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PowerPoint Slides prepared by: V. Andreea CHIRITESCU Eastern Illinois University

N. GREGORY MANKIW

PRINCIPLES OF

ECONOMICS Eight Edition

Application: International Trade

CHAPTER

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The Determinants of Trade

•  The equilibrium without trade – Only domestic buyers and sellers – Equilibrium price and quantity

•  Determined on the domestic market – Total benefits

•  Consumer surplus •  Producer surplus

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Figure 1 Equilibrium without International Trade

When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. This figure shows consumer and producer surplus in an equilibrium without international trade for the textile market in the imaginary country of Isoland.

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Price of textiles

0 Quantity of textiles Equilibrium quantity

Consumer surplus

Producer surplus

Domestic demand

Equilibrium price

Domestic supply

ASK THE EXPERTS

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Trade Deals

“Past major trade deals have bene2ited most Americans.”

The Determinants of Trade

•  Allow for international trade? – Price and quantity sold in the domestic

market? – Who will gain from free trade; who will

lose, and will the gains exceed the losses?

– Should a tariff be part of the new trade policy?

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The Determinants of Trade

•  World price – Price of a good that prevails in the world

market for that good •  Domestic price

– Opportunity cost of the good on the domestic market

The Determinants of Trade

•  Compare domestic price with world price – Determine who has comparative

advantage – If domestic price < world price

•  Export the good •  The country has comparative advantage

– If domestic price > world price •  Import the good •  The world has comparative advantage

Winners and Losers from Trade

•  Exporting country – Domestic equilibrium price before trade is

below the world price – Once trade is allowed

•  Domestic price rises to equal the world price •  Domestic quantity supplied is greater than

domestic quantity demanded •  The difference: exports

Figure 2 International Trade in an Exporting Country Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of textiles produced domestically, and the demand curve shows the quantity consumed domestically. Exports from Isoland equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. Sellers are better off (producer surplus rises from C to B + C + D), and buyers are worse off (consumer surplus falls from A + B to A). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well- being of the country as a whole.

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Price of textiles

Quantity of textiles

Domestic quantity

demanded

Domestic quantity supplied

Domestic supply

Domestic demand

Price before trade

Price after trade

World price

Exports

The area D shows the increase in total surplus and represents the gains from trade

Winners and Losers from Trade

•  Exporting country – Before international trade

•  Consumer surplus •  Producer surplus

– With international trade •  Smaller consumer surplus •  Higher producer surplus •  Higher total surplus

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Winners and Losers from Trade

•  Exporting country, with international trade – Domestic producers of the good are better

off – Domestic consumers are worse off – Trade raises the economic well-being of a

nation •  Gains of the winners exceed the losses of the

losers

Winners and Losers from Trade

•  Importing country – Domestic equilibrium price before trade is

above world price – Once trade is allowed

•  Domestic price drops to equal the world price •  Domestic quantity supplied is less than

domestic quantity demanded •  The difference: imports

Figure 3 International Trade in an Importing Country Once trade is allowed, the domestic price falls to equal the world price. The supply curve shows the amount produced domestically, and the demand curve shows the amount consumed domestically. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off (consumer surplus rises from A to A + B + D), and sellers are worse off (producer surplus falls from B + C to C). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well- being of the country as a whole.

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Price of textiles

Quantity of textiles

Domestic quantity supplied

Domestic quantity demanded

Domestic supply

Domestic demand

Price before trade

Price after trade

World price

Imports

The area D shows the increase in total surplus and represents the gains from trade

Winners and Losers from Trade

•  Importing country – Before international trade

•  Consumer surplus •  Producer surplus

– With international trade •  Higher consumer surplus •  Smaller producer surplus •  Higher total surplus

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Winners and Losers from Trade

•  Importing country, with international trade – Domestic producers of the good are worse

off – Domestic consumers are better off – Trade raises the economic well-being of a

nation •  Gains of the winners exceed the losses of the

losers

•  Trade can make everyone better off © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Winners and Losers from Trade

•  Tariff – Tax on goods produced abroad and sold

domestically •  Free trade

– Domestic price = World price •  Tariff on imports

– Raises domestic price above world price •  By the amount of the tariff

Figure 4 The Effects of a Tariff A tariff, a tax on imports, reduces the quantity of imports and moves a market closer to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area D + F. These two triangles represent the deadweight loss from the tariff.

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Price of textiles

Quantity of textiles

Imports without tariff

Imports with tariff

D F E

Domestic demand

Domestic supply

Price without tariff World price

Price with tariff

Q1S Q2S Q2D Q1D

Tariff

The area D + F shows the fall in total surplus and represents the deadweight loss of the tariff.

Winners and Losers from Trade

•  The effects of a tariff – Price rises by the amount of the tariff – Domestic quantity demanded decreases – Domestic quantity supplied increases – Reduces the quantity of imports – Moves the domestic market closer to its

equilibrium without trade – Domestic sellers are better off – Domestic buyers are worse off

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Winners and Losers from Trade

•  Before the tariff – Consumer surplus – Producer surplus – Government tax revenue = 0

•  The effects of a tariff – Consumer surplus is smaller – Producer surplus is bigger – Government tax revenue – Total surplus is smaller

Winners and Losers from Trade

•  Other benefits of international trade – Increased variety of goods – Lower costs through economies of scale – Increased competition – Enhanced flow of ideas

•  Transfer of technological advances around the world

Arguments for Restricting Trade

•  The domestic producers – Oppose free trade – Believe that the

government should protect the domestic industry from foreign competition

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“You like protectionism as a ‘working man.’ How about as a consumer?”

Arguments for Restricting Trade

•  The jobs argument – “Trade with other countries destroys

domestic jobs” – Free trade creates jobs at the same time

that it destroys them •  The national-security argument

– “The industry is vital for national security” – When there are legitimate concerns over

national security

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Arguments for Restricting Trade

•  The infant-industry argument – “New industries need temporary trade

restriction to help them get started” – Difficult to implement in practice – The “temporary” policy is hard to remove – Protection is not necessary for an infant

industry to grow

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Arguments for Restricting Trade

•  The unfair-competition argument – “Free trade is desirable only if all countries

play by the same rules” – Increase in total surplus for the country

•  The protection-as-a-bargaining-chip argument – “Trade restrictions can be useful when we

bargain with our trading partners” – The threat may not work

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ASK THE EXPERTS

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Trade Deals

“Refusing to liberalize trade unless partner countries adopt new labor or environmental rules is a bad policy, because even if the new standards would reduce distortions on some dimensions, such a policy involves threatening to maintain large distortions in the form of restricted trade.”

Trade agreements and the WTO

•  World Trade Organization, WTO •  Unilateral approach to achieve free trade

– Remove its trade restrictions on its own – Great Britain, 19th century – Chile and South Korea, recent years

•  Multilateral approach to free trade – Reduce its trade restrictions while other

countries do the same – NAFTA, GATT

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Trade agreements and the WTO

•  North American Free Trade Agreement (NAFTA) – 1993, lowered trade barriers among the

United States, Mexico, and Canada •  General Agreement on Tariffs and Trade

(GATT) – Continuing series of negotiations among

many of the world’s countries with the goal of promoting free trade

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Trade agreements and the WTO

•  GATT – United States helped to found GATT

•  After World War II •  In response to the high tariffs imposed during

the Great Depression – Successfully reduced the average tariff

among member countries from about 40 to 5%

– Enforced by the WTO – 2015: 162 countries; more than 97 % of

world trade 28

Trade agreements and the WTO

•  Advantages of the multilateral approach – Potential to result in freer trade than

unilateral approach •  Reduce trade restrictions abroad and at

home – Political advantage

•  Producers are fewer and better organized than consumers

•  Greater political influence

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