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Chapter 8
International trade and
trade policy
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-1
Introduction
• Understanding the economic issues of international
trade
– The benefits of trade
– The costs of trade
– The economic impact of trade restrictions
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-2
Comparative advantage as a basis for
trade
• The principle of comparative advantage tells us that
we can all enjoy more goods and services when each
country produces according to its comparative
advantage, and then trades with other countries.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-3
Production and consumption possibilities
and the benefits of trade
• Closed economy
– An economy that does not trade with the rest of the world.
• Open economy
– An economy that trades with the rest of the world.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-4
The production possibilities curve for a
many-worker economy
• Example
– A two-goods economy (Brazil) -- computers and coffee.
– Two workers who work 50 weeks/year.
 Carlos
• Can produce 100 kg of coffee/week or 1 computer.
 Maria
• Can produce 100 kg of coffee/week or 2 computers.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-5
The production possibilities curve for a
many-worker economy (cont.)
• Example
– Slope of PPC (Maria)
Maria's OCcomputers 
-100 kg coffee/wk
  50 #s of coffee/computer
2 computers/wk
– Slope of PPC (Carlos)
Carlos' OCcomputers 
-100 kg coffee/wk
  100 #s of coffee/computer
1 computers/wk
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-6
Production possibilities curve for a manyworker economy
A
Coffee (kg/year)
C
Observations
• The OC of producing an
additional unit = the slope of
the line that touches the point
• OC will increase as output of
on good increases
D
B
Computers (number/year)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-7
Production and consumption possibilities
and the benefits of trade
• A country’s PPC shows the quantities of different
goods that its economy can produce.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-8
Consumption possibilities with and without
international trade
• Consumption possibilities
– The combinations of goods and services that a country’s
citizens might feasibly consume.
• In a closed economy
– Society’s production possibilities = consumption possibilities.
– If a country is self-sufficient, it is called autarky.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-9
Consumption possibilities with and without
international trade (cont.)
• In an open economy
– The society’s consumption possibilities are typically greater
than its production possibilities.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-10
Brazil’s consumption possibilities with trade
F
13 000
Coffee (kg/year)
10 000
5 000
Consumption possibilities with trade
Slope = - 80 kg coffee/computer
A
Production possibilities
Slope = - 50 kg coffee/computer
Production possibilities
Slope = - 100 kg coffee/computer
C
B
G
100
150 162.5
Computers (number/year)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-11
Consumption possibilities curve for a
many-worker economy
F
Consumption
possibilities
• Slope of FG = relative prices of coffee &
computers on the world market
• Maximum consumption by producing at C
(slope of PPC = FG) and trading for the
desired combination on FG
Coffee (kg/year)
A
C
Production
possibilities
B
G
Computers (number/year)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-12
Production and consumption possibilities
and the benefits of trade
• Thinking as an economist
– Does ‘cheap’ foreign labour pose a danger to high-wage
economies?
– Scenario




Australia and Fredonia produce clothing and wool.
Real wages in Fredonia are lower than in Australia.
Fredonia is half as productive as Australia in wool production.
Fredonia is one-tenth as productive in clothing production.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-13
Production and consumption possibilities
and the benefits of trade (cont.)
• Thinking as an economist
– Outcome
 Fredonia has a comparative advantage in wool.
 Australia has a comparative advantage in clothing.
 Australia will trade clothing for wool and increase its
consumption of both.
 Employment in the clothing industry in Australia increases and
employment in the wool industry will decrease.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-14
The market for computers in Brazil
Price of computers
Closed economy
equilibrium
Domestic
supply
E
p
World
price
Imports
Domestic
demand
qS
qD
q
Quantity of computers
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-15
A supply and demand perspective on
trade
• If the price of a good or service in a closed economy
is greater than the world price, and that economy
opens itself to trade, the economy will tend to
become a net importer of that good or service.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-16
The market for coffee in Brazil
Domestic
supply
Exports
Price of coffee
World
price
E
p
Closed economy
equilibrium
Domestic
demand
qD
q
qS
Quantity of coffee
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-17
A supply and demand perspective on
trade
• If the price of a good or service in a closed economy
is lower than the world price, and that economy
opens itself for trade, the economy will tend to
become a net exporter of that good or service.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-18
A supply and demand perspective on
trade (cont.)
• Observations of the mutually beneficial gains from
trade
– Countries will profit by exporting the goods and services for
which they have a comparative advantage.
– The revenue from the exports are used to import goods and
services for which they do not have a comparative
advantage.
– The markets will ensure that goods will be produced where
opportunity cost is lowest.
– The consumption possibilities will be maximised.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-19
A supply and demand perspective on
trade (cont.)
• Winners and losers from trade
– Winners
 Domestic consumers of imported goods
 Domestic producers of exported goods
– Losers
 Domestic consumers of exported goods
 Domestic producers of imported goods
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-20
Protectionist politics: tariffs and
quotas
• Protectionism
– The use of policies that are intended to protect domestic
industries from foreign competition.
• Tariff
– A tax imposed on an imported good.
• Quota
– A legal limit on the quantity of a good that may be imported.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-21
The market for computers after the
imposition of an import tariff
Price of computers
Domestic
supply
Production w/o
tariff
E
World price
Domestic
demand
Imports
before
tariff
qS
qD
Quantity of computers
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-22
The market for computers after the
imposition of an import tariff (cont.)
Price of computers
Domestic
supply
Production w/o
tariff
Tariff tax collection
E
World price plus tariff
pT
World price
Domestic
demand
Imports
after
tariff
qS
q’S
q’D
qD
Quantity of computers
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-23
A supply and demand perspective on trade
• Tariffs
– The market for computers in Brazil:
 Demand = QD = 3000 - 0.5 PC
 Supply = QS = 1000 + 0.5 PC
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-24
A supply and demand perspective on
trade (cont.)
• Tariffs
– Closed economy
 Equilibrium price:
• 1000 + 0.5 PC = 3000 - 0.5 PC
• PC = $2, 00
 Equilibrium quantity:
• 1000 + 0.5(2000) = 2000 computers
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-25
A supply and demand perspective on
trade (cont.)
• Tariffs
– Open economy




P = world price = $1500
qS = 1000 + 0.5(1500) = 1750
qD = 3000 - 0.5(1500) = 2250
Imports = 2250 - 1750 = 500 computers/yr
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-26
A supply and demand perspective on
trade (cont.)
• Tariffs
– Tariff imposed






Tariff = $300/computer
P = world price + tariff = $1500 + $300 = $1800
qs = 1000 + (0.5)(1800) = 1900 computers/year
qD = 3000 = (0.5)(1800) = 2100
Imports = 2100 - 1900 = 200
Tariff revenue = $300/computer x 200 computers/year
= $60 000/year
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-27
The market for computers after the imposition
of an import quota
Price of computers
Domestic
supply
World
price
Domestic
demand
Imports with
open economy
qS
qD
Quantity of computers
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-28
The market for computers after the imposition
of an import quota (cont.)
Price of computers
• Impact of quota = impact of tariff
• Revenue from quota goes to the producer
Domestic
supply
Domestic
supply
plus quota
F
pT
World
price
Domestic
demand
Import
quota
qS
q’S
q’D
Quantity of computers
qD
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-29
A supply and demand perspective on
trade
• Quotas and tariffs
– Market effects of tariffs are the same.
– Tariffs generate tax revenue.
– Quotas generate revenue for the firms that hold an import
licence.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-30
A supply and demand perspective on
trade (cont.)
• Effects of an import quota
– Without quota:
 qS = 1000 + 0.5PC
– With a quota of 200 computers




qS = 1000 + 0.5PC + 200 = 1200 + 0.5PC
qD = 3000 - 0.5PC
Equilibrium = 1200 + 0.5PC = 3000 - 0.5 PC
Equilibrium price = $1800
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-31
A supply and demand perspective on
trade (cont.)
• Effects of an import quota
– With a quota of 200 computers
 Domestic quantity supplied
• 1000 + 0.5($1800) = 1900 computers/year
 Domestic quantity demanded
• 3000 - 0.5($1800) = 2100 computers/year
 Imports = 2100 - 1900 = 200
 Revenue to the importers
• ($1800 - $1500) x 200 = $60 000
• Thinking as an economist
– What would happen if, instead of being given away, import
licences were sold to the highest bidder in an auction?
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-32
A supply and demand perspective on
trade (cont.)
• Other barriers to trade
– Red-tape barriers
– Regulations
• The inefficiency of protectionism
– Trade barriers are inefficient and reduce the size of the
economic pie.
– Because trade barriers benefit certain groups, and these
groups may be well organised, they may be successful in
lobbying for trade barriers.
– The gains from trade could be used to assist groups that
have been hurt by trade.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings
Slides prepared by Nahid Khan
8-33