International Trade Policy Flashcards

Lecture 12: International Trade Policy

Objectives:

• Explain how markets work with international trade.

• Identify the gains from international trade and its winners and losers.

• Explain the effects of tariffs on trade.

• Align and promote economic analysis with the UN Sustainable Development Goals.

Outline:

• Modelling Specialisation and Trade

  • Production Possibilities Frontier and tradeoff (pp.72 – 73)

  • Gains from Trade (pp.78 -82)

  • Comparative and Absolute Advantage

  • A numerical illustration: Comparative Advantage

  • Gains from Trade – Demand and Supply

  • International Trade Restrictions - tariffs

Chapter 2: Specialisation and Trade

Modelling Specialisation and Trade

• Production Possibilities Frontier and tradeoff (pp.72 – 73)

• Gains from Trade (pp.78 -82)

• Comparative and Absolute Advantage

Production Possibilities Frontier (PPF)

• The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology.

PPF Key Points:

• We can produce at any point inside the PPF or on the frontier.

• We cannot produce at any point outside the PPF.

PPF Example: Two Countries

• Two countries with PPFs for Coal and Cars

• Before trade, Australia produces and consumes at point A and Japan at point B.

Specialisation and Trade

Absolute Advantage

• When one person (or nation) is more productive than another.

• Need fewer inputs or less time to produce a good or perform a production task. (i.e. productivity).

Comparative Advantage

• The ability of a person (or nation) to perform an activity or produce a good or service at a lower opportunity cost than someone else (or another nation).

Numerical Illustration: Comparative Advantage

Before Trade

• Output of Cars and Coal in Australia and Japan

• Opportunity Cost (O.C.) of producing 1 Car:

  • Australia: +12 cars → -24 coal (MT) which is +1 car → -2 coal (MT). (i.e. \frac{24}{12} = 2)

  • Japan: +18 cars → -12 coal (MT) which is +1 car → -0.666 coal (MT). (i.e. \frac{12}{18} = 0.666)

  • Japan has a lower opportunity cost (comparative advantage) in producing cars and thus should produce cars.

Opportunity Cost of producing 1MT of Coal:

• Australia: +24 coal (MT) ® - 12 cars which is +1 coal (MT) ® -0.5 car. (ie. \frac{12}{24} = 0.5)

• Japan: +12 coal (MT) ® - 18 cars which is +1 coal (MT) ® -1.5 car. (ie. \frac{18}{12} = 1.5)

• Australia has a lower opportunity cost (comparative advantage) in producing coal and thus should produce coal.

Specialisation

• Specialisation according to comparative advantage increases total output

Specialisation Example

• Australia specialises in Coal: 48 MT, 0 Cars

• Japan specialises in Cars: 36 Cars, 0 Coal

• Total: 36 Cars, 48 Coal

With Trade

• Australia and Japan agree to a trade of 16 Cars for 16 MT of Coal.

After Trade

• Australia: 16 Cars, 32 Coal

• Japan: 20 Cars, 16 Coal

• Both countries are now consuming more of both goods than before.

Gains From Trade

• Through specialization and trade, reaching point G is possible.

• Trade (a form of technology) encourages economic growth and improves society’s welfare.

• We can measure society’s welfare via consumer and producer surplus.

Global Markets in Action - Demand-Supply Analysis

• International trade plays a fundamental role in promoting sustained, inclusive and sustainable economic growth, creating jobs, raising incomes and enhancing welfare of peoples.

• A supportive international economic environment is crucial.

• Sustainable development: Economic development that is conducted without depletion of natural resources.

Gains from Trade – Demand and Supply

Importer’s View

• Before Trade: Australia imports cars from the rest of the world.

With Trade

• The world price is less than the domestic price, so the rest of the world has a comparative advantage in producing cars.

  • Price per car in Australia falls to $15,000.

  • Australians increase the quantity they buy.

  • Australian car makers decrease the quantity they produce.

  • Australia imports cars.

Note:

• If other nations are specialising in production of a good, they can produce at a lower cost (i.e. lower opp. cost). Hence, the world price is lower than the local price.

Welfare effects

• Consumer surplus increases.

• Producer surplus decreases.

Exporter’s View

• Before Trade: Australia exports (say coal) to the rest of the world.

With Trade

• The world market for coal determines the world price.

• The world price is higher, so Australia has a comparative advantage in producing coal.

  • The price of coal in Australia rises.

  • Australian miners increase the quantity they produce.

  • Australian power stations cut the quantity they buy.

  • Australia exports coal.

Note:

• If a nation is specialising in production of a good, it can produce at a lower cost (lower opp. cost). Hence, the local price is lower than the world price.

Welfare effects

• Producer surplus increases.

• Consumer surplus decreases.

International Trade Restrictions

• Governments use four sets of tools to influence international trade and protect domestic industries:

  • Tariffs

  • Import quotas

  • Other import barriers

  • Export subsidies

• For EFB231, we will only cover Tariffs.

Tariffs

• A tariff is a tax on a good that is imposed by the importing country when an imported good crosses its international boundary.

Effects of Tariffs

• With free trade, the price is the world price.

• A tariff raises the price and car imports decrease.

Winners, Losers and Social Loss from a Tariff

• Consumer surplus shrinks.

• Producer surplus expands.

• Tariff revenue equals the imports of cars multiplied by the tariff.

• The tariff revenue is area C.

• The sum of the two areas labelled D is the loss of total surplus—a deadweight loss.

Review of Lecture

• Modelling Specialisation and Trade

  • Production Possibilities Frontier and trade-off (pp.72 – 73)

  • Gains from Trade (pp.78 -82)

  • Comparative and Absolute Advantage

  • A numerical illustration: Comparative Advantage

  • Gains from Trade – Demand and Supply

  • International Trade Restrictions - tariffs