Chapter 9: Application: International Trade

other benefits of international trade

- Increased variety of goods. - lower costs through economies of scale - increased competition - enchanted flow of ideas

The gains and losses of an exporting country

- Though domestic quantity supplied and domestic quantity demanded differ, textile market is still in equilibrium because the rest of the world acts as another participant - horizontal line at the world price can be viewed as the rest of the worlds demand for textile --this demand curve is perfectly elastic because Isoland, as a small economy, can sell as many textiles as it wants at the world price.

the effects of tariffs

- raises the price of imported textiles above the world price by the amount of the tariff -domestic suppliers of textiles, can now sell their textiles for the world price plus the amount of the tariff - Price of textiles—both imported and domestic—rises by the amount of the tariff and is, therefore, closer to the price that would prevail without trade - change in price affects the behavior of domestic buyers and sellers -A tariff reduces the quantity of imports and moves a market closers to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area D+F. These two triangles represent the deadweight loss from the tariff.

Gains and losses from the tariff

-Because tariff raises the domestic price, domestic sellers are better off, and domestic buyers are worse off. -Government raises revenue

International Trade in an Exporting Country

-Once trade is allowed, domestic price rises to equal world price. - S curve shows the quantity of textiles produced domestically, and the D curve shows the quantity consumed domestically. -Exports from the country equal the difference between domestic quantity supplied and the domestic quantity demanded at the world price. * Because domestic quantity supplied is greater than domestic quantity demanded, Isoland sells textiles to other countries. (exporter) -Sellers are better off (producer surplus rises from C to B+C+D), and buyers are worse off (consumer surplus falls from A+B to A ). - Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole.

Gains and losses from opening to free trade

-trade forces the domestic price to rise to the world price. - Domestic producers of textiles are better off because they can now sell textiles at a higher price, but... - domestic consumers of textiles are worse off because they have to buy textiles at a higher price. To measure, look at changes in consumer and producer surplus. -Sellers benefit because producer surplus increases by area B+D. -Buyers are worse off because consumer surplus decreases by area B -Because gains of sellers exceed the losses of buyers by the area D, total surplus in Isoland increases.

The unfair-competition argument

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 goes) to expect the firms to compete in the international marketplace. Rather than objecting to the foreign subsidies, perhaps Isoland should send Neighborland a thank-you note.

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.

Deadweight loss of the tariff

Add the change in consumer surplus (negative), the change in producer surplus (positive), and change in government revenue (positive) total surplus in the market decreases by the area *D+F*

The protection as a bargaining chip argument

Another argument for trade restrictions concerns the strategy of bargaining. 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 bargaining strategy is that the threat may not work. If it doesn't work, the country faces a choice between two bad options.

Increased variety of goods

Goods produced in different countries are not exactly the same. German beer, for instance, is not the same as American beer. Free trade gives consumers in all countries greater variety from which to choose.

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. Economists are often skeptical about such claims, largely because the infant-industry argument is difficult to implement in practice. To apply protection successfully, the government would need to decide which industries will eventually be profitable and decide whether the benefits of establishing these industries exceed the costs of this protection to consumers. In addition, many economists are skeptical about the infant-industry argument in principle. In this case, firm owners should be willing to incur temporary losses to obtain the eventual profits. Protection is not necessary for an infant industry to grow. History shows that start-up firms often incur temporary losses and succeed in the long run, even without protection from competition.

The jobs argument

Opponents of free trade often argue that trade with other countries destroys domestic jobs. Yet free trade creates jobs at the same time that it destroys them. The transition may impose hardship on some workers in the short run, but it allows Isolandians as a whole to enjoy a higher standard of living.

Will trade make everyone better off?

Probably not. In practice, compensation for the losers from international trade is rare.

Lower costs through economies of scale

Some goods can be produced at low cost only if they are produced in large quantities—a phenomenon called economies of scale. A firm in a small country cannot take full advantage of economies of scale if it can sell only in a small domestic market. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully.

Enhanced flow of ideas

The transfer of technological advances around the world is often thought to be linked to the trading of the goods that embody those advances. The best way for a poor agricultural nation to learn about the computer revolution, for instance, is to buy some computers from abroad rather than trying to make them domestically.

The Equilibrium without international trade

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

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 are 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. Companies have an incentive to exaggerate their role in national defense to obtain protection from foreign competition

International trade in an importing country

When trade forces the domestic price to fall, domestic consumers are better off (they can now buy textiles at a lower price), and domestic producers are worse off (they now have to sell textiles at a lower price). -Changes in consumer and producer surplus measure the size of the gains and losses.

price takers

a country that takes the world price of textiles as given. The country can be an exporting country or an importing country.

Tariff and deadweight loss

a tariff causes deadweight loss because a tariff is a type of tax. It distorts incentives and pushes the allocation of scarce resources away from the optimum.

import quotas

creates surplus for those who obtain the licenses to import.

domestic price

domestic price reflects the opportunity cost of textiles: it tells us how much a country must give up to obtain one unit of textiles. - If low, the cost of producing textiles in the country is low, suggesting that country has a comparative advantage in producing textiles relative to the rest of the world. - If high, the cost of producing textiles in the country is high, suggesting that foreign countries have a comparative advantage in producing textiles.

small economy

means a country's actions have little effect on world markets. Specifically, any change in a country's trade policy will not affect the world price of textiles

tariff

tax on goods produced abroad and sold domestically. - will have no effect if Isoland becomes a textile exporter - matters only if Isoland becomes a textile importer

world price

the price of a good that prevails in the world market for that good. - Comparing the world price and the domestic price before trade indicates whether a country has a comparative advantage in producing a textile.

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. • 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 are better off, and producers are worse off. In both cases, the gains from trade exceed the losses. • A tariff—a tax on imports—moves a market closer to the equilibrium that would exist without trade and, therefore, reduces the gains from trade. Although domestic producers are better off and the government raises revenue, the losses to consumers exceed these gains. • There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions. Although some of these arguments have merit in some cases, economists believe that free trade is usually the better policy.

Exporting country two conclusions

• 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. • Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.

Importing country two conclusions parallel to those for an exporting country

• 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. • 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 Isoland opens its textile market to international trade, the change creates winners and losers, regardless of whether Isoland ends up exporting or importing textiles.