technology and ideas globally.

Why All the Opposition to Trade?

• Gains and Losses:
  • Trade can make everyone better off, and the winners could compensate the losers.
  • However, compensation rarely occurs.
• Concentrated vs. Diffuse Effects:
  • Losses are often concentrated among a small group, who feel them acutely.
  • Gains are spread thinly over many people, who may not perceive the benefits.
• Incentives:
  • The losers have a greater incentive to organize and lobby for trade restrictions.

Tariff: An Example of a Trade Restriction

• Tariff Definition:
  • A tariff is a tax on imports.
• Example:
  • Cotton shirts with a world price of P_W = $20.
  • Tariff: T = $10\/shirt.
  • Consumers must pay $30 for an imported shirt, allowing domestic producers to charge the same.
• General Effect:
  • The price facing domestic buyers and sellers equals $P_W + T$.

Analysis of a Tariff on Cotton Shirts

• Without Tariff:
  • P_W = $20
  • Buyers demand 80 shirts.
  • Sellers supply 25 shirts.
  • Imports = 55 shirts.
• With Tariff:
  • T = $10\/shirt, price rises to $30.
  • Buyers demand 70 shirts.
  • Sellers supply 40 shirts.
  • Imports = 30 shirts.
• Welfare Effects:
  • Without Tariff:
    • CS = A + B + C + D + E + F
    • PS = G
    • Total surplus = A + B + C + D + E + F + G
  • With Tariff:
    • CS = A + B
    • PS = C + G
    • Revenue = E (tariff revenue)
    • Total surplus = A + B + C + E + G
    • Deadweight loss = D + F
• Deadweight Losses:
  • D = deadweight loss from overproduction of shirts.
  • F = deadweight loss from under-consumption of shirts.

Import Quotas: Another Way to Restrict Trade

• Definition:
  • An import quota is a quantitative limit on the import of a good.
• Effects:
  • Similar effects to a tariff:
    • Raises price, reduces the quantity of imports.
    • Reduces buyers’ welfare.
    • Increases sellers’ welfare.
• Revenue:
  • A tariff creates revenue for the government, while a quota creates profits for foreign producers, unless the government auctions licenses to import.

In the News: Textile Imports from China

• Expiration of Quotas:
  • On December 31, 2004, U.S. quotas on apparel & textile products expired.
• Impact:
  • U.S. imports of these products from China increased significantly.
  • Loss of jobs in the U.S. textile industry.
• Response:
  • The U.S. textile industry & labor unions fought for new trade restrictions.
  • The National Retail Federation opposed any restrictions.
  • Bush administration agreed to limit growth in imports from China.

Arguments for Restricting Trade

1. The Jobs Argument

• Claim:
  • Trade destroys jobs in industries that compete with imports.
• Economists’ Response:
  • Rising imports do not necessarily cause rising unemployment, because job losses from imports 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.

2. The National Security Argument

• Claim:
  • An industry vital to national security should be protected from foreign competition to prevent dependence on imports during wartime.
• Economists’ Response:
  • Policy should be based on true security needs.
  • Producers may exaggerate their importance to national security to obtain protection.

3. The Infant-Industry Argument

• Claim:
  • A new industry needs temporary protection until it matures and can compete with foreign firms.
• Economists’ Response:
  • It is difficult for the government to determine which industries will eventually be able to compete, and whether the benefits of establishing these industries exceed the costs to consumers of restricting imports.
  • If a firm will be profitable in the long run, it should be willing to incur temporary losses.

4. The Unfair-Competition Argument

• Claim:
  • Producers argue their competitors in another country have an unfair advantage, e.g., due to government subsidies.
• Economists’ Response:
  • Subsidies from other countries are beneficial because the gains to our consumers will exceed the losses to our producers.

5. The Protection-as-Bargaining-Chip Argument

• Claim:
  • The U.S. can threaten to limit imports to bargain for trade concessions.
• Economists’ Response:
  • If the other country refuses, the U.S. faces two bad options:
    • Restrict imports, which reduces welfare in the U.S.
    • Don’t restrict imports, and suffer a loss of credibility.

Trade Agreements

• Liberalizing Trade:
  • A country can liberalize trade through unilateral reductions in trade restrictions or multilateral agreements with other nations.
• Examples:
  • North American Free Trade Agreement (NAFTA)
  • General Agreement on Tariffs and Trade (GATT)
• World Trade Organization (WTO):
  • Established in 1995 to enforce trade agreements and resolve disputes.

Chapter Summary

• Exports:
  • A country will export a good if the world price is higher than the domestic price without trade.
  • Trade raises producer surplus and total surplus but reduces consumer surplus.
• Imports:
  • A country will import a good if the world price is lower than the domestic price without trade.
  • Trade raises consumer and total surplus but lowers producer surplus.
• Tariffs:
  • A tariff benefits producers and generates government revenue, but the losses to consumers exceed these gains.
• Arguments for Restricting Trade:
  • Common arguments include protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
  • Economists generally believe that free trade is the better policy, though some arguments may have merit in certain cases.