Application:
International Trade
Copyright©2004 South-Western
• What determines whether a country imports or
exports a good?
Copyright © 2004 South-Western/Thomson Learning
• Who gains and who loses from free trade
among countries?
Copyright © 2004 South-Western/Thomson Learning
• What are the arguments that people use to
advocate trade restrictions?
Copyright © 2004 South-Western/Thomson Learning
THE DETERMINANTS OF TRADE
• Equilibrium Without Trade
• Assume:
• A country is isolated from rest of the world and produces
steel.
• The market for steel consists of the buyers and sellers in
the country.
• No one in the country is allowed to import or export
steel.
Copyright © 2004 South-Western/Thomson Learning
Figure 1The Equilibrium without International Trade
Price
of Steel
Domestic
supply
Consumer
surplus
Equilibrium
price Producer
surplus
Domestic
demand
0 Equilibrium Quantity
quantity of Steel
Copyright © 2004 South-Western
The Equilibrium Without International Trade
• Equilibrium Without Trade
• Results:
• Domestic price adjusts to balance demand and supply.
• The sum of consumer and producer surplus measures the
total benefits that buyers and sellers receive.
Copyright © 2004 South-Western/Thomson Learning
The World Price and Comparative Advantage
• If the country decides to engage in international
trade, will it be an importer or exporter of steel?
Copyright © 2004 South-Western/Thomson Learning
The World Price and Comparative Advantage
• The effects of free trade can be shown by
comparing the domestic price of a good without
trade and the world price of the good. The
world price refers to the price that prevails in
the world market for that good.
Copyright © 2004 South-Western/Thomson Learning
The World Price and Comparative Advantage
• If a country has a comparative advantage, then
the domestic price will be below the world
price, and the country will be an exporter of the
good.
Copyright © 2004 South-Western/Thomson Learning
The World Price and Comparative Advantage
• If the country does not have a comparative
advantage, then the domestic price will be
higher than the world price, and the country
will be an importer of the good.
Copyright © 2004 South-Western/Thomson Learning
Figure 2 International Trade in an Exporting Country
Price
of Steel
Price Domestic
after supply
trade World
price
Price
before
trade
Domestic
Exports demand
0
Domestic Domestic Quantity
quantity quantity of Steel
demanded supplied
Copyright © 2004 South-Western
Figure 3 How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Domestic
Price supply
after A Exports
trade World
B D price
Price
before
C
trade
Domestic
demand
0 Quantity
of Steel
Copyright © 2004 South-Western
Figure 3 How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Consumer surplus
before trade Domestic
Price supply
after A Exports
trade World
B D price
Price
before
C
trade
Producer surplus
before trade Domestic
demand
0 Quantity
of Steel
Copyright © 2004 South-Western
How Free Trade Affects Welfare in
an Exporting Country
Copyright © 2004 South-Western/Thomson Learning
THE WINNERS AND LOSERS
FROM TRADE
• The analysis of an exporting country yields two
conclusions:
• Domestic producers of the good are better off, and
domestic consumers of the good are worse off.
• Trade raises the economic well-being of the nation
as a whole.
Copyright © 2004 South-Western/Thomson Learning
The Gains and Losses of an Importing
Country
• International Trade in an Importing Country
• If the world price of steel is lower than the domestic
price, the country will be an importer of steel when
trade is permitted.
• Domestic consumers will want to buy steel at the
lower world price.
• Domestic producers of steel will have to lower their
output because the domestic price moves to the
world price.
Copyright © 2004 South-Western/Thomson Learning
Figure 4 International Trade in an Importing Country
Price
of Steel
Domestic
supply
Price
before
trade
Price World
after price
trade
Domestic
Imports
demand
0 Domestic Domestic Quantity
quantity quantity of Steel
supplied demanded Copyright © 2004 South-Western
Figure 5 How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
Domestic
supply
A
Price
before trade B D
Price World
after trade C price
Imports
Domestic
demand
0 Quantity
of Steel
Copyright © 2004 South-Western
Figure 5 How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
Consumer surplus
before trade Domestic
supply
A
Price
before trade B
Price World
after trade C price
Producer surplus Domestic
before trade demand
0 Quantity
of Steel
Copyright © 2004 South-Western
Figure 5 How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
Consumer surplus
after trade Domestic
supply
A
Price
before trade B D
Price World
after trade C price
Imports
Producer surplus Domestic
after trade demand
0 Quantity
of Steel
Copyright © 2004 South-Western
How Free Trade Affects Welfare in
an Importing Country
Copyright © 2004 South-Western/Thomson Learning
THE WINNERS AND LOSERS
FROM TRADE
• How Free Trade Affects Welfare in an
Importing Country
• The analysis of an importing country yields two
conclusions:
• Domestic producers of the good are worse off, and
domestic consumers of the good are better off.
• Trade raises the economic well-being of the nation as a
whole because the gains of consumers exceed the losses
of producers.
Copyright © 2004 South-Western/Thomson Learning
THE WINNERS AND LOSERS
FROM TRADE
• The gains of the winners exceed the losses of
the losers.
• The net change in total
surplus is positive.
Copyright © 2004 South-Western/Thomson Learning
The Effects of a Tariff
• A tariff is a tax on goods produced abroad and
sold domestically.
• Tariffs raise the price of imported goods above
the world price by the amount of the tariff.
Copyright © 2004 South-Western/Thomson Learning
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Equilibrium
without trade
Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without tariff Copyright © 2004 South-Western
Figure 6 The Effects of a Tariff
Price
of Steel
Consumer surplus
before tariff Domestic
supply
Producer
surplus Equilibrium
before tariff without trade
Price World
without tariff price
Domestic
demand
S D
0 Q Q Quantity
of Steel
Imports
without tariff Copyright © 2004 South-Western
Figure 6 The Effects of a Tariff
Price
of Steel
Consumer surplus
with tariff Domestic
supply
A
Equilibrium
without trade
B
Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without tariff Copyright © 2004 South-Western
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Producer
surplus Equilibrium
after tariff without trade
Price
with tariff C Tariff
Price World
without tariff G Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without tariff Copyright © 2004 South-Western
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Tariff Revenue
Price
with tariff Tariff
E
Price World
without tariff Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without tariff Copyright © 2004 South-Western
Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
A
Deadweight Loss
B
Price
with tariff C Tariff
D E F
Price World
without tariff G Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without tariff Copyright © 2004 South-Western
The Effects of a Tariff
Copyright © 2004 South-Western/Thomson Learning
The Effects of a Tariff
• A tariff reduces the quantity of imports and
moves the domestic market closer to its
equilibrium without trade.
• With a tariff, total surplus in the market
decreases by an amount referred to as a
deadweight loss.
Copyright © 2004 South-Western/Thomson Learning
The Effects of an Import Quota
• An import quota is a limit on the quantity of a
good that can be produced abroad and sold
domestically.
Copyright © 2004 South-Western/Thomson Learning
Figure 7 The Effects of an Import Quota
Price
of Steel
Domestic
supply
Equilibrium
without trade
Domestic
Quota
supply
+
Import supply
Isolandian
price with
Equilibrium
quota
with quota
Price
World World
without =
price Imports price
quota Domestic
with quota
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without quota Copyright © 2004 South-Western
The Effects of an Import Quota
• Because the quota raises the domestic price
above the world price, domestic buyers of the
good are worse off, and domestic sellers of the
good are better off.
• License holders are better off because they
make a profit from buying at the world price
and selling at the higher domestic price.
Copyright © 2004 South-Western/Thomson Learning
Figure 7 The Effects of an Import Quota
Price
of Steel
Domestic
supply
Equilibrium
without trade
Domestic
Quota
supply
A
+
Import supply
Isolandian
price with B
Equilibrium
quota
with quota
C D E'
Price E" F
World World
without =
price G Imports price
quota Domestic
with quota
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without quota Copyright © 2004 South-Western
The Effects of an Import Quota
Copyright © 2004 South-Western/Thomson Learning
The Effects of an Import Quota
• With a quota, total surplus in the market
decreases by an amount referred to as a
deadweight loss.
• The quota can potentially cause an even larger
deadweight loss, if a mechanism such as
lobbying is employed to allocate the import
licenses.
Copyright © 2004 South-Western/Thomson Learning
The Lessons for Trade Policy
• If government sells import licenses for full
value, revenue equals that of an equivalent
tariff and the results of tariffs and quotas are
identical.
Copyright © 2004 South-Western/Thomson Learning
The Lessons for Trade Policy
• Both tariffs and import quotas . . .
• raise domestic prices.
• reduce the welfare of domestic consumers.
• increase the welfare of domestic producers.
• cause deadweight losses.
Copyright © 2004 South-Western/Thomson Learning
The Lessons for Trade Policy
• Other Benefits of International Trade
• Increased variety of goods
• Lower costs through economies of scale
• Increased competition
• Enhanced flow of ideas
Copyright © 2004 South-Western/Thomson Learning
Summary
• The effects of free trade can be determined by
comparing the domestic price without trade to
the world price.
• A low domestic price indicates that the country has
a comparative advantage in producing the good and
that the country will become an exporter.
• A high domestic price indicates that the rest of the
world has a comparative advantage in producing the
good and that the country will become an importer.
Copyright © 2004 South-Western/Thomson Learning
Summary
• When a country allows trade and becomes an
exporter of a good, producers of the good are
better off, and consumers of the good are worse
off.
• When a country allows trade and becomes an
importer of a good, consumers of the good are
better off, and producers are worse off.
Copyright © 2004 South-Western/Thomson Learning
Summary
• A tariff—a tax on imports—moves a market
closer to the equilibrium than would exist
without trade, and therefore reduces the gains
from trade.
• Import quotas will have effects similar to those
of tariffs.
Copyright © 2004 South-Western/Thomson Learning
Summary
• There are various arguments for restricting
trade: protecting jobs, defending national
security, helping infant industries, preventing
unfair competition, and responding to foreign
trade restrictions.
• Economists, however, believe that free trade is
usually the better policy.
Copyright © 2004 South-Western/Thomson Learning
