CHAPTER 37International Trade

A. Short-Answer, Essays, and Problems

1. Describe the quantity of exports for the United States. How do exports compare with other nations?

2. What are the major imports and exports of the United States?

3. Who are the major players in international trade?

4. Cite three important reasons why nations trade.

5. “The international flow of goods helps compensate for the international immobility of resources.” Analyze and explain.

New 6. Suppose that by devoting all of its resources to the production of A, the nation of Econia can produce 50 A. By devoting all of its resources to the production of B, Econia can produce 25 B. The comparable figures for the nation of Optima are 5 A and 5 B. According to the principle of comparative advantage, which nation will specialize in which product? What are the limits to the terms of trade?

New 7. Suppose that by devoting all of its resources to the production of rice (R), Japan can produce 40 units. By devoting all of its resources to corn (C), it can produce 20 units. Comparable figures for Mexico are 15 units of rice (R) and 15 units of corn (C). Explain why each nation will specialize in which product. What are the limits to the terms of trade?

8. Answer the next three questions on the basis of the following production possibilities data for Francia and Galacia. All data are in tons.

Francia production possibilities:A B C D E  

Soup 60 45 30 15 0Nuts 0 15 30 45 60

Galacia production possibilities:A B C D E  

Soup 20 15 10 5 0Nuts 0 15 30 45 60

(a) If trade occurs between Francia and Galacia, which nation should export what product? Why?(b) What are the limits of the terms of trade between Francia and Galacia?

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(c) Assume that prior to specialization and trade, Francia and Galacia chose production possibility “C.” Now each specializes according to comparative advantage. What will be the resulting gains from trade? Explain your answer.

9. Answer the next three questions on the basis of the following production possibilities data for Narnia and Somosa. All data are in 1,000s.

Narnia production possibilities:A B C D E  

Computer chips 80 60 40 20 0Fuel injectors 0 20 40 60 80

Somosa production possibilities:A B C D E  

Computer chips 40 30 20 10 0Fuel injectors 0 20 40 60 80

(a) If trade occurs between Narnia and Somosa, which nation should export what product? Why?(b) What are the limits of the terms of trade between Narnia and Somosa?(c) Assume that prior to specialization and trade, Narnia and Somosa chose production possibility “C.” Now each specializes according to comparative advantage. What will be the resulting gains from trade? Explain your answer.

10. Given the data in the graph below, which nation should specialize in steel production and which nation in wheat production? Why?

11. Use the extreme points from a production possibilities schedule below to draw two straight line production possibilities curves for two nations, A and B using the below graphs. Assume constant costs.

Nation Food Clothing A 4 4B 2 8

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(a) What is the cost ratio for the two products?(b) If each nation specializes according to comparative advantage, who should produce and trade each product? Why?(c) What will be the range for the terms of trade? If the terms are set at 1 food = 2 clothing, show how the trading possibilities lines will change in the graph. Explain.

12. State at least one economic benefit to increased international trade.

13. How can supply and demand analysis be used to explain the equilibrium price and quantity of exports and imports for aluminum when there is trade between two nations (e.g., the United States and Canada)?

14. Define the four basic types of trade barriers.

15. Which is more effective in blocking imports, a tariff or a quota?

16. Who gains and who loses from a protective tariff? Explain.

17. What are the similarities and differences in the economic effects of tariffs and quotas?

18. “Unless a tariff is prohibitive, it does not inhibit competition as much as a quota.” Evaluate.

19. Do protectionist policies benefit producers, consumers, workers, or the government? Explain.

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20. The next three questions refer to the information in the following table.

Quantity demanded Quantity supplied            domestically             Price           domestically          

700 $6 1,100800 5 1,000900 4 900

1,000 3 8001,100 2 7001,200 1 600

(a) What would price and quantity be if the market were closed to international trade? What would the domestic and foreign quantity supplied be if it were open to international trade and the world price was $2?(b) If the world price was $2 and a tariff of $1 were placed on the product, what would be the total revenues going to domestic producers, foreign producers (after-tax), and the government? Explain.(c) Given a world price of $2, what would be the difference in the total revenue received by foreign producers with a $1 per unit tariff compared with a quota of 200 units?

21. The next three questions refer to the information in the following table.

Quantity demanded Quantity supplieddomestically (in 1,000s) Price domestically (in 1,000s)

60 $10 8070 8 7080 6 6090 4 50

(a) What would price and quantity be if the market were closed to international trade? What would the domestic and foreign quantity supplied be if it were open to international trade and the world price was $6?(b) If the world price was $4 and a tariff of $2 were placed on the product, what would be the total revenues going to domestic producers, foreign producers (after-tax), and the government? Explain.(c) Given a world price of $4, what would be the difference in the total revenue received by foreign producers with a $2 per unit tariff compared with a quota of 20,000 units?

22. The next three questions refer to the below graph, where Sd and Dd are the domestic supply and demand for a product. The world price of the product is $6.

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(a) How much total revenue would go to domestic producers if the market were closed to international trade compared to a market open to international trade? Explain.(b) If the economy is open to trade, but a $2 per unit tariff were applied, what would be the total revenue going to domestic producers, foreign producers (after-tax revenue), and to the government? Explain.(c) What would be the difference in revenue with a tariff of $2 per unit versus a quota of 80 units?

23. The next three questions refer to the below graph, where Sd and Dd are the domestic supply and demand for a product. The world price of the product is $12.

(a) How much total revenue would go to domestic producers if the market were closed to international trade compared to a market open to international trade? Explain.(b) If the economy is open to trade, but a $3 per unit tariff were applied, what would be the total revenue going to domestic producers, foreign producers (after-tax revenue), and to the government? Explain.(c) What would be the difference in revenue with a tariff of $3 per unit versus a quota of 20 units?

24. What are the net costs of tariffs and quotas on consumption and income distribution?

25. Explain and evaluate the validity of the military self-sufficiency argument for trade protection.

26. Explain four problems with the argument that trade protection is needed to protect American jobs.

27. Evaluate the argument: “Restricting imports from other nations will save U.S. jobs.”

28. Why might trade barriers be a highly ineffective technique for increasing domestic employment?

New 29. (Consider This) Why is a trade war like shooting yourself in the foot?

30. What are the limitations to the diversification for stability argument for trade protection?

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31. Evaluate the validity of the argument that a new industry in a nation needs protection from foreign competition if it is to prosper.

32. What is the problem with protecting industries in the United States from the dumping of foreign products on the domestic market?

33. Evaluate the statement: “Tariffs and quotas are needed to protect American products from dumping.”

34. How can the United States compete successfully with relatively low-wage nations such as India and China?

35. Evaluate this argument for a trade barrier: “The U.S. needs protection from cheap foreign labor.”

36. What does the historical evidence indicate about the value of free trade compared with trade protection? Cite evidence to support your case.

New 37. What five trade liberations is the World Trade Organization seeking to get adopted?

New 38. (Last Word) Evaluate the controversies surrounding the policies of the World Trade Organization from the perspective of trade liberalization.

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B. Answers to Short-Answer, Essays, and Problems

1. Describe the quantity of exports for the United States. How do exports compare with other nations?

About 12% of the GDP of the United States is accounted for by exports of goods and services. The percentage of exports is much higher (30 to 56%) in other industrially advanced nations (e.g., Germany, Netherlands). [text: E p. 690; MA p. 356; MI p. 446]

2. What are the major imports and exports of the United States?

The principal exports of the United States are computers, semiconductors, chemicals, consumer durables, and generating equipment, while its major imports are automobiles, petroleum, computers, and clothing. [text: E p. 691; MA p. 357; MI p. 447]

3. Who are the major players in international trade?

The major participants in international trade are the United States, Japan, and the nations of western Europe. Newer participants include Hong Kong, Singapore, South Korea, Taiwan, and China. The collapse of the former Soviet Union changed trade patterns for Russia and the nations of eastern Europe. Mainland China has also increased its trade. [text: E p. 691; MA p. 357; MI p. 447]

4. Cite three important reasons why nations trade.

First, specialization and trade among nations is advantageous because the world’s resources are not evenly distributed. To obtain resources or products that a nation does not have but that are desired by society requires trade with other nations. Second, the efficient production of different commodities necessitates different methods and combinations of resources. These different methods and combinations can be obtained through trade. Third, products vary in quality and in other ways. People prefer this variety, which often can only be obtained through imports. [text: E pp. 691-692; MA pp. 357-358; MI pp. 447-448]

5. “The international flow of goods helps compensate for the international immobility of resources.” Analyze and explain.

If resources were as mobile as goods, they would flow across borders until cost conditions were equalized throughout the world and there would be no need for specialization and trade. However, it is clear that this is impossible. Even human resources are somewhat immobile and natural resources are not equally endowed in each nation. Therefore, cost conditions differ from nation to nation, and some nations can produce some things relatively more cheaply than others. This leads to specialization and exchange according to the principle of comparative advantage. It is the goods that are bought and sold across borders rather than the resources, and this enables countries to be compensated for the differences in the cost of production. [text: E pp. 691-692; MA pp. 357-358; MI pp. 447-448]

New 6. Suppose that by devoting all of its resources to the production of A, the nation of Econia can produce 50 A. By devoting all of its resources to the production of B, Econia can produce 25 B. The comparable figures for the nation of Optima are 5 A and 5 B. According to the principle of comparative advantage, which nation will specialize in which product? What are the limits to the terms of trade?

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In Econia, the cost of producing 1 B is 2 A (25 B = 50 A) given the stated cost conditions. In Optima, the cost of producing 1 B is only 1 A. Thus, in terms of opportunity costs of the amount of A that must be given up to get each B, Optima can produce units of B more cheaply. Therefore, Optima should product Bs and Econia should produce units of A. Optima should trade away some of its B to Econia for some of the units of A produced in Econia.

The limits to the terms of trade are set by the cost ratio in each country. In other words, it is to Econia’s advantage to trade away units of A for as many units of B as it can get above the lower limit of 0.5 B, which is what each A costs in Econia. However, Optima will not be willing to trade more than one B for each A since any more than that could be gotten more cheaply by producing them at home. Therefore the limits to the terms of trade will be between 0.5 B and 1 B for each A. And Optima will be able to get between 1 A and 2 A for each B. [text: E pp. 733-734; MA pp. 377-378; MI pp. 475-476]

New 7. Suppose that by devoting all of its resources to the production of rice (R), Japan can produce 40 units. By devoting all of its resources to corn (C), it can produce 20 units. Comparable figures for Mexico are 15 units of rice (R) and 15 units of corn (C). Explain why each nation will specialize in which product. What are the limits to the terms of trade?

In Japan, the cost of producing 1 C is 2 R (20 C = 40 R) given the stated cost conditions. In Mexico, the cost of producing 1 C is only 1 R. Thus, in terms of opportunity costs or the amount of R that must be given up to get each C, Mexico can produce units of C more cheaply. Therefore, Mexico should produce Cs and Japan should produce units of R, and Mexico should trade away some of its C to Japan for some of the units of R produced in Japan.

The limits to the terms of trade are set by the cost ratio in each country. In other words, it is to Japan’s advantage to trade away units of R for as many units of C as it can get above the lower limit of 0.5 C, which is what each R costs in Japan. However, Mexico will not be willing to trade more than one C for each R since any more than that could be gotten more cheaply by producing them at home. Therefore the limits to the terms of trade will be between 0.5 C and 1 C for each R. And Mexico will be able to get between 1 R and 2 R for each C. [text: E pp. 733-734; MA pp. 377-378; MI pp. 475-476]

8. Answer the next three questions on the basis of the following production possibilities data for Francia and Galacia. All data are in tons.

Francia production possibilities:A B C D E  

Soup 60 45 30 15 0Nuts 0 15 30 45 60

Galacia production possibilities:A B C D E  

Soup 20 15 10 5 0Nuts 0 15 30 45 60

(a) If trade occurs between Francia and Galacia, which nation should export what product? Why?(b) What are the limits of the terms of trade between Francia and Galacia?(c) Assume that prior to specialization and trade, Francia and Galacia chose production possibility “C.” Now each specializes according to comparative advantage. What will be the resulting gains from trade? Explain your answer.

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(a) Francia should export soup and Galacia should export nuts. Francia is the low cost producer of soup. The opportunity cost of 1 unit of soup is 1 unit of nuts. For Galacia the opportunity cost of 1 unit of soup is 3 units of nuts.

Galacia is the low cost producer of nuts. The opportunity cost for Galacia to produce nuts is 1/3 unit of soup. The opportunity cost of nuts for Francia is 1 unit of nuts for 1 unit of soup.(b) From 1 unit of soup for 1 unit of nuts up to 1 unit of soup for 3 units of nuts.(c) Before specialization, Francia produced 30 units and Galacia 10 units of soup for a total of 40 units. After specialization and trade, 60 units of soup are produced by Francia for a gain of 20 units of output.

Before specialization, Francia produced 30 units and Galacia 30 units of nuts. After specialization and trade, Galacia will produce 60 units. Output did not change with this product. [text: E pp. 692-693; MA pp. 358-359; MI pp. 448-449]

9. Answer the next three questions on the basis of the following production possibilities data for Narnia and Somosa. All data are in 1,000s.

Narnia production possibilities:A B C D E  

Computer chips 80 60 40 20 0Fuel injectors 0 20 40 60 80

Somosa production possibilities:A B C D E  

Computer chips 40 30 20 10 0Fuel injectors 0 20 40 60 80

(a) If trade occurs between Narnia and Somosa, which nation should export what product? Why?(b) What are the limits of the terms of trade between Narnia and Somosa?(c) Assume that prior to specialization and trade, Narnia and Somosa chose production possibility “C.” Now each specializes according to comparative advantage. What will be the resulting gains from trade? Explain your answer.

(a) Narnia should export computer chips and Somosa should export fuel injectors. Narnia is the low-cost producer of computer chips. The opportunity cost of 1 unit of computer chips is 1 unit of fuel injectors. For Somosa the opportunity cost of 1 unit of computer chips is 2 units of fuel injectors.

Somosa is the low-cost producer of fuel injectors. The opportunity cost for Somosa to produce fuel injectors is 1/2 unit of computer chips. The opportunity cost of fuel injectors for Narnia is 1 unit of fuel injectors for 1 unit of computer chips.(b) From 1 unit of computer chips for 1 unit of fuel injectors up to 1 unit of computer chips for 2 units of fuel injectors.(c) Before specialization, Narnia produced 40 units of computer chips and Somosa 20 units for a total of 60 units. After specialization and trade, 80 units of computer chips are produced by Narnia for a gain of 20 units of output.

Before specialization, Narnia produced 40 units of fuel injectors and Somosa 40. After specialization and trade, Somosa will produce 80 units. Output did not change with this product. [text: E pp. 693-696; MA pp. 359-362; MI pp. 449-452]

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10. Given the data in the graph below, which nation should specialize in steel production and which nation in wheat production? Why?

The opportunity cost for 1 unit of wheat is 1 unit of steel in nation Y. The opportunity cost of 1 unit of wheat is 1/2 unit of steel in nation X. Nation X is the lower cost producer of wheat.

Nation Y should specialize in the production of steel where it has the comparative cost advantage. For nation Y, 1 steel = 1 wheat. For nation X 1 steel = 2 wheat. [text: E pp. 692-693; MA pp. 358-359; MI pp. 448-449]

11. Use the extreme points from a production possibilities schedule below to draw two straight line production possibilities curves for two nations, A and B using the below graphs. Assume constant costs.

Nation Food Clothing A 4 4B 2 8

(a) What is the cost ratio for the two products?(b) If each nation specializes according to comparative advantage, who should produce and trade each product? Why?(c) What will be the range for the terms of trade? If the terms are set at 1 food = 2 clothing, show how the trading possibilities lines will change in the graph. Explain.

(a) The cost of 1 unit of food for nation A is 1 unit of clothing but the cost of food for nation B is 4 units of clothing. The cost of 1 unit of clothing for nation A is 1 unit of food. The cost of 1 unit of clothing for nation B is 1/4 unit of food.(b) Nation A should trade food for clothing with nation B. Nation A is the low cost producer of clothing and nation B is the low cost producer of food.(c) The terms of trade will be set between 1 food = 1 clothing (nation A’s cost condition) and 1 food = 4 clothing (nation B’s cost condition). If the terms are set at 1 food = 2 clothing, then nations A and B can shift their trading possibilities lines outward as shown in the graph. The end points for nation A’s graph will now be 4 food and 8 clothing. The end points for nation B’s graph will be 4 food and 8 clothing. [text: E pp. 693-695; MA pp. 359-361; MI pp. 449-451]

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12. State at least one economic benefit to increased international trade.

Benefits include increased specialization and efficiency, increased competition that also should increase efficiency, provision of jobs in exporting industries, improved quality, and lower prices for consumers where imports compete with domestic products. [text: E pp. 696-697; MA pp. 362-363; MI pp. 452-453]

13. How can supply and demand analysis be used to explain the equilibrium price and quantity of exports and imports for aluminum when there is trade between two nations (e.g., the United States and Canada)?

For the United States, there will be domestic supply and demand and export supply and import demand for aluminum. The price and quantity of aluminum are determined by the intersection of the domestic demand and supply curves in a world without trade. In a world with trade, the export supply curve for the United States shows the amount of aluminum that American producers will export at each world price above the domestic equilibrium price. American exports will increase when the world price rises relative to the domestic price. The import demand curve for the United States shows the amount of aluminum that Americans will import at each world price below the domestic equilibrium price. American imports will increase when world prices fall relative to the domestic price.

For Canada, there will be domestic supply and demand and export supply and import demand for aluminum. The description of these supply and demand curves is similar for those of the United States. The price and quantity of aluminum are determined by the intersection of the domestic demand and supply curves in a world without trade. In a world with trade, the export supply curve for Canada shows the amount of aluminum that the Canadian producers will export at each world price above the domestic equilibrium price. Canadian exports will increase when the world price rises relative to the domestic price. The import demand curve for Canada shows the amount of aluminum that Canadians will import at each world price below the domestic equilibrium price. Canadian imports will increase when world prices fall relative to the domestic price.

The equilibrium world price and equilibrium world levels of exports and imports of aluminum can be determined with further supply and demand analysis. The export supply curves of the United States and Canada can be plotted on one graph. The import demand curves of both nations can be plotted on the same graph. In this two-nation model, equilibrium will be achieved when the United States’ import demand curve for aluminum intersects the Canadian export supply curve. [text: E pp. 697-700; MA pp. 363-366; MI pp. 453-456]

14. Define the four basic types of trade barriers.

First, tariffs are excise taxes on imports. They may be used to collect revenue or government for they may be protective tariffs that are supposed to protect domestic producers from foreign competition. Second, import quotas specify the maximum amounts of imports allowed into a nation over a period of time. Third, nontariff barriers refer to licensing requirements, unreasonable standards, or bureaucratic red tape in customs procedures. Fourth, there can be voluntary export restrictions, which are agreements by foreign firms to “voluntarily” limit their exports to another nation. [text: E pp. 700-701; MA pp. 366-367; MI pp. 456-457]

15. Which is more effective in blocking imports, a tariff or a quota?

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Generally, an import quota, especially if it is set low, is more effective in blocking the entry imports into a nation. The reason is that once the import quota has been met, no more goods can be imported into the nation. With a tariff, it is still possible to import goods into a nation, so long as people are willing to pay the tariff on the imported good. Of course the precise answer depends on how low the quota is and how high the tariff is on the product. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]

16. Who gains and who loses from a protective tariff? Explain.

A tariff increases the price of the imported product. First, consumers are hurt. Some consumers will not be able to purchase the product at the higher price and the consumers who do purchase the good will pay the higher price. Second, a tariff helps domestic producers because they receive more revenue than they would without the tariff. Third, workers in the tariff-protected industry may benefit because it may protect jobs and maintain higher wages than would be the case without the tariff. Fourth, business and workers in industries that import or service the import product are hurt. Fifth, foreign producers of the imported product receive less revenue than would be the case with free trade. Sixth, the federal government gains from a tariff because it receives the amount of the tariff times the number of the products that are imported. Overall, the nation loses because the gains for the industry protected by a tariff and workers in that industry are significantly offset by the losses to consumers and economic inefficiency that comes from an industry that cannot compete on world markets. [text: E pp. 700-701; MA pp. 366-367; MI pp. 456-457]

17. What are the similarities and differences in the economic effects of tariffs and quotas?

Tariffs and quotas have essentially the same economic effects. They both cause a decline in consumption because of the higher price that results. They both increase domestic production. They both reduce the quantity of imports. They also both have the same indirect effects of promoting the expansion of inefficient industries that do not have a comparative advantage. The major difference between a tariff and a quota is that a tariff raises revenue for the government while a quota transfers revenue to foreign producers. [text: E pp. 701-702; MA pp. 367-368; MI pp. 457-458]

18. “Unless a tariff is prohibitive, it does not inhibit competition as much as a quota.” Evaluate.

A tariff raises the price of an import, but it does not limit the quantity imported. It is also possible that the price of the import will not rise by the full extent of the tariff imposed. The foreign manufacturer can absorb part or all of the tariff amount, or may be motivated to find lower-cost production methods to reduce the price. Clearly, when this happens the competition remains. Even where the price of the product is raised by the entire amount of the tariff, competition remains and domestic producers are limited in their own pricing decisions by the foreign competition.

A quota, however, limits the amount of the imported product to a specific amount. This may encourage the foreign producer to raise prices to cover the loss in revenue that resulted from the limited quantity. It will also cause a leftward shift in the total supply (domestic plus foreign) curve to consumers, allowing domestic producers to also charge a higher price. The end result of a quota is certain higher prices and lower quantities, and no resulting tariff revenue for the Federal government. The end result of a tariff is uncertain with regard to price, the quantity purchased may not decline, and the government receives some tariff revenues. [text: E pp. 701-702; MA pp. 367-368; MI pp. 457-458]

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19. Do protectionist policies benefit producers, consumers, workers, or the government? Explain.

Protectionism in the form of tariffs or quotas reduces the total supply (domestic plus foreign) of the good. As a consequence, the price will rise. This change has a number of profound effects on all groups. Some consumers will not be able to purchase the product at the higher price. Those consumers that still purchase the good will pay a higher price. So consumers are hurt by protectionist legislation. Domestic producers will receive more revenue and workers in those industries may benefit from the improved revenue for business because it may mean fewer layoffs or higher wages. Thus, domestic producers and workers in those industries benefit, which explains why their organizations often lobby hard for the protectionist legislation. Businesses and workers in industries that import or service foreign products are hurt by tariffs and quotas. Foreign producers receive less revenue than would be the case with free trade. The government will benefit from a tariff, but will receive no revenue from a quota. Overall, the gains for protected industries and workers come at the expense of the whole economy. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]

20. The next three questions refer to the information in the following table.

Quantity demanded Quantity supplied            domestically             Price           domestically          

700 $6 1,100800 5 1,000900 4 900

1,000 3 8001,100 2 7001,200 1 600

(a) What would price and quantity be if the market were closed to international trade? What would the domestic and foreign quantity supplied be if it were open to international trade and the world price was $2?(b) If the world price was $2 and a tariff of $1 were placed on the product, what would be the total revenues going to domestic producers, foreign producers (after-tax), and the government? Explain.(c) Given a world price of $2, what would be the difference in the total revenue received by foreign producers with a $1 per unit tariff compared with a quota of 200 units?

(a) The price would be $4 and 900 units would be produced in a closed economy. In an open economy with a $2 world price, the market price would be $2 and 1,100 units would be demanded. There would be 1,100 units supplied. (700 domestic and 400 foreign.)(b) Domestic producers would receive $2,400 ($3 x 800). Foreign producers would receive $400 [($3 x 200) – ($1 x 200)]. The government would receive $200 ($1 x 200).(c) Foreign producers would receive $200 more in revenue with a quota than a tariff because there would be no payment to government. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]

21. The next three questions refer to the information in the following table.

Quantity demanded Quantity supplieddomestically (in 1,000s) Price domestically (in 1,000s)

60 $10 8070 8 7080 6 6090 4 50

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(a) What would price and quantity be if the market were closed to international trade? What would the domestic and foreign quantity supplied be if it were open to international trade and the world price was $6?(b) If the world price was $4 and a tariff of $2 were placed on the product, what would be the total revenues going to domestic producers, foreign producers (after-tax), and the government? Explain.(c) Given a world price of $4, what would be the difference in the total revenue received by foreign producers with a $2 per unit tariff compared with a quota of 20,000 units?

(a) The price would be $8 and 70,000 units would be produced in a closed economy. In an open economy with a $6 world price, the market price would be $6 and 80,000 units would be demanded. There would be 80,000 units supplied. (60,000 domestic and 20,000 foreign)(b) Domestic producers would receive $360,000 ($6 x 60,000). Foreign producers would receive $80,000 [($6 x 20,000) – ($2 x 20,000)]. The government would receive $40,000 ($2 x 20,000).(c) Foreign producers would receive $40,000 more in revenue with a quota than a tariff because there would be no payment to government. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]

22. The next three questions refer to the below graph, where Sd and Dd are the domestic supply and demand for a product. The world price of the product is $6.

(a) How much total revenue would go to domestic producers if the market were closed to international trade compared to a market open to international trade? Explain.(b) If the economy is open to trade, but a $2 per unit tariff were applied, what would be the total revenue going to domestic producers, foreign producers (after-tax revenue), and to the government? Explain.(c) What would be the difference in revenue with a tariff of $2 per unit versus a quota of 80 units?

(a) In a closed market, $1,200 in total revenue would go to domestic producers ($12 x 100). In a market open to world trade, only $240 in total revenue would go to domestic producers ($6 x 40).(b) The $2 per unit tariff would make the market price $8 ($6 world price + $2 tariff). At $8, there were 140 units sold, so total revenue is $1,120. Of this amount domestic producers would get $480 ($8 x 60), foreign producers would get $480 [($8 x 80) – ($2 x 80)], and the government would collect $160 ($2 x 80).(c) A tariff produces $160 in revenue for government, but with a quota that revenue goes to foreign producers who now earn $640 instead of $480. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]

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23. The next three questions refer to the below graph, where Sd and Dd are the domestic supply and demand for a product. The world price of the product is $12.

(a) How much total revenue would go to domestic producers if the market were closed to international trade compared to a market open to international trade? Explain.(b) If the economy is open to trade, but a $3 per unit tariff were applied, what would be the total revenue going to domestic producers, foreign producers (after-tax revenue), and to the government? Explain.(c) What would be the difference in revenue with a tariff of $3 per unit versus a quota of 20 units?

(a) In a closed market, $900 in total revenue would go to domestic producers ($18 x 50). In a market open to world trade, only $360 in total revenue would go to domestic producers ($12 x 30).(b) The $3 per unit tariff would make the market price $15 ($12 world price + $3 tariff). At $15, there were 60 units sold, so total revenue is $900. Of this amount domestic producers would get $600 ($15 x 40), foreign producers would get $240 [($15 x 20) – ($3 x 20)], and the government would collect $60 ($3 x 20).(c) A tariff produces $60 in revenue for government, but with a quota that revenue goes to foreign producers who now earn $300 instead of $240. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]

24. What are the net costs of tariffs and quotas on consumption and income distribution?

The cost to society is that protectionism raises product prices by raising the imported price of the product. Higher priced imports cause some consumers to switch to higher priced domestic products, thus increasing the price of domestic products. Any benefits for government, businesses, and workers from tariffs and quotas are outweighed by the costs to American society. Efforts to obtain trade protection are also a form of rent seeking that causes a misallocation of resources for society. There is also an effect on the distribution of incomes because import restrictions are more costly for low-income families than high-income families. [text: E p. 702; MA p. 368; MI p. 458]

25. Explain and evaluate the validity of the military self-sufficiency argument for trade protection.

The basic argument is that domestic industries that are vital to national defense should be protected against foreign competition because otherwise the industries will not be able to compete or be economically viable. Nations do not want to be dependent on other nations for national defense. The argument is generally one of the need for military self-sufficiency as opposed to economic efficiency.

The problem with the argument is that nearly every industry is critical in one way or another to national defense. It is difficult to select “defense” industries to protect.

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Every industry can claim that it is directly or indirectly vital to national defense. Also, imposing tariffs imposes costs only on those consumers who purchase an industry’s products because the prices of those products will be above competitive levels. Thus, only the people who buy the protected products bear the burden of protecting the domestic industries considered vital to national defense. It would be more economical and more equitable for government to subsidize those industries that are deemed vital to national defense. [text: E p. 703; MA p. 369; MI p. 459]

26. Explain four problems with the argument that trade protection is needed to protect American jobs.

There are several problems with using trade protection to “save American jobs.” First, imports may eliminate some jobs, but they create others in those industries that import products. Second, there is a fallacy of composition. The imports of one nation are the exports of another nation. Using trade policy to protect domestic jobs in the United States will weaken the trading partners of the United States. The reason for this weakness is that the trading partners will export less and thus have less income with which to buy imports from the United States. Third, there is the possibility of retaliation from trading partners that make all nations worse off. This problem occurred in the 1930s when high tariffs were imposed by the U.S. Smoot-Hawley Tariff Act of 1930. Fourth, there are long-run feedback effects from an excess of exports over imports. This policy leads to less income abroad that nations have to buy our goods. Workers in those export industries in the United States are thus hurt and resources are reallocated to protected industries at a great cost to the nation. [text: E p. 703; MA p. 369; MI p. 459]

27. Evaluate the argument: “Restricting imports from other nations will save U.S. jobs.”

The argument is a flawed one for several reasons. First, imports may eliminate some U.S. jobs, but they create others in those sectors that import products. Import restrictions change the composition of employment, but they have little effect on the total amount of employment. Second, there is a fallacy of composition with the argument. Restricting imports may help the U.S., but they make other nations that trade with the U.S. poorer and thus the actions will eventually hurt U.S. exports. Third, other nations can retaliate by imposing restrictions on imports from the U.S., thus causing a trade war that hurts all nations. Fourth, in the long run a nation must import to export. Domestic dollars spent on imports become income for foreign nations that they in turn can spend on U.S. exports. [text: E p. 704; MA p. 370; MI p. 460]

28. Why might trade barriers be a highly ineffective technique for increasing domestic employment?

First, trade barriers lower living standards by making consumer goods more expensive. This means that consumers have less to spend on everything including domestic goods. Second, trade barriers invite retaliation that can hurt our exports and those employed in export industries. Even without retaliation, in the long run exports are hurt as foreigners have fewer dollars to spend on American goods since their imports to the U.S. have declined. Third, barriers limit the advantages to be gained by specializing in production where costs are relatively lower and prevent attaining the lower costs which specialization allows.

If the world has a more efficient allocation of resources and a higher level of material well-being as a result of free trade, it follows that in the long run barriers would reduce output and incomes throughout the world. A nation can have full employment with or without free trade, but without free trade workers will be employed less productively and their incomes will be lower. [text: E p. 704; MA p. 370; MI p. 460]

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New 29. (Consider This) Why is a trade war like shooting yourself in the foot?

A trade war between Nation X and Nation Y is destructive to the economies of both nations. If Nation X boycotts or slaps protective tariffs on the imports from Nation Y, then Nation Y will not be able to export as many goods and services. The economy of Nation Y will suffer and there will be less income. As a consequence, Nation Y will not be able to import as many goods and services from Nation X, so the economy of Nation X will suffer. So trade wars hurt both nations by reducing imports and exports of each nation. A trade war has no winners and only losers. It is like shooting yourself in the foot. [text: E p. 704; MA p. 370; MI p. 460]

30. What are the limitations to the diversification for stability argument for trade protection?

There may be a legitimate reason for a nation to protect certain industries until they become viable. The best case would be in nations that have one basic resource or export and are seeking to diversify their economies. For example, the Saudi Arabian economy is based on oil, but it may seek to limit imports if it is to develop other industries so that it is not dependent on the price of one commodity. The argument may also be valid for other less developed nations with only one or two major industries.

Nevertheless, there are problems with this line of reasoning. First, it does not apply to the economy of the United States or other industrially advanced nations with diversified economies. Second, the economic costs of diversification may be great even for nations dependent on basically one industry. These nations may not have a comparative advantage in other industries and will never become economically efficient in these industries. [text: E pp. 704-705; MA pp. 370-371; MI pp. 460-461]

31. Evaluate the validity of the argument that a new industry in a nation needs protection from foreign competition if it is to prosper.

The infant-industry argument is based on the idea that new industries need time to become mature and sufficiently strong and large to compete with more mature industries from other nations. These new industries allegedly may need “temporary” protection to gain productive efficiency—to become low-cost producers of a product. A modern variant of this argument is a strategic trade policy that seeks protection for domestic industries involved in advanced technology.

The problems with this argument are several. First, it is difficult to determine which industries are the best to protect. Second, protection may persist after maturity is achieved in the industry. Third, direct subsidies for new industries are better than tariffs. Tariffs penalize consumers of those products, firms that import those products, and workers in those import industries. They also misallocate resources. A better method of support would be subsidies to the emerging industries because they make the amount of the support explicit. [text: E pp. 704-705; MA pp. 370-371; MI pp. 460-461]

32. What is the problem with protecting industries in the United States from the dumping of foreign products on the domestic market?

Trade protection is sought in this case because it is thought that another nation is dumping (selling) its excess production at below cost. When this product is sold in the United States, it undercuts the domestic market. Economists see two plausible reasons for this type of economic behavior. First, foreign firms may in fact be trying to drive out U.S. competition. Second, dumping can be a form of price discrimination.

The problem is that it is difficult to determine if a nation is dumping its product on another nation’s market at below the cost of production. This practice is prohibited

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under U.S. trade law, but there are few valid cases of it each year. The existence of dumping does not justify the imposition of strong trade protection. The evidence for dumping needs to be evaluated on a case-by-case basis. [text: E p. 705; MA p. 371; MI p. 461]

33. Evaluate the statement: “Tariffs and quotas are needed to protect American products from dumping.”

Dumping is a form of price discrimination that might be practiced by foreign producers who sell their product at a high price in the domestic market and at a lower price in the export market. Also, a foreign company with large financial resources may sell a product below cost for an extended period to gain market share in another nation and to drive out domestic competitors in that nation. Dumping can be beneficial for consumers in that export market because they pay a lower price for the product.

The dumping charge has been used to justify tariffs or quotas, but there is little need for such permanent and across-the-board measures to address this problem. Dumping is prohibited by trade law in the United States. If it is found to be practiced by a foreign firm, then it requires investigation and damages can be assessed. Dumping, however, is relatively rare and it is difficult to determine whether a company is selling below cost or is just a more efficient producer. [text: E pp. 705-706; MA pp. 371-372; MI pp. 461-462]

34. How can the United States compete successfully with relatively low-wage nations such as India and China?

If those low wages are a reflection of a low level of productivity, the per-unit cost of Indian and Chinese products will not be any greater than the unit costs in the U.S. It is not the level of wages alone that determines the cost of a product, but rather the wage relative to the level of output per hour. Wages in the U.S. are high, but so is the level of productivity, often keeping unit costs as low as or lower than those in low-wage nations. [text: E pp. 705-706; MA pp. 371-372; MI pp. 461-462]

35. Evaluate this argument for a trade barrier: “The U.S. needs protection from cheap foreign labor.”

The argument is flawed on several grounds. First, U.S. consumers benefit from being able to purchase a product at a lower price than they would have if they had to buy a domestically produced product. Second, U.S. workers earn a high wage because they are productive. Gains from trade are based on comparative advantage, not absolute advantage. Although the U.S. labor can produce many goods and services, according to comparative advantage, it should produce those products for which the domestic opportunity cost is the least. If it does so it will earn more income and the nation will have a higher standard of living. Whether foreign labor is cheap is not important. What is important for the nation’s standard of living is to use labor resources most productively and efficiently. [text: E p. 706; MA p. 372; MI p. 462]

36. What does the historical evidence indicate about the value of free trade compared with trade protection? Cite evidence to support your case.

The historical evidence shows that free trade has positive effects and trade protection hurts economies. Consider this evidence: (a) The U.S. Constitution prevents trade protection across states making the U.S. a large, free-market area. This condition has contributed to U.S. economic growth. (b) The European Common Market created a free-trade zone in Europe that has continued under the European Union. (c) The world economy has grown after World War II because of the move to tariff reduction that

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began in the mid-1930s. (d) The Smoot-Hawley tariff of 1930 lead to retaliatory tariffs that worsened the economic conditions of the Great Depression; and (e) Nations with high protectionist policies have slower growth than those without. [text: E p. 706; MA p. 372; MI p. 462]

New 37. What five trade liberations is the World Trade Organization seeking to get adopted?

After the 1994 Uruguay “round” of trade agreements, the World Trade Organization was formed by 120 nations to oversee the agreements and get them implemented by 2005. The major provisions of the agreements included: (1) widespread reduction in tariffs worldwide; (2) new rules to promote the growing trade in services; (3) plans to cut subsidies in agriculture; (4) the inclusion of protection for intellectual property rights—patents, trademarks, copyrights—in trade rules; and (5) phased reduction in quotas on textiles and apparel. [text: E pp. 707-708; MA pp. 373-374; MI pp. 463-464]

New 38. (Last Word) Evaluate the controversies surrounding the policies of the World Trade Organization from the perspective of trade liberalization.

The purpose of the World Trade Organization is to liberalize trade and thus encourage more economic growth worldwide. It is estimated that if the trade liberalization it seeks to get adopted by 2005 are put into place, the world’s GDP for 2005 will be $6 billion greater. The critics of the WTO are often drawn from labor unions in developed nations and environmental groups. These groups seek special changes as a condition of getting the new trading rules adopted. The labor unions seek to have more stringent labor standards applied to other nations, which would adversely affect less developed nations. The environmentalists want tough environmental rules applied to all nations, which would also adversely affect developing nations. The problem is that the purpose of the WTO is to advance trade liberalization, and not worldwide labor standards or environmental laws. The critics need to find other organizations to advance those issues. It is not part of the job of the WTO. [text: E pp. 707-708; MA pp. 373-374; MI pp. 463-464]

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