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LECTURE #8: MICROECONOMICS CHAPTER 9

LECTURE #8: MICROECONOMICS CHAPTER 9. Determinants of Trade Arguments for Restricting Trade. Determinants of Trade. Objective: Increase the standard of living Key Factor: Comparative advantage Local Price vs. World Price If LP < WP, we export, else we import. Eventually LP = WP

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LECTURE #8: MICROECONOMICS CHAPTER 9

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  1. LECTURE #8: MICROECONOMICSCHAPTER 9 Determinants of Trade Arguments for Restricting Trade

  2. Determinants of Trade • Objective: Increase the standard of living • Key Factor: Comparative advantage • Local Price vs. World Price • If LP < WP, we export, else we import. • Eventually LP = WP • Winners and Losers • If LP < WP, local consumers will suffer welfare losses. • If LP > WP, local producers will suffer welfare losses. • Regardless, trade raises the total economic wellbeing

  3. International Trade Exporting Country Impact on LP and LQ when WP > LP Price of textiles Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of textiles produced domestically, and the demand curve shows the quantity consumed domestically. Exports from Isoland equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. 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. A World Price B Price after trade Price before trade C D Exports Exports Domestic Supply Domestic Quantity Demanded Domestic Quantity Supplied Quantity of textiles 0 The area D shows the increase in total surplus and represents the gains from trade Domestic Demand 3

  4. International Trade Importing Country Impact on LP and LQ when WP < LP Price of textiles Once trade is allowed, the domestic price falls to equal the world price. The supply curve shows the amount produced domestically, and the demand curve shows the amount consumed domestically. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off (consumer surplus rises from A to A + B + D), and sellers are worse off (producer surplus falls from B + C to C). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole World Price A Price before trade Price after trade B C Imports D Domestic Supply Domestic Quantity Supplied Domestic Quantity Demanded Quantity of textiles 0 The area D shows the increase in total surplus and represents the gains from trade Domestic Demand 4

  5. Determinants of Trade • Impact of Tariffs • Tariffs effectively raise price of imports above the world price (WP) • Purpose of tariff: protect local producers if LP > WP • Imposing tariff reduces imports and helps local market move to equilibrium • Tariffs impose deadweight loses in the same manner as taxes

  6. Determinants of Trade • The Effects of a Tariff • Price – rises by the amount of the tariff • Domestic quantity demanded – decrease • Domestic quantity supplied – increase • Reduces the quantity of imports • Moves the domestic market closer to its equilibrium without trade • Domestic sellers – better off • Domestic buyers – worse off 6

  7. Determinants of Trade • The effects of a tariff • Before the tariff • Consumer surplus = Producer surplus • Government tax revenue = 0 • With a tariff • Consumer surplus - smaller • Producer surplus - bigger • Government tax revenue • Total surplus - smaller 7

  8. The Effects of a Tariff Price of textiles A tariff reduces the quantity of imports and moves a market closer 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. World Price A Tariff Price with tariff Price without tariff C E G Imports with tariff Imports without tariff B D F Q1D Q1S Q2S Q2D Domestic Supply The area D + F shows the fall in total surplus and represents the deadweight loss of the tariff Quantity of textiles 0 Domestic Demand 8

  9. Determinants of Trade • Benefits of international trade • Increased variety of goods • Lower costs through economies of scale • Increased competition • Enhanced flow of ideas 9

  10. Arguments For Restricting Trade • Potential for loss of jobs • Potential for harm to national security • The need to protect young/new industries • Possibility of unfair competition (subsidies by foreign governments) • Protection as bargaining chip • Unilateral vs. Bilateral vs. Multilateral trade agreements

  11. Trade Agreements & Organizations • NAFTA (North American Free Trade Assoc.) US, Canada, Mexico • GATT (General Agreement on Trade & Tariffs (multi-lateral) • WTO (World Trade Organization) administer trade agreements, settle disputes

  12. Homework • Questions for Review: 1, 2, 4 • Problems and Applications: 1, 2

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