Economics 201 – Microeconomics
Chapter 2- Q3 & 4
Chapter 3 – Q8 & 10
- This chapter is based off interdependence, people we have never met providing us with
the goods we need.
- How does trade benefit everyone?
- The slope on PPFs determines opportunity costs. This leads to differing amounts of
resources between two different countries who are producing the same thing. Thus, if
these countries work together, they can become exporters and importers of different
goods based in between the opportunity costs of the two countries and what it takes to
produce a certain good more efficiently. This way, both countries are benefitted more
than without trade without putting in more labor. You can consume beyond the PPF
- Both parties produce on their PPF, export goods, and then can consume beyond the
PPF line. With many countries, we can consume far beyond our PPFs. There are always
gains in resources through trade.
- Where do the gains come from? Absolute advantage (using fewer inputs than another
producer to produce a good). Comparative advantage (opportunity cost; the ability to
produce a good at a lower opportunity cost). Whoever has the lower opportunity cost can
give up one commodity for another, even if they don’t have the absolute advantage, both
groups can benefit from specialization. (See slides)
- Gains from trade arise from comparative advantage. When each country specializes in
the good(s) in which it has a comparative advantage, total production in all countries is
higher, the “economic pie” is bigger, and all countries can gain from trade.
- Opportunity costs of two items in one country are always the reciprocal of one another.
- Figuring out the cost depends on this trade-off. See slides. 1/5 wine W the country does not have comparative
advantage, so under free trade, the country will import the good.
- A small economy is a price taker in world markets. Its actions have no effect on world
price. When a small economy engages in free trade, the world price is the only relevant
- When a good is imported, the consumers gain and the producers lose…but when the
good is exported, producers gain and domestic consumers lose. However, it is more
often the case that the businesses will be the ones bringing up the issue with the
government. - Overall, trade brings gains. It is just a matter of who gets the surplus advantage. Total
surplus will always increase. Trade creates winners and losers, but overall, the gains
exceed the losses.
- There is no “paying back” to compensate for these losses, because it would be
incredibly complex and a ton of work to efficiently accomplish. There is also a ton of
people that would be claiming for money. In theory this could happen, but in reality the
system would not be plausible.
- Other benefits: an increased variety in goods, companies may achieve lower costs by
producing on a larger scale, increased competition, trade also enhances the spread of
ideas so more people can use them.
- So why does trade get opposed? The losses that come from trade on the losing side,
are big losses. i.e. New jobs, moving, difficult changes. Also, gains are spread over
many people, who may not be able to see how the trade is benefitting them. Losers
therefore, have the incentive to lobby and organize restrictions on trade.
- Tariff: a tax on imports.
- Ex. Cotton shirts… world price = $20, T= $10, so consumers pay $30. This means that
domestic producers will sell their shirts for $30. Since this is a tax, there is a DWL. But
this means that producers can gain a lot from convincing the government from putting
tariffs on certain goods. Depending on the elasticities, the DWL can be quite bad. DWL
can be from overproducing or under producing a good.
- Quota: a quantitative limit on imports of a good.
- Quotas mostly have the same effects as a tariff, minus the government revenue. Raises
price, reduces quantity of imports, reduces buyers’ welfare, and increases sellers’
welfare. The quota creates profits for the foreign producers of the imported goods, who
can sell them at the higher price. Quotas are often auctioned off by the government.
- Arguments against free trade: 1. Trade destroys jobs in industries that compete against
imports. (Economists argue that the work force can better go towards exports, especially
if we have the comparative advantage). 2. National security…some goods need to be
able to be individually produced in the case of war. Reliance can’t always be guaranteed,
we need to be able to provide for ourselves. We do need to maintain some primary
industries, but we need to find which industries really are necessary. 3. The infant-
industry argument: new industries should be supported and protected temporarily by
governments because over time they will grow bigger and compete with foreign firms.
(Economists say how does the government know whether or not you will succeed? It’s
coming out of everyone’s taxes). 4. The unfair competition argument: Producers argue
that their competitors in another country have an unfair advantage (due to government
subsidies). (Economists say that this is great, then we can import extra-cheap products
subsidized by other country’s taxpayers). 5. The protection-as-bargaining-chip argument:
i.e. If you’re putting a tax on my good, I will put a tax on yours. A threat. However, if no
change comes from the threat, they go through with their threat, which is a loss to the
country, or they don’t do anything, which is bad on the world market’s perception and
you don’t get what you wanted. Resolving factor: trade agreements. - A country can liberalize trade with: unilateral reductions in trade restrictions, multilateral
agreements with other nations.
- Examples: NAFTA, GATT, WTO enforces these, resolving disputes. But unfortunately,
the WTO has no real power.
- Externalities are the uncompensated impact of one person’s actions on the well-b