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.
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
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.
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
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,