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