Download LECTURE #8: MICROECONOMICS CHAPTER 9

LECTURE #8: MICROECONOMICS
CHAPTER 9
Determinants of Trade
Arguments for Restricting Trade
Determinants of Trade
Objective: Increase the standard of living
Key Factor: Comparative advantage
Local Price vs. World Price
If LP < WP, we export, else we import.
Eventually LP = WP
Winners and Losers
If LP < WP, local consumers will suffer welfare
losses.
If LP > WP, local producers will suffer welfare
losses.
Regardless, trade raises the total economic wellbeing
International Trade Exporting Country
Impact on LP and LQ when WP > LP
Price of
textiles
Domestic
Supply
Exports
A
Price
after
trade
B
Price
before
trade
World
Price
D
C
Domestic
Demand
Exports
0
Domestic
Quantity
Demanded
Consumer Surplus
Producer Surplus
Total Surplus
Domestic
Quantity
Supplied
Once trade is allowed, the domestic price rises to
equal the world price. The supply curve shows
the quantity of textiles produced domestically,
and the demand curve shows the quantity
consumed domestically. Exports from Isoland
equal the difference between the domestic
quantity supplied and the domestic quantity
demanded at the world price. Sellers are better
off (producer surplus rises from C to B + C + D),
and buyers are worse off (consumer surplus falls
from A + B to A). Total surplus rises by an
amount equal to area D, indicating that trade
raises the economic well-being of the country as
a whole.
Quantity of textiles
Before
trade
After
trade
Change
A+B
C
A+B+C
A
B+C+D
A+B+C+D
-B
+(B+D)
+D
The area D shows
the increase in total
surplus and
represents the
gains from trade
3
International Trade Importing Country
Impact on LP and LQ when WP < LP
Price of
textiles
Domestic
Supply
A
Price
before
trade
B
Price
after
trade
D
World
Price
C
Domestic
Demand
Imports
0
Domestic
Quantity
Supplied
Consumer Surplus
Producer Surplus
Total Surplus
Once trade is allowed, the domestic price falls to
equal the world price. The supply curve shows
the amount produced domestically, and the
demand curve shows the amount consumed
domestically. Imports equal the difference
between the domestic quantity demanded and
the domestic quantity supplied at the world price.
Buyers are better off (consumer surplus rises
from A to A + B + D), and sellers are worse off
(producer surplus falls from B + C to C). Total
surplus rises by an amount equal to area D,
indicating that trade raises the economic wellbeing of the country as a whole
Domestic Quantity of textiles
Quantity
Demanded
Before
trade
After
trade
Change
A
B+C
A+B+C
A+B+D
C
A+B+C+D
+(B+D)
-B
+D
The area D shows
the increase in total
surplus and
represents the
gains from trade
4
Determinants of Trade
Impact of Tariffs
Tariffs effectively raise price of imports
above the world price (WP)
Purpose of tariff: protect local producers if
LP > WP
Imposing tariff reduces imports and helps
local market move to equilibrium
Tariffs impose deadweight loses in the same
manner as taxes
Determinants of Trade
The Effects of a Tariff
Price – rises by the amount of the tariff
Domestic quantity demanded – decrease
Domestic quantity supplied – increase
Reduces the quantity of imports
Moves the domestic market closer to its
equilibrium without trade
Domestic sellers – better off
Domestic buyers – worse off
6
Determinants of Trade
The effects of a tariff
Before the tariff
Consumer surplus = Producer surplus
Government tax revenue = 0
With a tariff
Consumer surplus - smaller
Producer surplus - bigger
Government tax revenue
Total surplus - smaller
7
The Effects of a Tariff
Price of textiles
Domestic
Supply
A
Tariff
B
Price with tariff
C
Price without
tariff
G
0
E
D
F
World Price
Imports
with tariff
Q1S
Q2S
A tariff reduces the quantity of
imports and moves a market closer
to the equilibrium that would exist
without trade. Total surplus falls by
an amount equal to area D + F.
These two triangles represent the
deadweight loss from the tariff.
Domestic
Demand
Q2D Q1D
Quantity of textiles
Imports without tariff
Consumer Surplus
Producer Surplus
Government Revenue
Total Surplus
Before tariff
After
tariff
Change
A+B+C+D+E+F
G
None
A+B+C+D+E+F+G
A+B
C+G
E
A+B+C+E+G
-(C+D+E+F)
+C
+E
-(D+F)
The area D + F
shows the fall in
total surplus and
represents the
deadweight loss of
the tariff
8
Determinants of Trade
Benefits of international trade
Increased variety of goods
Lower costs through economies of scale
Increased competition
Enhanced flow of ideas
9
Arguments For Restricting Trade
Potential for loss of jobs
Potential for harm to national security
The need to protect young/new industries
Possibility of unfair competition
(subsidies by foreign governments)
Protection as bargaining chip
Unilateral vs. Bilateral vs. Multilateral
trade agreements
Trade Agreements &
Organizations
NAFTA (North American Free Trade
Assoc.) US, Canada, Mexico
GATT (General Agreement on Trade &
Tariffs (multi-lateral)
WTO (World Trade Organization)
administer trade agreements, settle
disputes
Homework
Questions for Review: 1, 2, 4
Problems and Applications: 1, 2