ECO 102 Chapter 9 Study Sheet

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

The Unfair-Competition Argument

A common argument is free trade is desirable only if all countries play by the same rules

Increased competition

A company shielded from foreign competitors is more likely to have market power which gives ability to raise prices above competitive levels

Protection as a Bargaining Chip Argument

Argument for trade restrictions concern strategy of bargaining

Difference between domestic quantity demanded and domestic quantity supplied

Bought from other countries

deadweight loss

Fall in total surplus because of the tariff

Increased variety of goods

Goods produced in different countries are not exactly the same.

Tariff matters

If Isoland becomes textiles importer

Economist often skeptical

Infant industry argument is difficult to implement in practice

World price lower than textiles

Isoland will import textiles

Small economy assumption

Isoland' actions have little affect on world price of textiles

To analyze welfare effects of free trade

Isolandian economists star with the assumption that Isoland is a small economy

Foreign sellers offer better price

Isolandian textile consumers will quickly start buying textiles from other countries

Free trade allowed

Isolandians end up buying or selling textiles

North American Free Trade Agreement(NAFTA)

Lowered trade barriers among the United States, Mexico, and Canada.

World Trade Organization(WTO)

Primary goal is to administer trade agreements, provide a forum for negotiations, and handle disputes among member countries

Supply curve shows

Quantity of textiles supplied by Isolandian sellers

Lower costs through economies of scale

Some goods can be produced at low cost only if they are produced in large quantities

Trading partner's claim

The threat of trade restriction concerns strategy of bargaining

If firms in different countries are subject to different laws and regulations

Then it's unfair to expect firms to compete in international marketplace

price takers

They take world price of textiles are given

Policymakers claim to support free trade

Trade restrictions can be useful when we bargain with trading partners

Opponent's argument of opening free trade

Trade with other countries destroys jobs Ex: Free trade in textiles produced in Isoland and thus reducing employment in the Isolandian textile industry

Enhanced flow of ideas

Transfer of technological advances around the world is often thought to be linked to the trading of goods that embody those advances

To Measure Gains and Losses

We look at changes in consumer and producer surplus

General Agreement on Tariffs(GATT)

a continuing series of negotiations among many of the world's countries with the goal of promoting free trade

tariff

a tax on goods produced abroad and sold domestically

Domestic price

adjusts to balance the quantity supplied by domestic sellers

Lower price will raise

amount of textiles Isolandians consume and lower amount of textiles Isolandians produce

Older industries

argue they need protection to them adjust to new conditions

if domestic price is high

cost of producing textiles is high which suggests that foreign countries have comparative advantage in producing textiles

if domestic price is low

cost of producing textiles is low, suggesting that Isoland has comparative advantage in producing textiles relative to rest of the world

Gains of winners

could exceed losses of the losers, so the winners could compensate losers

quantity demanded by

domestic buyers

When trade is allowed

domestic price rises to world price

When country allows trade and becomes exporter of a good

domestic producers of the good are better off and domestic consumers of the good are worse off

After domestic price is risen to equal world price

domestic quantity supplied differs from domestic quantity demanded

Tariff raises domestic prices

domestic sellers are better off while buyers are worse off

One country is better than another at producing everything

each country can still gain from trading with the other

Trade raises

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

Companies have incentives to

exaggerate their role in national defense in order to protect foreign competition

Opening up trade

fosters competition and gives invisible hand a better chance to work it's magic

To apply protection successfully

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 consumer.

making similar assumptions

is a key part of building a useful economic model

Trade is beneficial

it allows each nation to specialize in doing what's best

When tariff raises price that domestic textile consumers have to pay

it encourages them to reduce consumption of textiles

Sum of consumer and producer surplus

measures total benefits buyers and sellers receive from participating in the textile market

Tariff reduces the quantity of imports and

moves domestic market closer to its equilibrium without trade

Government decree

no one in Isoland is allowed to import or export textiles

Policymakers for textile markets

often place trade restrictions to protect domestic producers from foreign competitors

domestic price reflects

on opportunity cost

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 world price is lower Isolandian price

price will fall

If world price is higher than Isolandian price

price will rise

Demand curve shows

quantity of textiles demanded by Isolandian buyers

Isolandians consume and

raise amount of textiles that Isolandians produce

Higher price will

reduce the amount of textiles

Tariff raises prices of textiles

reduces domestic quantity demanded

One views horizontal line at world price as

representing the rest of the world's demand for textiles

Price of textiles imported and domestic

rises by the amount of the tariff and is closer to the price that would prevail the trade

Comparing world price and domestic price

shows whether Isoland has comparative advantage in producing textiles

Cost of making incremental units exceeds cost of buying them at world price

tariff makes it profitable for domestic producers to manufacture them nonetheless

New industries argue for

temporary trade restrictions to help get started

Once powerful industry is protected from foreign competition

the "temporary" policy is sometimes hard to remove

world price

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

Before trade allowed

the price of textiles adjusts to balance domestic supply and domestic demand

Protecting key industries may be appropriate when

there are legitimate concerns over national security

Textile market

to examine gains and losses from international trade

Trade forces domestic price

to rise to world price

To determine total welfare effects of the tariff

we add change in consumer surplus, change in producer surplus, and change in government revenue

First issue economists take

whether Isoland is likely to become a textile importer or exporter

Domestic suppliers of textiles

who compete with suppliers of imported textiles can sell textiles for the world price plus the amount of the tariff

Any change in trade policy

will not affect the world price of textiles

Gains of consumers from buying it at lower price

would exceed losses of the producers