Chapter 9
Application: International Trade
Determinants of Trade
Factors influencing the quantity of goods a country imports or exports.
Questions:
Who benefits from trade? Who does trade harm? Are the gains from trade greater than the losses?
What happens when policymakers restrict imports?
Who benefits? Who is harmed? Do the gains from restricting imports outweigh the losses?
Common arguments for restricting trade and their validity.
Equilibrium Without Trade
Characteristics:
Market consists only of domestic buyers and sellers.
Equilibrium price ($PD$) and quantity ($QD$) are set based on domestic demand and supply.
Total surplus consists of:
Consumer Surplus (CS): The benefit consumers receive when they pay less than what they're willing to pay.
Producer Surplus (PS): The benefit producers receive when they sell at a higher price than the minimum they would be willing to accept.
Example 1: Costa Rica's Pineapple Market (No Trade)
Production:
Quantity produced: $Q = 2,000$ thousands of tons of pineapples annually.
Price: $P = 800$ per ton.
Consumption matches production: $Q = 2,000$ thousands of tons of pineapples.
World Price and Comparative Advantage
Definitions:
$P_W$: World price of a good.
$P_D$: Domestic price without trade.
Comparative Advantage:
If $PD < PW$, the country has a comparative advantage and exports the good.
If $PD > PW$, the country does not have a comparative advantage and imports the good.
The Small Economy Assumption
Characteristics:
A small economy acts as a price taker in world markets.
Its actions do not affect $P_W$.
In free trade, $P_W$ is the only relevant price:
No seller would accept less than $P_W$.
No buyer would pay more than $P_W$.
Example 2: Costa Rica Exports Pineapples
Trade Conditions:
Without trade:
$PD = 800$, $QD = 2000$.
With Free Trade:
$P_W = 900$.
Domestic consumers demand $Q_D = 1,600$.
Domestic producers supply $Q_S = 2,700$.
Exports = $QS - QD = 1,100$.
Welfare Analysis: Costa Rica (With Trade)
Total Surplus Calculation:
Without trade:
$CS = A + B$,
$PS = C$,
Total Surplus = $A + B + C$.
With trade ($P_W = 900$):
$CS = A$,
$PS = B + C + D$,
Total Surplus = $A + B + C + D$.
Example 3: Brazil Imports Cocoa Beans
Trade Conditions:
Without trade:
$PD = 3,000$, $QD = 170$.
With Free Trade:
$P_W = 2,500$.
Domestic consumers demand $Q_D = 200$.
Domestic producers supply $Q_S = 150$.
Imports = 50.
Welfare Analysis: Brazil (With Trade)
Total Surplus Calculation:
Without trade:
$CS = A$,
$PS = B + C$,
Total Surplus = $A + B + C$.
With trade ($P_W = 2,500$):
$CS = A + B + D$,
$PS = C$,
Total Surplus = $A + B + C + D$.
Summary of Welfare Effects of Trade
Trade creates both winners and losers; however, overall gains are greater than losses.
The direction of trade influences total surplus, producer surplus, and consumer surplus significantly.
Trade Deals
Major trade deals benefit most Americans by expanding markets and varieties available.
Active Learning: Examples from Romania
Corn:
Price doubled when Romania opened to trade.
Assess comparative advantage, exporter vs importer status, and consumer/producer welfare changes.
Chocolate:
Price declined upon opening to trade.
Similar assessments are needed for comparative advantage and changes in welfare.
Effects of a Tariff
Definition:
A tariff is a tax imposed on goods produced abroad and sold domestically.
Impacts:
Domestic prices rise above world prices due to tariffs.
Example 4: Brazil Imposes a Tariff on Imports
Tariff of $300$ per ton of cocoa beans.
Before tariff, $P_W = 2500$; imports = 50.
After tariff, $P = 2800$; new quantities: $QD = 182$, $QS = 162$; imports = 20.
Welfare Analysis: Tariffs
Total Surplus Calculation:
Free Trade:
$CS = A + B + C + D + E + F$,
$PS = G$.
With Tariff:
$CS = A + B$,
$PS = C + G$,
Tax Revenue = E.
Deadweight loss = $D + F$.
Benefits of International Trade
Advantages beyond comparative advantage:
Greater variety of goods.
Lower costs via economies of scale.
Increased competition and productivity.
Facilitates technology transfer.
Arguments for Restricting Trade
1. Jobs Argument
Argues that trade destroys domestic jobs, but free trade ultimately creates new jobs.
2. National Security Argument
Some industries essential for national security should be protected.
However, this can lead to exaggerated claims about defense needs and may foster corruption.
3. Infant Industry Argument
New industries may need temporary protection but historical data shows mixed outcomes.
4. Unfair Competition Argument
Achieving fairness in trade rules is crucial to avoid subsidized imports undermining local industries.
5. Protection-as-a-Bargaining-Chip Argument
Suggests trade restrictions can negotiate concessions, though effectiveness is uncertain.
Who Pays for Tariffs?
Tariffs can burden foreign sellers or US importers; the actual tax incidence depends on market elasticity.
Tariffs vs Income Tax:
Tariffs might not raise sufficient revenue as compared to income tax.
Forecasted revenues show personal income tax significantly outweighs potential tariff income.
Tariffs are generally regressive, disproportionately affecting low-income households.
Effects of Tariffs on Domestic Producers
Tariffs support low-end producers but can negatively affect advanced manufacturers by raising input costs and leading to inefficiencies.
Historical Context: Tariffs in the US
Comparison of current tariff rates against historical levels indicates significant fluctuations.
The effective tariff rate in the U.S. remains relatively low compared to historical highs in the past.
Conclusion
International trade presents various benefits including comparative advantage, while also illuminating challenges through arguments for trade restrictions. Dominant economic consensus advises that free trade is generally the optimal policy for maximizing welfare.