Economics 101, Introduction to Economics, Ch. 9 Notes

The effects of a tariff on a supply and demand curve.

A tariff reduces the quantity of imports and moves the market closer to the equilibrium that would exist without trade. Consumer surplus decreases substantially, producer surplus increases, government revenue is created, total surplus falls. Tariff increases quantity supplied, decreases quantity demanded.

Principle of Comparative Advantage (review)

Principle that states that all countries can benefit from trading with one another because trade allows each country to specialize in what it does best.

Will trade make everyone better off?

Probably not, because compensation from the losers from international trade is rare. Opening the economy to international trade is a policy that expands the size of the economic pie, while perhaps leaving some participants in the economy with a smaller slice.

Domestic price

Reflects the opportunity cost of a product: it tells us how much a country must give up to obtain one unit of textiles.

A country can be an exporter by...

Selling a product at the world price.

Which of the following trade policies would benefit producers, hurt consumers, and increase the amount of trade?

Starting to allow trade when the world price is greater than the domestic price.

Tariff

Tax on goods produced abroad and sold domestically. Tax on imported goods. Tariff only matters if a country is an importer.

Multilateral approach to achieve free trade

When a country reduces its trade restrictions while other countries do the same. In other words, it can bargain with its trading partners in an attempt to reduce foreign restrictions around the world.

Unilateral approach to achieve free trade

When a country removes trade restrictions on its own.

Price takers (review)

When a country takes the world price of a product as a given.

The Equilibrium without International Trade

When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. Sum of consumer and producer surplus measures the total benefits that buyers and sellers receive from participating in the textile market.

Arguments against trade: The National-Security Argument

When an industry is threatened with competition from other countries, opponents of free trade often argue that the industry is vital to national security. Economists acknowledge that protecting key industries may be appropriate when there is legitimate concerns over national security. One should be wary of the national-security argument when it is made by representatives of industry rather than the defense establishment.

WTO

World Trade Organization, established in 1995 and headquartered in Geneva, Switzerland. The functions of the WTO are to administer trade agreements, provide a forum for negotiations, and handle disputes among member countries.

Advantages of the multilateral approach to free trade

The multilateral approach has the potential to result in freer trade than a unilateral approach because it can reduce trade restrictions abroad as well as at home. The multilateral approach may have a political advantage. The multilateral approach to free trade can sometimes win political support when a unilateral approach cannot.

World price

The price of a good that prevails in the world market for that good. Ex: If the world price of textiles is higher than the domestic price, then a country will export textiles once trade is permitted. However, if the world price of textiles is lower than the domestic price, then a country will import textiles.

What is the role of a tariff in a country's economy?

The tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.

Why is the textile market still in equilibrium?

There is now another participant in the market, the rest of the world. One can view the horizontal line at the world price as representing the rest of the world's demand for textiles.

Other benefits of international trade

1. Increased variety of goods. Free trade gives consumers in all countries greater variety from which to choose. 2. Lower costs through economies of scale. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully. 3. Increased competition. A company shielded from foreign competitors is more likely to have market power, which in turn gives it the ability to raise prices above competitive levels. This is a type of market failure. Opening up trade fosters competition and gives the invisible hand a better chance to work its magic. 4. Enhanced flow of ideas. The transfer of technological advances around the world is often thought to be linked to the trading of goods that embody those advances.

Conclusions from analyzing an exporting country:

1. When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off, and domestic consumers of the good are worse off. 2. Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.

Conclusions from analyzing an importing country:

1. When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, while domestic producers of the good are worse off. 2. Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.

If domestic quantity supplied is greater than domestic quantity demanded...

A country will sell textiles to another country. Therefore, this country becomes a textile exporter.

Economies of scale

A phenomenon in which some goods can be produced at low cost only if they are produced in large quantities.

The main difference between imposing a tariff and handing out licenses under an import quota is...

A tariff increases government revenue.

Conclusion to arguments against free trade.

Although some of these arguments have merit in some cases, economists generally believe that free trade is usually the better policy.

A country can be an importer by...

Buying a product at the world price.

Fall in total surplus is called the...

Deadweight loss of the tariff. A tariff causes a deadweight loss because a tariff is a type of tax.

If a country opens itself to world trade in coffee beans and the domestic price falls...

Domestic production of coffee falls, and the country becomes a coffee importer.

GATT

General Agreement on Tariffs and Trade (GATT), a continuing series of negotiations among many of the world's countries with the goal of promoting free trade. GATT has successfully reduced the average tariff among member countries from about 40% after WWII to about 5% today.

Supply and Demand curve of an importing country

Horizontal line at the world price represents the supply of the rest of the world. This supply curve is perfectly elastic because the importing country is a small economy, and therefore, can buy as many textiles as it wants at the world price.

Arguments against trade: The Unfair-Competition Argument

If firms in different countries are subject to different laws and regulations, then it is unfair (the argument goes) to expect the firms to compete in the international marketplace. However, the case for free trade is the same as it goes before: the gains of the consumers from buying at the low price would exceed the losses of producers. If a country decides to subsidize large parts of its textile industries, its the taxpayers who bear the burden, not the country's trading partners.

Arguments against trade: The protection-as-a-bargaining chip argument

Many policymakers claim to support free trade but, at the same time, argue that trade restrictions can be useful when we bargain with our trading partners. They claim that the threat of a trade restriction can help remove a trade restriction already imposed by a foreign government. The problem with this argument is that the threat may not work. If it doesn't work, this country faces a choice between two options. It can carry out its threat and implement the trade restriction, which would reduce its own economic welfare. Or it can back down from its threat, which would cause it to lose prestige in international affairs.

Arguments against trade: The Infant-Industry Argument

New industries sometimes argue for temporary trade restrictions to help them get started. After a period of protection, the argument goes, these industries will mature and be able to compete with foreign firms. This argument is difficult to implement in practice because the government would need to decide which industries will eventually be profitable and decide whether the benefits of establishing these industries exceeds the costs of this protection to consumers. Yet "picking winners" is extremely difficult. And once a powerful industry is protected from foreign competition, the "temporary" policy is sometimes hard to remove.

NAFTA

North American Free Trade Agreement, which in 1993 lowered trade barriers between the United States, Mexico, and Canada.

International trade in an importing country

Once trade is allowed, the domestic price falls to equal the world price. Supply curve shows domestic supply, demand curve shows domestic demand. Imports = difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off as consumer surplus rises, while sellers are worse off as producer surplus falls. Total surplus rises, indicating that trade raises the economic well-being of the country as a whole.

Supply and Demand graph of an exporting country

Once trade is allowed, the domestic price rises to equal the world price. Supply curve shows the domestic supply, demand curve shows the domestic demand. Exports of a country = difference between the quantity supplied and the domestic quantity demanded at the world price. Sellers are better off as producer surplus rises, while buyers are worse off. Total surplus rises as well, indicating that trade raises the economic well-being of the country as a whole. (See graph on p. 174, textbook)

Arguments against trade: The Jobs Argument

One argument as to why a country should not engage in trade. Not a very good argument because free trade creates jobs at the same time that it destroys them. Each country can still gain from trading with each other. Workers in each country will eventually find jobs in an industry in which that country has a comparative advantage.

If the domestic price is high...

The cost of producing textiles in this country is high, suggesting that foreign countries have a comparative advantage in producing textiles.

If domestic price is low...

The cost of producing textiles in this country is low, suggesting that this country has a comparative advantage in producing textiles relative to the rest of the world.

If the domestic quantity supplied is less than the domestic quantity demanded...

The difference between the domestic quantity demanded and the domestic quantity supplied is bought from other countries, and the country becomes a textile importer.

Why is the demand curve of an exporting country perfectly elastic?

The exporting country, as a small economy, can sell as many textiles as it wants at the world price.