Microeconomics Econ 101 Chapter 9: International Trade Notes

Other Benefits of International Trade

1. Increased variety of goods. 2. Lower costs through economies of scale. 3. Increased competition. 4. Enhanced flow of ideas, technology, culture etc.

Analysis of an exporting country yields two conclusions (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.

Analysis of an exporting country yields two conclusions. (Importing Country)

1. When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and 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.

The Unfair-Competition Argument (An argument for restricting trade)

A common argument is that free trade is desirable only if all countries play by the same rules. If firms in different countries are subject to different laws and regulations, then it is unfair (the argument states) to expect the firms to compete in the international marketplace.

What will a tariff on a good do?

A tariff on a good will have no effect if the country becomes an exporter of that good. If no one in that country is interested in importing that good, a tax on that goods imports are irrelevant. The tariff matter only if the country becomes an importer of that good.

Tariff

A tax on goods produced abroad and sold domestically/ a tax on imported goods.

How do you know who has the comparative advantage in producing a certain good or service?

By comparing the domestic and world prices before trade. The domestic price directly reflects the opportunity cost of that good or service.

When do the foreign countries have the comparative advantage?

If the domestic price is high, the cost of producing that good or service is then high, suggesting that foreign countries have the comparative advantage in producing that good or service in relation to the domestic country.

When does the domestic country have the comparative advantage?

If the domestic price is low, the cost of producing that good or service is low, suggesting that, that country has the comparative advantage in producing that good or service in relation to the rest of the world.

What happens for the market of a good under free trade?

In a free trade market, the domestic price equals the world price. A tariff raises the price of imported goods above the world price by the amount of the tariff. Domestic suppliers of goods, who compete with suppliers of imported goods, can now sell their good for the world price plus the amount of the tariff. The price of the good, both imported and domestic, rises by the amount of the tariff an dis, closer to the price that would prevail without trade.

What does the change in price do?

It affects the behaviour of domestic buyers and sellers, because the tariff raises the price of the good, it reduces the domestic quantity demanded from QD1 to QD2 and raises the domestic quantity supplied from QS1 to QS2. The tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.

Why is trade beneficial?

It allows each nation to specialize in doing what they do best.

What does a tariff do?

It causes a deadweight loss. It distorts incentives and pushes allocation of scarce resources away from the optimum. There is 2 affects: 1. When the tariff raises the domestic price of textiles above the world price, it encourages them to reduce consumption of that good. Even though the cost of making these incremental units exceeds the cost of buying them at the world price, the tariff makes it profitable for domestic producers to manufacture them nonetheless. 2. When the tariff reduce consumption of textiles from QD1 to QD2 even though domestic consumers value these incremental units at more than the world price, the tariff induces them to cut back their purchases.

What does the horizontal line at the world price represent? (Importing Country)

It represents the supply of the rest of the world. This supply curve is perfectly elastic because the country is a small economy and, therefore can buy as many of the good that they want at world price.

The Protection-as-a-Bargaining -Chip Argument (An argument for restricting trade)

Many policymakers claim to support free trade but, at the same time, argue that trade restrictions can be useful when we bargain with out trading partners. They claim that the threat of a trade restriction can help remove a trade restriction already imposed by a foreign government. For instance, a country A may threaten to impose a tariff on a certain good or service unless country B removes its tariff on a different good or service. If country B responds to this threat by removing it's tariffs on that food or service, the result can be freer trade. If the threat does not work, the country can either carry out its threat and implement the trade restriction, which would reduce it's economic welfare or it can back down from its threat and lose prestige in international affairs.

The Infant-Industry Argument (An argument for restricting trade)

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. Sometimes older industries ask for this as well, to help them adjust to new conditions. This argument is difficult to put into practice though, as picking which industries will be more profitable and beneficial in the future is hard. And if it is implemented it's hard to remove.

What happens when trade is allowed in a country that's domestic equilibrium price was below the world price before trade is allowed? (Exporting Country)

Once free trade is allowed, the domestic price rises to equal the world price. No seller of that good would accept less than the world price, and no buyer would pay more than the world price. After the domestic price has risen to equal to the world price, the domestic quantity supplied differs from the domestic quantity demanded. The supply curve shows the quantity of the good supplied by domestic suppliers. The demand curve shows the quantity of the good demanded by domestic buyers. Because the domestic quantity supplied is greater than the domestic quantity demanded, the country sells the good to other countries and becomes an exporter of that good. The market for this good still remains at equilibrium because there is now a new participant in the market: the rest of the world.

Small Economy Assumption

That country is a small country, with a small economy compared to the rest of the world. It means that the countries actions have little effect on the world markets. Specifically, any change in the countries trade policy will not affect the world price of certain goods or services.

Price Takers

The country takes the price of that good or service as given. They can sell that good or service at that price and be exporters or importers at this price.

What does the horizontal line at the world price represent? (Exporting Country)

The demand for a certain good or service from the rest of the world. This demand curve is perfectly elastic because the country, as a small economy, can sell as many of that good that it wants at world price.

How a country becomes an importer? (Importing Country)

The domestic price before trade is above the world price. After free trade is allowed, the domestic price must equal the world price. As 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 domestic country becomes an importer.

What does trade force? (Exporting Country)

The domestic price to rise to the world price. Domestic producers of that good are better off because they can now sell the good at a higher price, but domestic consumers of that good are worse off because they have to buy that good at a higher price.

World Price

The price of a good that prevails in the world market for that good.

The Jobs Argument (An argument for restricting trade)

Trade with other countries destroys domestic jobs. Free trade in a good or service, could cause a countries price of that good or service to fall, reducing the quantity produced, thus reducing employment in that industry. However, trade creates jobs at the same time that it rids of them as people from one industry move towards working in other industries as demand changes. Workers in each country will eventually find jobs in the industry in which that country has a comparative advantage.

The Equilibrium without International Trade

When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand.

The National-Security Argument (An argument for restricting trade)

When an industry is threatened with competition from other countries, opponents of free trade often argue that the industry is vital for national security. If a country was considering free trade in steel for example, domestic steel companies might point out that steel is used to make guns and tanks. Free trade would allow that country to become dependent on foreign countries to supply steel. If a war later broke out, that country might be unable to produce enough, and weapons to defend itself. Economists realize we should protect key industries when there are legitimate national security concerns. Economists also understand that producers are ear to gain at the consumers expense.

When would a country become a exporter of a certain good or service?

When the world price of that good or service is higher than the domestic price. The country will then become an exporter once trade is permitted.

When would a country become a importer of a certain good or service?

When the world price of that good or service is lower than the domestic price. The country will then become an importer. Due to foreign sellers having cheaper prices, that countries consumers would buy that good or service from other countries.

Gains and losses of trade. (Importing Country)

When trade forces the domestic price to fall, domestic consumers are better off, and domestic producers are worse off. Changes in CS and PS measure the size of gains and losses.