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9
Application: International Trade
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 2
International Trade: issues• What determines whether a country
imports or exports a good?
• Who gains and who loses from free trade among countries?
• What are the arguments that people use to advocate trade restrictions?
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Figure 1The Equilibrium without International Trade
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Equilibriumprice
Equilibriumquantity
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 5
The World Price and Comparative Advantage
• If the country decides to engage in international trade, will it be an importer or exporter of steel?
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 6
The World Price and Comparative Advantage
• The effects of free trade can be shown by comparing the domestic price of a good (in the absence of trade) and the world price of the good. – The world price is the price that prevails in the
world market for that good.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 7
The World Price and Comparative Advantage
• If a country has a comparative advantage in steel production, then its domestic price will be less than the world price
• In this case, the country will be an exporter of the good.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 8
The World Price and Comparative Advantage
• If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and
• this country will be an importer of the good.
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Figure 2 International Trade in an Exporting Country
Priceof Steel
0Quantityof Steel
Domesticsupply
Priceaftertrade World
price
DomesticdemandExports
Pricebeforetrade
Domesticquantity
demanded
Domesticquantitysupplied
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Figure 2 How Free Trade Affects Welfare in an Exporting Country
D
C
B
A
Priceof Steel
0 Quantityof Steel
DomesticsupplyPrice
aftertrade World
price
Domesticdemand
Exports
Pricebefore
trade
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 11
The Gains and Losses from trade for an Importing Country
• If the world price of steel is lower than the domestic price, the country will be an importer of steel when trade is permitted.
• Domestic buyers will want to buy steel at the lower world price.
• Domestic producers of steel will have to reduce their output because the domestic price will fall to the world price.
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Figure 3 International Trade in an Importing Country
Priceof Steel
0 Quantity
Priceafter
trade
Worldprice
of Steel
Domesticsupply
Domesticdemand
Imports
Domesticquantitysupplied
Domesticquantity
demanded
Pricebeforetrade
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Figure 3 How Free Trade Affects Welfare in an Importing Country
C
B D
A
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Priceafter trade
Worldprice
Imports
Pricebefore trade
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 14
The Gains and Losses from trade for an Importing Country
• Domestic producers of the imported good are worse off
• Domestic consumers of the imported good are better off.
• Trade raises the economic well-being of the nation as a whole– That is, the gains of consumers exceed the
losses of producers.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 15
The Winners And Losers From Trade
• Irrespective of whether a country exports a good or imports it, the gains of those who gain exceed the losses of those who lose.
• That is, the net change in total surplus is always positive.
• And yet, tariffs/taxes on imported goods are quite popular. Why?
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TARIFFS
CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 16
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 17
The Effects of a Tariff
• A tariff is a tax on goods produced abroad and sold domestically.
• Tariffs raise the price of imported goods above the world price by the amount of the tariff.– Domestic price = World price + Tariff
• This reduces trade and, therefore, the benefits of trade
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Figure 4 The Effects of a Tariff
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
WorldpriceImports
with tariff
QSQS QD QD
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Figure 4 The Effects of a Tariff
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
Worldprice
QS QD
Producer surplusbefore tariff
Consumer surplusbefore tariff
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Figure 4 The Effects of a Tariff
A
B
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
WorldpriceImports
with tariff
QSQS QD QD
Consumer surpluswith tariff
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Figure 4 The Effects of a Tariff
C
G
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
Worldprice
QS
Importswith tariff
QS QD QD
Producer surplusafter tariff
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Figure 4 The Effects of a Tariff
E
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Pricewithout tariff
Worldprice
QS
Importswith tariff
QS QD QD
Tariff Revenue
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Figure 4 The Effects of a Tariff
C
G
A
E
B
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Pricewithout tariff
WorldpriceImports
with tariff
QSQS QD QD
Deadweight Loss
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 24
The Effects of a Tariff
• A tariff reduces the quantity of imports and moves the domestic market closer to the no-trade equilibrium.
• Buyers of the imported good are worse off• Domestic sellers are better off• Total surplus decreases by an amount
referred to as a deadweight loss. – That is, the loss to the nation’s buyers of the
import-competing good exceed the gains to the nation’s sellers of that good
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 25
The Lessons for Trade Policy
• Tariffs– raise domestic prices.– reduce the welfare of domestic consumers.– increase the welfare of domestic producers.– cause deadweight losses.
• Free trade maximizes total surplus
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 26
The Lessons for Trade Policy
• Other benefits of international trade– Increased variety of goods– Lower costs through economies of scale– Increased competition– Enhanced flow of ideas
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27
The Arguments For Restricting Trade
• Jobs are shipped abroad• National Security is endangered• Infant Industries need to be shielded• Unfair Competition
– Cheap labor– Lax environmental standards
• Hard for domestic regulators to keep out defective or harmful imported goods
• Protection-as-a-Bargaining Chip• Increasing inequality
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 28
CASE STUDY: Trade Agreements and the World Trade Organization
• UnilateralUnilateral: when a country removes its trade restrictions on itsits own.
• MultilateralMultilateral: a country reduces its trade restrictions while other countries do the same.
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29
CASE STUDY: Trade Agreements and the World Trade Organization
• UnilateralUnilateral: – politically difficult to achieve– Negative terms-of-trade effect for a large
country
• MultilateralMultilateral:– politically easier to achieve because exporters
can be mobilized to oppose the import-competing industries that oppose free trade
– Less risk of negative terms-of-trade effect
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 30
CASE STUDY: Trade Agreements and the World Trade Organization
• NAFTA– The North American Free Trade Agreement
(NAFTA) is an example of a multilateral trade agreement.
– In 1993, NAFTA lowered the trade barriers among the united states, Mexico, and Canada.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 31
CASE STUDY: Trade Agreements and the World Trade Organization
• GATT– The General Agreement on Tariffs and Trade
(GATT) refers to a continuing series of negotiations among many of the world’s countries with a goal of promoting free trade.
– GATT has successfully reduced the average tariff among member countries from about 40 percent after WWII to about 5 percent today.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 32
Summary
• The effects of free trade can be determined by comparing the domestic price without trade to the world price.– A low domestic price indicates that the country
has a comparative advantage in producing the good and that the country will become an exporter.
– A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 33
Summary
• When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off.
• When a country allows trade and becomes an importer of a good, consumers of the good are better off, and producers are worse off.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 34
Summary
• A tariff—a tax on imports—moves a market closer to the equilibrium than would exist without trade, and therefore reduces the gains from trade.
• Import quotas will have effects similar to those of tariffs.
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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 35
Summary
• There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
• Economists, however, believe that free trade is usually the better policy.