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MACROECONOMICS:
EXPLORE & APPLY
by Ayers and Collinge
Chapter 16
“Policy Toward Trade”
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
1
Learning Objectives
1. Use the concept of a world price to explain
imports, exports, and the gains from trade.
2. Discuss the GATT and other trade
arrangements among countries.
3. Distinguish among the various barriers to
trade that countries might impose.
4. Assess the arguments for and against
protectionist policies.
5. Examine whether an oil import fee can
promote energy security.
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16.1
ASSESSING THE GAINS FROM TRADE
• International trade occurs in response to
differences between the domestic price of goods
and the world price of goods.
• When a country opens it doors to international
trade, the price in the domestic market will
come to equal that of the world price.
• If this adjustment means that the domestic
price rises to meet the world price, the country
will exports the good.
• If the world price causes the domestic price to
drop, then the country import the good.
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Gains From Imports
o Free trade implies that a country’s producers
must accept world market prices, which would
entail a higher price for some goods and a
lower price for others.
o Imports allow domestic consumers to pay a
lower price for goods.
o They also gain by consuming more of the good.
o The gains to consumers from imports more
than offsets the losses to producers, which
reveals that the country as a whole is better off
allowing imports.
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Imports – Effects on Price and
Quantity
Imports result from
$ a world price that
is below the country’s price prior to
trade. The lower price causes
consumption to rise and production to
fall , with the difference being the
amount imported.
•
Price if
no trade
World
Price
•
Domestic
Supply
Equilibrium if
no trade
•
Imports
Quantity
Supplied
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Quantity
Demanded
Domestic
Demand
Quantity
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Gains and Losses from Imports
$
Loss to
producers
Domestic
Supply
A
•
Price if
no trade
B
World
Price D
•
C
Gain to
consumers
•
Imports
Quantity
Supplied
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The consumer surplus
rises from area A to
area A + B + C. The
producer surplus drops
from areas B+ D down
to area D.
Quantity
Demanded
Domestic
Demand
Quantity
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Gains from Exports
In the case of exports, producers win and
consumers lose.
Producers win because they sell more at a higher
price.
Consumers lose because they must pay a higher
world price, and thus consume less.
On balance, the country as a whole gains from
international trade by allowing exports.
Both imports and exports lead to more gains
than losses.
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Imports
–
Effects
on
Price
and
Gains from Exports
Quantity
$
Domestic
Supply
•
World
Price
Exports result from a
world pricePrice
that isifabove
a country’s
prior to
noprice
trade
trade. The higher price
causes a country’s
production to rise and
consumption to fall by the
amount being exported.
Quantity
Demanded
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•
•
Equilibrium if
no trade
Exports
Quantity
Supplied
Domestic
Demand
Quantity
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Gains from Exports
$
Loss to
producers
World A
Price
•
B
Price if
no trade
Domestic
Supply
•
C
•
D
Gain to
producers
Exports
Quantity
Demanded
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Quantity
Supplied
The country’s consumer
surplus drops from areas
A+B to only area A. The
Producer surplus rises
From area D to areas B+
C+D.
Domestic
Demand
Quantity
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16.2
TRADE AGREEMENTS
Countries must choose how wide to open their
doors to international trade.
An open economy is one that erects no barriers
to international trade and investment.
A closed economy shuts itself off from foreign
investment and trade.
Countries design their trade policies with an
eye towards their own self interest.
Most countries have learned from the Great
Depression of the 1930’s that their interest are
best served with free trade.
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Trade Agreements
Most countries have signed the General Agreement
on Tariffs and Trade (GATT), which aims to avoid
trade wars and promote free trade.
The GATT has been administered by the World
Trade Organization, an arm of the GATT created to
settle trade disputes among GATT members and
monitor compliance with provisions of the GATT.
The Smoot-Hawley Act of 1930 was passed by the
U.S. Congress and imposed high tariffs an
imported goods to save jobs.
The surprising result of the act was that unemployment
was even higher after its imposition.
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Trade Agreements
The GATT negotiations required significant
tariff reductions.
They have also placed restrictions on quotas,
which limit the quantity of imported products a
country allows.
Other non-tariff barriers are also restricted,
which is a catch all phrase for the variety of
actions a country can take to restrict trade.
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Trade Agreements
The Uruguay Round of GATT was ratified
by the U.S. and other nations in 1994.
It established the WTO, and dealt with the
following thorny issues.
Tariffs
Agricultural subsidies
Services
Intellectual property rights
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Regional Trade Blocs
The European Union is an example of a regional
trading bloc, which is an agreement that lowers
trade barriers among member countries.
The U.S., Canada, and Mexico have also formed a trading
bloc by signing the North American Free Trade
Agreement (NAFTA).
Trading blocs allows countries to specialize
according to comparative advantage, and have a
trade creation effect.
Trading blocs also have a trade diversion effect, as
product flow between trade bloc countries, that may
have been traded with non trade bloc countries.
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16.3
TRADE POLICY OPTIONS
A tariff is a tax on an imported product.
Demand for imported products is sometimes
referred to as residual demand, since it
represents what is left over after consumers
have bought from domestic suppliers.
Tariffs increase the cost of selling imported
products.
This in turn increases the cost of imported
goods in the domestic market, and reduces
the quantity demanded.
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Tariffs
• By raising the barriers to entry of foreign
products, tariffs can be viewed as a for of price
support for domestic producers.
• The higher price of imports causes the demand
curve to shift to the right for domestic products
that are close substitutes.
• Tariffs are said to be transparent, meaning that
their effects on prices are clear for all to see.
• Tariff rates are kept low by GATT.
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Tariffs
$
Price
rises
Tariff raises
price and
lowers quantity
Supply for
abroad
•
•
Tariff
A tariff on imports
helps U.S. producers
who can sell at higher
prices, but hurts consumer
who must pay the higher
price.
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Supply plus
tariff
U.S. demand
for imports
Quantity
Imports
decline
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Effective U.S. Tariff Rates 1992-2000
SECTOR
1992
1993
1994
1995
1996
1997
1998
1999
2000
Food and live animals
1.99
2.07
1.81
1.42
1.41
1.19
1.34
1.36
1.18
Beverages and tobacco
3.33
3.66
2.71
1.76
1.90
2.04
1.10
1.21
0.95
Crude materials, inedible, except fuels
Mineral fuels, lubricants and related
materials
Animal and vegetable oils, fats and
waxes
0.36
0.36
0.32
0.24
0.21
0.20
0.20
0.16
0.16
0.47
0.48
0.50
0.42
0.35
0.32
0.42
0.35
0.20
1.05
1.19
0.91
0.64
0.53
0.70
0.84
0.76
1.05
Chemicals and related products, n.e.s.
Manufactured goods classified chiefly
by material
Machinery and transport equipment
Miscellaneous manufactured articles
Commodities and transactions not
classified elsewhere in the SITC
3.64
3.95
3.81
2.23
1.93
1.73
1.56
1.24
1.03
3.47
2.00
8.41
3.31
2.02
7.81
3.16
1.86
7.70
2.71
1.53
6.86
2.56
1.35
6.45
2.42
1.14
6.18
2.14
0.94
5.88
1.91
0.85
5.54
1.76
0.73
5.49
0.02
0.03
0.03
0.05
0.07
0.06
0.10
0.09
0.03
All sectors
3.15
3.07
2.91
2.43
2.20
2.07
1.95
1.76
1.59
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Quotas
o Import quotas are an alternative to imports
tariffs and can accomplish the same goals.
o An import quota restricts the quantity of
imports directly, and thus cuts off supply from
abroad at the quota quantity.
o The truncated supply from abroad under a
quota leads to an increase in prices at home.
o GATT limits the extent to which quotas can be
imposed by countries.
o It does allow quotas for agricultural products to
avoid disruption to countries’ domestic economies.
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Quotas
Quotas reduce the supply of
imports and increase the
Import supply with quota
domestic price. The
$ quota
truncates supply at the
A quota can
allowable import quantity,
have the same
causing import supply to be
effect as a tariff
vertical at that point.
Price
rises
•
Unrestricted
import supply
•
U.S. demand
for imports
Quantity allowed
by quota
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Quantity
Imports
decline
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Voluntary Export Restraints
 As an alternative to tariffs and import quotas,
the U.S. and some other countries have chosen to
negotiate voluntary export restraints (VER’s).
 With VER’s, individual exporting countries
agree to limit the quantities they export.
 The multi-fiber agreement currently scheduled
for elimination in 2004, sets country by country
quotas on clothing exports to the U.S. and some
other countries.
 The U.S. offers to forego quotas in favor of VER’s to
maintain good relations with other governments.
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An Assortment of Non-tariff
Barriers to Trade.
Most non-tariff barriers to trade do not
restrict imports explicitly.
Their effects are less obvious than quotas.
Paperwork and red tape can inhibit
trade.
Inspections, which include sampling of
imported products can inhibit trade.
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16.4
THE FREE-TRADE DEBATE
The objections to free trade commonly have
limited applicability or are based on
questionable logic.
The national defense argument is valid but
overused.
Translating national defense into policy requires
judgments and debate.
Trade sanctions restrict trade with nations that
have policies that our government opposes.
Do trade sanctions punish the wrong people?
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The Free-Trade Debate
 Some U.S. products are more expensive than
foreign products because of the added cost of
complying with environmental, health , and safety
standards.
 The U.S. imposes a tariff to achieve a level playing field.
 Higher level of pollution for some countries is a
normal good, since more environmental quality is
demanded as the income in a country rises.
 Poorer countries have a higher opportunity cost of
environmental quality, and might specialize in
industries with a higher pollution content.
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The Free-Trade Debate
 Dumping is defined as the selling of a good for
less than it cost to produce.
 Dumping may occur for many reasons.
 A company may have overestimated demand for its
product, and so for itself stuck with too much
product and have a clearance sale.
 It may be covering its operating expenses, but not
the cost of capital or other fixed cost.
 In these cases, even though the company loses
money, it would lose more if it did not sell.
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The Free-Trade Debate
 Dumping occurs within a country, as well as in
international trade.
 Dumping is illegal across countries according to
the GATT.
 The U.S. presumes dumping whenever
whenever a foreign company charges less in the
U.S. than it does at home, irrespective of its
cost.
 Strategic dumping is dumping that aims to
drive the competition out of business so that the
firms doing the dumping can monopolize
output and drive prices up in the future.
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The Free-Trade Debate
• Developing countries often try to nurture new
industries they hope will one day become the source
of export earnings.
• These infant industries are thought to need
protection in the rough world marketplace.
• The infant industry argument unconvincing if
markets function efficiently.
• In the free marketplace, venture capitalist and
other private investors will often support firms
through many years of losses.
• Governments around the world support infant
industries that never grow up.
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The Free-Trade Debate
• By requiring government subsidies to stay
afloat, and by charging prices above those in
the rest of the world, such infant industries
have proven to be expensive for governments
and consumers alike.
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28.4 EXPLORE & APPLY
Energy Security
o The U.S. economy consumes tremendous
amounts of oil.
o About 777 million gallons per day as of January
2002.
o The U.S. is vulnerable to political instability in
the middle east and in other oil-exporting
countries.
o The U.S. is a source of income to Middle
Eastern countries with interest hostile to those
of the U.S.
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Energy Security
• The external cost of imports are not
reflected in the price paid by importers.
• To internalize them, the U.S. could
impose an oil import fee.
– An oil import fee is a common name for a
tariff when applied to oil.
• Since oil is a non-renewable resource,
opponents of oil import fees say such a
fee would “drain” America first.
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Energy Security
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Terms Along the Way
 free trade
 open economy
 General Agreement
on Tariffs and Trade
(GATT)
 World Trade
Organization (WTO)
 tariff
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




Smoot-Hawley Act
quotas
non-tariff barriers
trading bloc
North American Free
Trade Agreement
 trade creation effect
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Terms Along the Way (continued)
 trade diversion effect
 voluntary export
restraints
 Dumping
 strategic dumping
 infant industries
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Test Yourself
1. When a country imports a good, it will
a. gain more in consumer surplus than it loses in
producer surplus.
b. gain more in producer surplus than it loses in
consumer surplus.
c. find that its gain of consumer surplus is
exactly offset by its loss of producer surplus.
d. Find that its gain of producer surplus is
exactly offset by its loss of consumer surplus.
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Test Yourself
2.
a.
b.
c.
The GATT was created in response to
the Great Depression of the 1930’s.
the cold war of the 1950’s and 1960’s.
Reagonomics, the economic policies of
President Regan in the 1980’s.
d. President Clinton’s desire to forge closer
relationships with China in the 1990’s.
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Test Yourself
3. The World Trade Organization
a. is a trading bloc that consist of the United
States and the countries of Japan and China.
b. has many member countries, but not the
United States.
c. competes with GATT for members, with
about half the world’s countries belonging to
the GATT and the other half belonging to the
World Trade Organization.
d. is a component of the GATT that administers
the GATT Agreement.
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Test Yourself
4. An import tariff shifts the _________
curve of imports upward and
__________ the price of the good paid
by the consumer.
a. supply;increases
b. supply;decreases
c. demand;decreases
d. demand;increases
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Test Yourself
5. Which is an example of a voluntary
export restraint?
a. A tariff.
b. A quota.
c. The multi-fiber agreement.
d. The GATT.
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Test Yourself
6. Which of the following is NOT offered
as a reason to restrict trade?
a. Infant industries.
b. Dumping.
c. Level playing field.
d. Comparative advantage.
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The End!
Next Chapter 17
“Economic
Development"
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