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Chapter 9 International Trade

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Keith Diaz Chapter 9: International Trade  Country has comparative advantage if it produces good at lower opportunity cost than others. Countries gain from trade if each exports the goods in which it has comparative advantage. World Price  Pw = the world price of a good, the price that prevails in world markets  Pd = domestic price without trade  If Pd < Pw  If Pw < Pd - Country has comparative advantage in good  Country doesn’t have comparative advantage - Under free trade, the country exports the good  Under free trade, country imports the good Small economy assumption  A small economy is a price taker in world markets  its actions have no effect on Pw - Not always true, but simplifies the analysis  When an economy engages in free trade, Pw is the only relevant price - No seller accepts less than Pw, no buyer would pay more than Pw Consumer and producer surplus Without trade  with trade  CS = A +B  CS = A  PS = C  PS = B + C + D  TS = A + B + C  TS = A + B + C + D  Net gain from trade = D  At Pe, D = S. But at Pw, S > D, so they export the surplus Benefits  Consumers enjoy increased variety of goods  Producers sell to a larger market and may achieve lower costs through economies of scale  Competition from abroad may reduce market power of some firms  increase total welfare  Trade enhance flow of ideas, facilitates the spread of technology around the world 1. Tariffs: A tax that is charged on imported goods  Before the tariff: (Pw) ­ 0-Q2 of the goods consumed at Pw. ­ Domestic production 0-Q1 ­ Imports were Q1-Q2.  After the tariff: (Pw+T) ­ QD falls from 0-Q2 to 0-Q4 ­ Domestic revenue increases ­ Foreign producers supply Q3-Q4, and receive Pw + T, but have to pay tariff E to government.  Before  after ­ CS = A + B + C + D + E + F  A + B ­ PS = G  C + G ­ TS = A + B + C + D + E + F + G  A + B + C + E + G ­ Deadweight loss: D + F Keith Diaz  Costs: A. Consumers keep the amount k that they would have spent, but there is a loss of consumer surplus , because the good is not purchased anymore  dead-weight loss of welfare B. Q1-Q3 is now produced by inefficient domestic producers, as opposed to more efficient foreign producers. The foreign producers would produce this quantity for minimum revenue, whereas the domestic producers need more. misallocation  deadweight loss of welfare 2. Quota: quantitative limit on imports of a good  Before quota: (Pw) ­ 0-Q2 of the good is purchased at Pw. ­ Domestic supply is 0-Q1 ­ imports are Q1-Q2.  After quota of Q1-Q3 amount of good ­ domestic producers supply 0-Q1 at Pw ­ Importers produce their quota of Q1-Q3. ­ Excess demand of Q3-Q2 at Pw, so price increases. ­ Sdomestic shifts to the right,
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