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INTERNATIONAL TRADE
• Principles of Microeconomic Theory,
ECO 284
• John Eastwood
• CBA 247
• 523-7353
• [email protected]
• Harmonized tariff schedule (HTS) of the
United States:
http://www.usitc.gov/taffairs.htm#HTS
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Static Gains from Trade
• Specialization along the lines of
comparative advantage increases world
output.
• Trade raises consumption beyond autarky.
• Greater variety of goods and services
• Imported resources
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Dynamic Gains from Trade
• Trade speeds economic growth
– When more K goods are imported than
produced in autarky, PPF shifts out.
– Trade diffuses new technology.
– Trade raises real income. Savings rise.
– Free trade an effective anti-trust policy
– Trade expands the market; firms achieve
economies of scale.
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Commercial Policy
• Governments action that may change the
composition and volume of trade flows
– Tariffs
– Quotas
– Other non-tariff barriers
– Subsidies
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Tariffs
• Taxes on
– Imports
– Exports
• Components
– Ad valorem-- % of value
– Specific -- flat fee per unit
– Compound -- both
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Positive Effects of Tariffs
• Revenue Effect -- provide tax revenue
• Protective Effect -- shelter domestic
producers from foreign competition
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Tariffs as tools of int’l policy
• Most Favored Nation status, MFN
– granted as a reward, withheld as a punishment
• Generalized System of Preferences, GSP
– Most developed countries have GSP as means
of helping developing countries
• access to markets of developed countries
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Non-tariff Barriers
• Voluntary export restraints (VER)
• Tariff-rate quotas (TRQs),
• WTO members are replacing existing
quotas with TRQs
• Quotas (on apparel and textiles) are to be
phased out by 2005
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Welfare Cost Analysis
• Use Supply and Demand
– One import or export good
• Measure Changes in Consumer Surplus and
Producer Surplus
• Start with a small country
– Its trade is too small to affect terms of trade
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Consumers’ Surplus
• Consumers’ Surplus is the difference between
consumers’ maximum willingness-to-pay and the
amount they actually paid.
• The amount actually paid equals PQ.
• Graphically, Consumers’ Surplus (CS) is the area
under the demand curve above P.
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Producer Surplus
• Producer surplus is the price of a good
minus the opportunity cost of producing it.
– Graphically, Producers’ Surplus (PS) is the area
under the Price line and above Supply.
Price (dollars per pizza)
An Efficient Market for Pizza
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Consumer
surplus
S
20
15
10
5
0
Producer
surplus
5
D
10
15
20
Quantity (thousands of pizzas per day)
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Price ($ per bushel of
grapes)
Gains from free trade -- imports 14
Domestic Supply
of grapes
10
6
a
b
c
3
2
World price of grapes
Domestic demand for grapes
0
1
4
7
10
Quantity (millions bushels of grapes per year)
Welfare of a Move to Free Trade
A Small Country’s Imports
Change in Consumer Surplus
+a +b +c
Change in Producer Surplus
-a
Net Welfare Change
+b +c
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Price ($ per jar of
honey)
Gains from free trade -- exports 16
Domestic Supply
of honey
10
World price of honey
9
g
e
f
6
2
Domestic demand for honey
0
1
4
7
10
Quantity (millions jars of honey per year)
Welfare of a Move to Free Trade
A Small Country’s Exports
Change in Consumer Surplus
-e
Change in Producer Surplus
+e +f +g
Net Welfare Change
-f
+g
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grapes)
Price ($ per bushel of
Welfare Cost of a Tariff
on Imports -- Small Country
19
Domestic Supply
of grapes
10
World price + tariff $2/bu
5
a
c
b
3
2
d
World price of grapes
Domestic demand for grapes
0
1
3
5
7
10
Quantity (millions bushels of grapes per year)
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Welfare Cost of a Tariff
on Imports -- Small Country
Change in Consumer Surplus
-a -b -c -d
Change in Producer Surplus
+a
Change in Gov't Revenue
Net Welfare Change
(a.k.a. Deadweight loss)
+c
-b
Loss = 0.5 x tariff x change in imports
-d
Price per pound
Exhibit 6: Effect of a Quota21
0.10
0
In panel a, D is the U.S. demand curve
and S is the supply curve of U.S.
producers. The world price of sugar is
(a)
$0.10 (the price that would prevail in
the U.S. market) and a total of 70
S
million pounds would be demanded 
U.S. producers would supply 20 million
pounds and importers 50 million
pounds.
Now suppose that U.S. officials impose a
quota of 30 million pounds per month
As long as the U.S. price is at or above
the world price of $0.10 per pound,
D
foreigners supply 30 million pounds 
the total supply of sugar to the U.S.
20
70 Sugar market is found by adding 30 million
(millions of pounds per month) pounds of imported sugar to the amount
supplied by U.S. producers
Exhibit 6: Effect of a Quota22
Thus, the supply curve that sums
domestic production and imports
is horizontal at the world price of
$0.10 per pound and remains so
until the quantity supplied
reaches 50 million pounds.
(a)
S +30
Price per pound
S
$0.15
e
0.10
D
0
20
50
70 Sugar
(millions of pounds per month)
For prices above $0.10, the new
supply curve, S + 30, adds
horizontally the 30 million pound
quota to S, the supply curve of U.S.
producers as shown by the dark red
line. The U.S. price is found where
this new supply curve intersects the
domestic demand curve  point e
 an effective quota, by limiting
imports, raises the price of
domestic sugar above the world
price and reduces quantity below
the free trade level.
Price per pound
Exhibit 6: Effect of a Quota23
The right panel
shows the
distribution and
efficiency aspects
of the quota. As
a result of the $0.15
quota, U.S.
consumer
0.10
surplus declines
by the blue and
pink shaded
areas.
(a)
(b)
S
S +30
S
e
S +30
$0.15
a
0.10
c
b
d
D
0
20
50
70 Sugar
(millions of pounds per month)
D
60 70 Sugar
0
20 30
(millions of pounds per month)
Area a becomes producer surplus  no loss of U.S. welfare. The blue rectangle,
c, shows the increased profit to those permitted by the quota to sell Americans 30
million pounds at $0.15 per pound. To the extent that foreign exporters rather
than U.S. importers reap this profit, area c reflects a net loss in domestic welfare.
The pink triangle,
b, shows by how
much the
marginal cost of
producing
another 10
million pounds in
the U.S. exceeds
the world price
 a welfare loss
to the U.S.
economy because
sugar could have
been purchased
abroad for $0.10
and the resources
employed to
increase sugar
production could
have been used
more efficiently
to produce other
goods.
Price per pound
Exhibit 6: Effect of a Quota24
$0.15
(a)
(b)
S
S +30
S
e
S +30
$0.15
a
0.10
0.10
D
0
20
50
70 Sugar
(millions of pounds per month)
c
b
d
D
60 70 Sugar
0
20 30
(millions of pounds per month)
The pink triangle, d, is also a welfare loss, because it reflects a reduction in
consumer surplus with no offsetting gain to anyone  the two pink shaded areas
measure the minimum welfare cost imposed on the domestic economy by an
effective quota. To the extent that the profit from quota rights, area c, accrues to
foreigners, this increases the U.S. welfare loss resulting from the quota
Price ($1000 per car)
Welfare effects of a domestic
production subsidy
Domestic supply
of small cars
20
25
Domestic supply
with subsidy
Subsidy = $T
12
10
6
4
0
World price + new equivalent tariff
a
b
World price of small cars
Domestic demand
2 4 6 8 10
14
18
Quantity (thousands of cars per year)
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Welfare effects of a domestic
production subsidy
Change in Consumer Surplus
Change in Producer Surplus
+a
Change in Gov't Revenue
-a -b
Net Welfare Change
(a.k.a. Deadweight loss)
-b
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Welfare Cost of Tariffs as a
Percentage of GDP
• Tariffs & NTBs often exclude new goods
– e.g., computers, just-in-time inventory
processes
• GDP loss almost twice the tariff rate
– Ten percent tariff lowers GDP by 19.8%
– Twenty-five percent tariff lowers GDP by 47%
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