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Chapter 9

Chapter 9 - International Trade.pdf

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Department
Economics
Course
ECON 1
Professor
Enrico Moretti
Semester
Spring

Description
Ch. 9 Notes: International Trade I.Determinants of Trade • examining the textile market in imaginary country of Isoland A. The Equilibrium without Trade • Isolandian textile market isolated from rest of world • Isoland not allowed to import or export textiles because no int’l trade, market textiles in Isoland consists solely of Isolandian buyers and • sellers • • suppose Isoland elects new president and re-evaluates trade policy, asking: • If gov’t allows Isolandians to import and export textiles, what will happen to the price of textiles and the quantity of textiles sold in the domestic textile market • Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses? • Should a tariff (a tax on textile imports) be part of the new trade policy? B. The World Price & ComparativeAdvantage • first issue = whether Isoland is likely to become a textile importer or exporter • to answer question, compare domestic prices (P ) wdth the world price • world price (P )W the prevailing price of textiles in the world markets • if PW> P :dIsoland will export textiles • domestic producers will be excited to receive higher prices available abroad if P > P : Isoland will import textiles • d W • domestic consumers will be excited to pay lower prices available from abroad • in essence, comparing P aWd P inddcates whether Isoland has a comparative advantage in producing textiles • if d is low, then suggests comparative advantage • if d is high, then suggests foreign countries have comparative advantage • trade among nations largely based on comparative advantage • trade is beneficial because allows each nation to specialize in doing what it does best • by comparing P wwth P befdre trade, we can determine whether Isoland is better or worse at producing textiles than the rest of the world II. Winners and Losers from Trade • to analyze welfare effects of free trade, Isolandian economists begin with assumption that Isoland is a small economy compared to the rest of the world small-economy assumption means Isoland’s actions have little effect on world markets (i.e. • any change in trade policy will not affect P w • thus, Isolandians are price takers • price takers: they take the world price as a given whether they are exporting or importing • small-economy assumption ≠ necessary to analyze gains and losses from int’l trade; simply tool to make simplified economic model A. The Gains and Losses of an Exporting Country • • domestic producers are better off while domestic consumers are worse off from exporting goods • total economic welfare increases, as is seen by the addition of D to total surplus; winners’ gains exceed losers’losses B. The Gains and Losses of an Importing Country • • domestic consumers are better off while domestic producers are worse off from importing goods • total economic welfare increases, as is seen by the addition of D to total surplus; winners’ gains exceed losers’losses C. The Effects of a Tariff • tariff: a tax on imported goods • will have no effect of Isoland is an exporter of textiles • tariff only matters if Isoland is an importer of textiles • under free trade, P d P w • • a tariff raises the price of imported textiles to be above P w • this means that domestic producers can increase P to P d tariwf • thus price of textiles (both imported and domestic) increases and becomes closer to the price that would prevail without trade • increased price causes: • reduction in domestic Q d • increase in domestic Q s • tariff reduces the quantity of imports and moves domestic market closer to its equilibrium without trade • gains and losses from tariff • • • tariff causes deadweight loss because it is a type of tax • distorts incentives and pushes allocation of scarce resources away from optimum • two effects: • encourages producers to increase production from Q to Q S1 S2 • even though the cost of making these incremental units exceeds cost of buying them at world price, the tariff makes it profitable for domestic producers to manufacture them anyways reduces quantity demanded from Q D to QD • 1 2 • even though domestic consumers value these incremental units at more than the world price, tariff induces them to cut back their purchases D. The Lessons for Trade Policy • once trade is allowed, Isolandian price of textiles will be driven to equal the price prevailing around the world • if PW> P :dIsoland will export textiles • domestic producers will gain because get to receive higher prices available abroad • if Pd> P W Isoland will import textiles • domestic consumers will be gain because pay lower prices available from abroa a tariff only has an impact if Isoland becomes a textile importer • • in this case, ariff moves economy closer to the no-trade equilibrium and has DWL • although tariff improves welfare of domestic producers and raises revenue for gov’t, these gains are more than offset by losses suffered by consumers • best policy from standpoint of economic efficiency would be to allow trade without tariff E. Other Benefits of International Trade • increased variety of goods • goods produced in diff. countries not exactly the same (e.g. German beer differs from American beer) • gives consumers greater variety to choose from lower costs through economies of scale • • economies of scale: some goods can be produced at low cost only if they are produced in large quantities • small firm with small market cannot take full advantage of economies of scale • international trade gives firms access to larger world markets and allows them to realize economies of scale more fully • increased competition • companies shielded from foreign competitors has more market power, which gives ability to raise prices above competitive levels; can reduce efficiency and quality of goods/ services • this is called a market failure enhanced flow of ideas • • transfer of technological advances often linked to trading goods that embody those advances • e.g. poor agricultural nation learning about computer revolution by buying computers from abroad III.Arguments for Restricting Trade • losers from free trade will oppose it • e.g. domestic producers oppose imports b/c lower revenue • e.g. domestic consumers oppose exports b/c higher prices
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