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Chapter 9

Chapter 9 Economics.docx

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Harvard University
Economics 10a
Gregory Mankiw

Chapter 9 Economics:Application: International Trade • All countries can benefit from trading with one another because trade allows each country to specialized in doing what it does best • When there is no international trade, the domestic price adjusts to balance the quantity supplied by domestic sellers and the quantity demanded by domestic buyers • World price: the price of a good that prevails in the world market for that good • If the world price of textiles is higher than the domestic price, then the country will export textiles once trade is permitted • If the world price of textiles is lower than the domestic price, then the country will import textiles • Comparing the world price and the domestic price before trade indicates who has the comparative advantage in producing the good o Domestic price: opportunity cost of textiles  If domestic price is low, the country is more likely to have comparative advantage in producing that good  If domestic price is high, then the cost of producing the good is high, meaning that foreign countries probably have comparative advantage • The small country/small economy assumption means that such a country’s actions have little effect on world marketschanging trade policy will not affect the world price of the good o “Price takers” in the world economytake the price of the good that is given o Not necessary to analyze gains and losses from trade, but it simplifies analysis • The world price represents a perfectly elastic demand curvea small country can sell as many units of a good as it desires without affecting the world price • In exporter situations, domestic producers of a good are better off because they can sell the good at higher prices; consumers are worse off because they have to buy the good at a higher price • Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers • The horizontal line at world price represents the supply of the rest of the worldIt is perfectly elastic because the country is small and can buy as many goods at world price as it needs • When trade and importation of goods forces the domestic prices to fail, domestic consumers are better off (buy at lower price) and domestic producers are worse off (sell at a lower price) • Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers • With trade, the gains of the winners exceed the losses of the losers o Opening an economy to trade expands the economy pie, leaving some members of an economy with a smaller slice • Tariff: a tax on goods produced abroad and sold domestically (imports) o Atariff raises the price of imported goods above the world price by the amount of the tariff  This allows domestic producers to charge the world price plus the tariff for their goodsthe price of the imported and domestic goods rise by the amount of the tariff • The tariff reduces the quantity of imports and moves the domestic market closer to its 1 2 equilibrium without trade (1oves d2mestic quantity demanded from Q to Q and Dhe D quantity supplied from Q toSQ ) S • Atariff makes domestic sellers better off by raising the domestic price, but domestic buyers are worse off. The government also raises revenue. Area D represents deadweight loss from overproduction of textiles Area F represents deadweight loss form underconsumption of textiles • Tariffs cause deadweight losses because they are taxes on imports o They distort incentives and push the allocation of scarce resources away from the optimum 1 2 o Tariffs encourage domestic producers to increase production from Q to Q S S o When the tariff raises the price that domestic consumers have to pay, it encourages 1 2 them to reduce consumption of the good from Q to Q D D • Benefits of Free Trade: o Increased variety of goods o Lower costs through economies of scalesome goods can be produced at low cost only if they are produced in large quantities (economies of scale)  Firms in small countries cannot take advantage of economies of scale in a small domestic marketfree trade allows access to the larger world market and the ability to realize economies of scale more fully
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