MECO 6303 – Business MECO 6303 – Business EconomicsEconomics

Lesson 8Lesson 8

International Trade:International Trade:

Trade and welfare, tariffs and quotasTrade and welfare, tariffs and quotas

Exhibit # 2Lesson 11

International TradeInternational Trade

Who gains and who loses from free Who gains and who loses from free trade among countries?trade among countries?

What are the arguments that people What are the arguments that people use to advocate trade restrictions?use to advocate trade restrictions?

Countries do not trade individuals do!Countries do not trade individuals do! The determinants of international The determinants of international

trade are the same as the determinants trade are the same as the determinants of any trade – specialization and trade of any trade – specialization and trade bring mutual gains.bring mutual gains.

Exhibit # 3Lesson 11

Comparative Advantage and differences Comparative Advantage and differences in tastesin tastes

Why do people trade? Diversity among people and in nature.Why do people trade? Diversity among people and in nature. Different TastesDifferent Tastes Different Abilities and Resources – comparative advantageDifferent Abilities and Resources – comparative advantage

Comparative Advantage (CA) plays a big role in determining Comparative Advantage (CA) plays a big role in determining the pattern of trade – internal and internationalthe pattern of trade – internal and international

CA refers to CA refers to relativerelative, rather than , rather than absoluteabsolute, differences in , differences in costs (and prices)costs (and prices)

Activity/ValueActivity/Value TypingTyping

Words per Words per minuteminute

Legal PracticeLegal Practice

$ per hour$ per hour

SecretarySecretary 7575 00

AttorneyAttorney 9090 300300

Example: The Secretary and the Attorney – it pays Example: The Secretary and the Attorney – it pays to specialize.to specialize.The same principle applies in international trade.The same principle applies in international trade.

Exhibit # 4Lesson 11

Viva la differance!Viva la differance!

It Pays to be differentIt Pays to be different Any difference is an opportunity for mutual gainAny difference is an opportunity for mutual gain The more different you are, the more gains to be hadThe more different you are, the more gains to be had International Trade: small countries gain the mostInternational Trade: small countries gain the most

Adam SmithAdam Smith 1818thth century economist - 1776 century economist - 1776 Described the way trade benefit all partiesDescribed the way trade benefit all parties Increased productivity through specializationIncreased productivity through specialization

David RicardoDavid Ricardo 1919thth century economist – c. 1830 century economist – c. 1830 First to recognize importance of comparative advantageFirst to recognize importance of comparative advantage Analyzed consequences for mutually beneficial tradeAnalyzed consequences for mutually beneficial trade

Exhibit # 5Lesson 11

Equilibrium Without Equilibrium Without TradeTrade

Assume:Assume: A country is isolated from rest of the world A country is isolated from rest of the world

and produces steel.and produces steel. The market for steel consists of the buyers The market for steel consists of the buyers

and sellers in the country. and sellers in the country. No one in the country is allowed to import No one in the country is allowed to import

or export steel.or export steel.

Exhibit # 6Lesson 11

Equilibrium without International Equilibrium without International TradeTrade

Consumersurplus

Producersurplus

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Equilibriumprice

Equilibriumquantity

•Domestic Domestic price adjusts to price adjusts to balance balance demand and demand and supply.supply.•The sum of The sum of consumer and consumer and producer producer surplus surplus measures the measures the total benefits total benefits that buyers and that buyers and sellers receive.sellers receive.

Exhibit # 7Lesson 11

The World Price and Comparative The World Price and Comparative AdvantageAdvantage

If the country decides to engage in international If the country decides to engage in international trade, will it be an importer or exporter of steel?trade, will it be an importer or exporter of steel?

The effects of free trade can be shown by The effects of free trade can be shown by comparing the domestic price of a good without comparing the domestic price of a good without trade and the trade and the world priceworld price of the good. The of the good. The world world priceprice refers to the price that prevails in the world refers to the price that prevails in the world market for that good.market for that good.

If a country has a comparative advantage, then the If a country has a comparative advantage, then the domestic price will be below the world price, and domestic price will be below the world price, and the country will be an the country will be an exporterexporter of the good. of the good.

If the country does not have a comparative If the country does not have a comparative advantage, then the domestic price will be higher advantage, then the domestic price will be higher than the world price, and the country will be an than the world price, and the country will be an importerimporter of the good. of the good.

Exhibit # 8Lesson 11

How Free Trade Affects Welfare in an Exporting CountryHow Free Trade Affects Welfare in an Exporting Country

D

C

B

A

Price of steel

0 Quantityof Steel

DomesticsupplyPrice

aftertrade World

price

Domesticdemand

Exports

Pricebefore

trade

Producer surplusbefore trade

Consumer surplusbefore trade

ExportsDomestic Supply

Domestic Demand

PW

PD

Exhibit # 9Lesson 11

The Winners and Losers from The Winners and Losers from Export TradeExport Trade

The analysis of an exporting country The analysis of an exporting country yields two conclusions:yields two conclusions: Domestic producers of the good are Domestic producers of the good are

better off, and domestic consumers of better off, and domestic consumers of the good are worse off.the good are worse off.

Trade raises the economic well-being of Trade raises the economic well-being of the nation as a whole – gains outweigh the nation as a whole – gains outweigh losseslosses

These are partial and short term results.These are partial and short term results.

Exhibit # 10Lesson 11

The Gains and Losses of an Importing The Gains and Losses of an Importing

CountryCountry

International Trade in an Importing International Trade in an Importing CountryCountry If the world price of steel is lower than If the world price of steel is lower than

the domestic price, the country will be an the domestic price, the country will be an importer of steel when trade is permitted.importer of steel when trade is permitted.

Domestic consumers will want to buy Domestic consumers will want to buy steel at the lower world price.steel at the lower world price.

Domestic producers of steel will have to Domestic producers of steel will have to lower their output because the domestic lower their output because the domestic price moves to the world price.price moves to the world price.

Exhibit # 11Lesson 11

International Trade in an Importing CountryInternational Trade in an Importing Country

Priceof Steel

0 Quantity

Priceafter

trade

Worldprice

of Steel

Domesticsupply

Domesticdemand

Imports

Domesticquantitysupplied

Domesticquantity

demanded

Pricebefore

trade PD

PW

Imports

Consumer surplusbefore trade

C

B D

A

Producer surplusbefore trade

Domestic Supply

Domestic Demand

Exhibit # 12Lesson 11

The Winners and Losers from The Winners and Losers from Import Trade Import Trade

The analysis of an importing country The analysis of an importing country yields two conclusions:yields two conclusions: Domestic producers of the good are worse Domestic producers of the good are worse

off, and domestic consumers of the good are off, and domestic consumers of the good are better off.better off.

Trade raises the economic well-being of the Trade raises the economic well-being of the nation as a whole in the sense that the gains nation as a whole in the sense that the gains of consumers exceed the losses of of consumers exceed the losses of producers.producers.

These are partial and short term results.These are partial and short term results.

Exhibit # 13Lesson 11

The Effects of a TariffThe Effects of a Tariff

A A tarifftariff is a tax on goods produced is a tax on goods produced abroad and sold domestically.abroad and sold domestically.

Tariffs raise the price of imported Tariffs raise the price of imported goods above the world price by the goods above the world price by the amount of the tariff.amount of the tariff.

Exhibit # 14Lesson 11

Imposing a tariffImposing a tariffPrice

of Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Pricewithout tariff

WorldpriceImports

with tariff

Q2S Q2

DQ1S Q1

D

tariff

Imports with tariff

Producer surplusbefore tariff

Consumer surplusbefore tariff

A

FED

G

C

B

Tariff revenueDeadweight

Loss

Domestic Supply

Domestic Demand

Exhibit # 15Lesson 11

The Effects of a TariffThe Effects of a Tariff

A tariff reduces the quantity of A tariff reduces the quantity of imports and moves the domestic imports and moves the domestic market closer to its equilibrium market closer to its equilibrium without trade.without trade.

With a tariff, total surplus in the With a tariff, total surplus in the market decreases by an amount market decreases by an amount referred to as a deadweight loss.referred to as a deadweight loss.

Exhibit # 16Lesson 11

The Effects of an Import QuotaThe Effects of an Import Quota

An An import quotaimport quota is a limit on the is a limit on the quantity of a good that can be quantity of a good that can be produced abroad and sold produced abroad and sold domestically.domestically.

Exhibit # 17Lesson 11

Priceof Steel

0 Quantityof Steel

Domesticsupply

+Import supply

Domesticdemand

Price withquota

Importswithout quota

Equilibriumwith quota

Equilibriumwithout trade

Quota

Importswith quota

QD

Worldprice

Worldprice

Pricewithout

quota=

QS QDQS

A

E'C

G

D E" F

B

Imposing an Import QuotaImposing an Import Quota

Domestic Supply

Exhibit # 18Lesson 11

The Effects of an Import QuotaThe Effects of an Import Quota

Because the quota raises the domestic price above Because the quota raises the domestic price above the world price, domestic buyers of the good are the world price, domestic buyers of the good are worse off, and domestic sellers of the good are worse off, and domestic sellers of the good are better off.better off.

License holders are better off because they make a License holders are better off because they make a profit from buying at the world price and selling at profit from buying at the world price and selling at the higher domestic price.the higher domestic price.

With a quota, total surplus in the market decreases With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss.by an amount referred to as a deadweight loss.

The quota can potentially cause an even larger The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.is employed to allocate the import licenses.

Exhibit # 19Lesson 11

The Lessons for Trade PolicyThe Lessons for Trade Policy

If government sells import licenses for If government sells import licenses for full value, revenue equals that of an full value, revenue equals that of an equivalent tariff and the results of equivalent tariff and the results of tariffs and quotas are identical.tariffs and quotas are identical.

Both tariffs and import quotas . . .Both tariffs and import quotas . . . raise domestic prices.raise domestic prices. reduce the welfare of domestic consumers.reduce the welfare of domestic consumers. increase the welfare of domestic increase the welfare of domestic

producers.producers. cause deadweight losses.cause deadweight losses.

Exhibit # 20Lesson 11

The Arguments for Restricting The Arguments for Restricting TradeTrade

Jobs Jobs National Security National Security Infant IndustryInfant Industry Unfair CompetitionUnfair Competition Protection-as-a-Bargaining ChipProtection-as-a-Bargaining Chip

Exhibit # 21Lesson 11

Other Benefits of International TradeOther Benefits of International Trade

Increased variety of goodsIncreased variety of goods Lower costs through economies of Lower costs through economies of

scalescale Increased competition enhanced flow Increased competition enhanced flow

of ideas, of ideas,