9.1 The Determinants of Trade

The Equilibrium without Trade:

• When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand

The World Price and Comparative Advantage:

• World price- the price of a good that prevails in the world market for that good

• Trading with nations are based on comparative advantages (Review from Chapter 3)

  • By comparing the world price and the domestic price before the trade, we can determine if one nation is better or worse at producing products than the rest of the world.

9.2 The Winners and Losers from Trade

The Gains and Losses of an Exporting Country:

• Once the trade is allowed, the domestic price rises to equal the world price

  • The domestic quantity supplied differs from the domestic quantity demanded.

  • When the domestic quantity supplied is greater than the domestic quantity demanded, the nation that produced the products becomes the exporter.

• When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off, and domestic consumers of the good are 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.

The Gains and Losses of an Importing Country:

• Suppose the domestic price before the trade is above the world price

  • When trade is allowed, the domestic price must equal the world price

  • The difference between the domestic quantity demanded and the domestic quantity supplied is bought from other countries- the nation that produced the products becomes the importer.

• When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are 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

The Effects of a Tariff:

• Tariff- a tax on imported goods

  • It only matters when that nation becomes an importer

  • The tariff has no impact on a nation when it becomes an exporter

  • A deadweight loss because its a type of tax

• The price of products—both imported and domestic—rises by the amount of the tariff and is, therefore, closer to the price that would prevail without trade.

  • Thus, the tariff reduces the number of imports and moves the domestic market closer to its equilibrium without trade.

• When tariff raises the domestic price, the domestic sellers are better off and domestic buyers are worse off

• A tariff raises the domestic price of products above the world price

  • Encouraging domestic producers to increase production even when it exceeds the cost of buying them at the world price

  • Makes it profitable for domestic producers to manufacture the products

• When tariffs raise the price that domestic product consumers have to pay, it encourages them to reduce the consumption of textiles from one amount to another.

  • It induces them to cut back their purchases

The Lessons for Trade Policy:

• When tariff becomes part of a new trade policy, it moves the economy closer to the no-trade equilibrium

  • And with deadweight losses

• But it can improve the welfare of domestic producers and raises revenue for the government

  • These gains are more than offset by the losses suffered by consumers

• It's best to allow trade without a tariff

Other Benefits of International Trade:

• Increased variety of goods

• Lower costs through economies of scale

• Increased competition

• Enhanced flow of ideas

9.3 Arguments for Restricting Trade:

The Job Argument:

• Opponents of free trade argue that trade with other countries destroys domestic jobs

  • Free trade creates jobs but also destroys them

  • Even if one country may be better than another at producing products, each country can still gain from trading with each other

  • Gains from trade are based on comparative advantage, not absolute advantage

The National-Security Argument:

• When an industry is threatened by competitor countries, opponents of free trade often argue that industry is vital for national security

  • To argue back, free trade was made by representatives of industry rather than the defense establishment

The Infant-Industry Argument:

• New industries argue for temporary trade restrictions to assist their establishment

  • To argue, protection is not necessary for an infant industry to grow

The Unfair-Competition Argument:

• People argue that free trade is desirable only if all countries play by the same rule

  • Especially when different countries are subjected to different laws and regulations

The Protection-as-a-Bargaining-Chip Argument:

• People argue that trade restrictions concern the strategy of bargaining

  • People argue back that it can be useful when we bargain with our trading partners