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International trade
Today: Winners and losers of
various international trade policies
Previously, we talked about…
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How trade can benefit people
Comparative advantage being the core
of beneficial trade
An introduction of international trade
Today:
More on international trade
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Review of comparative advantage
Examining consumption possibilities
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Without trade
With trade
Supply and demand analysis of trade
Tariffs and Quotas
“Outsourcing”
Review of comparative
advantage
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Recall the principle of comparative
advantage
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“Everyone does best when each person (or
each country) concentrates on the
activities for which his or her opportunity
cost is lowest.” (F/B p. 39)
Today, we will apply this concept on a
countrywide scale
Comparative advantage: Same
numbers, different names
Productivity in
pizza production
Productivity in salad
production
United 20 pizzas cooked
States
per hour
10 salads made per
hour
Chile
4 salads made per
hour
16 pizzas cooked
per hour
Comparative advantage
U.S.
Chile
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Opportunity cost Opportunity cost of
of cooking a pizza
making a salad
½ salad
2 pizzas
¼ salad
4 pizzas
Recall: To find comparative advantage for
each person, find the lowest number in each
column
Recall increasing opportunity
cost
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Opportunity cost increases as
production increases within each
country
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Each country uses its best pizza maker to
make its first pizzas
Then, the next best pizza maker is used,
etc.
The same applies to salads
Production possibilities curve
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Recall from last
lecture that all of the
points along PGQ are
the efficient points of
the production
possibilities curve
Recall that this shape
occurs due to
increasing
opportunity costs as
more is produced
Production possibilities curve
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Without trade,
only points along
arc PGQ (or points
between this arc
and the origin)
can be consumed
We will see that
gains can be
made by trade
The world market
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In the world market, there is an
equilibrium price (based on world
supply and world demand)
Any one country that enters or exits the
market usually does not change the
market price much
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For ease of discussion, assume that entry
or exit by any one country does not
change the world price
Consumption possibilities
curve
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If we produce at
point G, we can
trade goods at the
given market price
Production at G
(with trade) 
Consumption
anywhere along
FGH
Which consumption possibility
curve is best?
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We could produce
at one of the red
dots before we
start trading
However, note
that there are
fewer
consumption sets
possible than
producing at G
Optimal production in an open
economy
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Since the red line is
suboptimal, we will
not utilize it
Similarly, any point
except G will produce
a similar result to the
red line
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Suboptimal
consumption
possibilities for any
production except G
Optimal production in an open
economy
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Solution
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Produce such that
the “line of trade
possibilities” is
tangent to the
production
possibilities curve
In this case, point
G is tangent to line
FGH
Supply and demand analysis
of trade
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As we just analyzed, we saw that total
surplus goes up when world trade is
possible
However, we will see that there are
winners and losers to trade
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Note that the winners’ gain is larger than
the losers’ loss
Market for cars, w/o trade
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Suppose that
without trade,
40,000 cars are
sold at a price of
$14,000
Market for cars, w/o trade
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Consumer
surplus is blue
shaded area
Producer surplus
is red shaded
area
Market for cars, with trade
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Notice that the
world price for
cars is $10,000
At this price,
notice that
20,000 cars will
be supplied and
60,000 cars will
be demanded in
this market
Market for cars, with trade
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What will happen?
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This is unlike the
case of rent control,
since the shortage is
picked up by the
world market
20,000 domestic
cars will be
purchased
40,000 foreign cars
will be purchased
Imports
Surplus with trade
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Consumer
surplus increases
substantially
Producer surplus
decreases, but
does not change
as much as
consumer
surplus does
Imports
Without imports (left)
With imports (right)
Imports
Net gain
Imports
A similar exercise can be done for
a country that is a net exporter
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When a country is a net exporter, the
world price is above what it would be if
trade was not possible
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Consumer surplus decreases when trade
occurs
Producer surplus increases when trade
occurs
Overall, total surplus increases
Tariffs, quotas, and bailouts
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Even when trade is not prohibited, countries use
other devices to control the amount of a particular
good imported
Tariff
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Quota
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Tax that must be paid for each unit of the good imported
A binding limit set on the amount of a good that can be
imported
Bailouts: An example with U.S. automakers
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Subsidized loans
See additional reading on class website
What happens when we
impose a tariff?
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In this case, the
tariff imposed is
$1000 per ton of
sugar imported
We will see that
some potential
economic surplus
is lost when the
tariff is imposed
What happens when we
impose a tariff?
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Total surplus
without tariffs
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Shaded area
What happens when we
impose a tariff?
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With a tariff, the price paid by
consumers is the world price plus the
amount of the tariff
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Think of a tariff just like a tax
This increases the quantity supplied
domestically and decreases the amount
imported
What happens when we
impose a tariff?
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Quantity supplied
domestically
increases
Imports decrease
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Before, 100 tons
minus 20 tons, or
80 tons
After, 80 tons
minus 40 tons, or
40 tons
Total surplus and tariff money
collected
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Consumer
surplus (CS)
Producer
surplus (PS)
Tariff revenue
generated
What is
missing?
Total surplus and tariff money
collected
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CS
PS
Tariffs
What is
missing?
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Two triangles
are lost with
the imposition
of tariffs
Total surplus and tariff money
collected
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The two triangles lost are potential
surplus that could be gained
Notice that relative to open global
trade, producer surplus is higher
Consumer surplus is lower with the
tariff (relative to open global trade)
Voluntary export restraints
(VERs)
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1970s
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Many American consumers bought fuel-efficient
Japanese cars
1980s
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VERs agreed to between US and Japan
U.S. auto makers benefited by decreased
competition
Japanese auto makers benefited by being able to
raise their prices
U.S. consumers lost by having to pay more for all
cars purchased
VERs
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VERs are a type of quota
What does economic theory tell us
about quotas?
Quotas
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Quotas are similar to
tariffs, except:
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Domestic supply plus
quota determines
supply available in a
country’s market
Equilibrium in this
example is price of
125, 80,000 TV’s
What else is different with
quotas?
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With quotas, no revenues are directly
generated
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Those with right to import and export gain
economic rents
The U.S. automaker bailout
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Bad decision making
CAFE standards
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What did fuel economy standards lead to?
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Minivans
SUVs
Bankruptcy for some U.S. automakers in
the near future?
“Outsourcing”
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“Outsourcing” has been a controversial
term in the media in recent years
There are definitely short-run costs of
outsourcing
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Displaced workers
Buildings and machinery that gets unused
“Outsourcing”
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Long-run benefits of outsourcing
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Each country can specialize what it has
comparative advantage in
Technological improvements lower the
costs of trade
Lower costs to consumers
How to make sure your job
does not get outsourced
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Make sure it requires a lot of face-toface contact
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Construction work
Automobile repair
Health care
Make sure that you have skills that
nobody else has
Final thoughts about
“outsourcing”
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Trade policy can be formed such that those
that are displaced are not any worse off
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Some of the gains from “making the pie bigger”
can be transferred to those that get displaced
Justification for re-training programs for displaced
workers
Overall, the standard of living of a country
improves with trade
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Example: Think how much bananas would cost if
we could not import them
Summary
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Trade improves overall surplus
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Some people win, while others lose
Trade barriers, such as protectionism,
quotas, and tariffs limit the gains from
trade
Outsourcing has short-run costs but
long-run benefits in a country’s
economy
Upcoming attractions
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For the next month, we will examine market
failures and some economic fields
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Market failures: Monopoly, oligopoly, monopolistic
competition, externalities, cost of information,
private provision of public goods
Fields
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Some potential topics: Labor, Income distribution,
Environment, Health/Safety, Public Good analysis
End of Unit 3
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Starting next week, Unit 4
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Monopoly, including profit maximization
and inefficiencies
Game theoretical tools needed to analyze
small groups of people or firms
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Applications, including Prisoner’s Dilemma
Study of externalities