trade

is 99 percent Muslim, a religion that forbids alcohol consumption. Thus, Algeria exports wine.

8fi3 T?aCe Restrieti*ns &nd Wetfare 3.mss Despite the benefits of exchange, nearly all countries at one time or another erect trade barriers, which benefit some domestic produc- ers but harm other domestic producers and all domestie consumers. In this section, we consider the effects of trade barriers and the reasons they are imposed.

eonsrxmer SurpEus amd Produeen Surplaxs f,rom fularEcet frxehange Before we explore the net effects of world trade on social welfare, let's develop a framework showing the benefits that consumers and producers get from market exchange. Consider a hypothetical market for chicken, shown in Exhibit 5. As discussed way back in Chapter 4, the height of the demand curve shows what consumers are willing and able to pay for each additional pound of chicken. In effect, the height of the demand curve shows tlnemarginal benef t consum- ers e4pect from that^pound of chicken. For exanlPle, the demand curve indicates that some consum- ers in this market are willing to pay $r.5o or more per pound for the first few pounds of chicken. But

i..i: i:iii;i i, i.: Consumer Surplus and Producer Surplus

! c o

' 1.00OJ o_ 6 o E o

Consumer surplus

every consumer gets to buy chicken at the l:-'il::' clearing price, which here is $o.5o per pouni i'r:" consumers thus get a bonus, or a surplus, fror:- ::-":"

ket exchange. The blue -shaded trian gle below the demani ; -"' =

and above the market price reflects the consums" ' -- plus in this market, which is the difference ber;;i:::: the most that consumers wouid pay for 6o pour::= :

chicken per day and the actual amount they do :a ': We a1l enjoy a consumer surplus from most prod-: '' we buy.

Producers usually derive a similar surplus. Tht height of the supply curve shows what producers ai: willing and able to accepl for each additional pou'-: of chicken. That is, the height of the supply cun"; shows the expected marginal cost from producin= each additional pound of chicken. For example, th: supply curve indicates that some producers face a marginal cost of $o.25 or less per pound for supplying the first few pounds of chicken. But every producer gets to sell chicken for the market-clearing price ol $o.5o per pound. The gold-shaded triangle above the supply curve and below the market price reflects the producer surplus, which is the difference between the actual amount that producers receive for 6o pounds of chicken and what they would accept to supply that amount.

The point is that market exchange usuaiiy gener-

ates a surplus, or a bonus, for both consumers and producers.In the balance of this chapter, we will con- Ltime r-tr rbr-rd'ur'.tbe^ ganirs rftnrr rinErrrattnrarr .t*.nrlr and how trade restriclions affect consumer and pro-

ducer surplus.

Tariffs AtariJf, a term first introduced in Chapter 3, is a tax on imports. (Tariffs can apply to exports, too, but \"'e wili focus on import tariffs.) A tariff can be either specifc, such as a tariff of $5 per barrel of oil, or ad valorem, such as ro percent on the import price of jeans. Consider the effects of a specific tariff on a particular good. In Exhibit 7 on the next page' D is the U.S. demand for sugar and S is the supply of sugar from U.S. growers (there were about ro,ooo U'S. sug- arcane growers in zooT). Suppose that the world price of sugar is $o. ro per pound, as it was in June zoo7. The

world price is determined by the world suPPlY and demand for a product. it is the price at which any sup- plier can sell output on the worid market and at which any demander can purchase output on the world market.

world price the pr;ce ai which

= g*od is tr*rieci o:t tle wcrld mari<*t; geier" mi*ed by tl,e w+:'irj C*- mand a*d v.rcrlc sr.gPiit frr the gosd

CHAPT'ER rB jtttt:t:ii-,ti'.:i,'a

With free trade, anyU.S. consumers could

buy any amount desired at the world price of

$o.ro per pound, so the quantity demanded is 7o million pounds per month' of which U.S. producers supply zo million pounds and importers supply 5o miilion pounds' Because U.S. buyers can purchase sugar at

the world price, U.S. producers can't charge

more than that. Now suppose that a specific

tariff of $o.os is imposed on each pound of imported sugar, raising its price from $o'ro to $o. r5 per pound. U.S. producers can there-

fore raise their own price to $o.i5 per pound

as well without losing business to imports' At the higher price, the quantity supplied by U.S. producers increases to 3o million pounds, but the quantity demanded by U'S' consumers deciines to 6o million pounds' Because quantity demanded has declined and quantity supplied by U.S. producers has

increased, U.S. imports fal} from 5o million

tixi:ii;lt ;: Effect of a Tariff

$0.1 5

0.10

f

o c)

'- o-

70 Sugar (millions of

pounds per month)

to 3o million Pounds Per month. Because the U.S' price is higher after the tariff,

U.S. consumers are worse off. Their loss in consumer

surplus is identified in Exhibit 7 by the combination oftire blue- and pink-shaded areas. Because both the

U.S. price and the quantity suppiied by U'S produc-

ur. h".r" increased, their total revenue increases by the areas a plus b plus f. But only area a represents an increase in producer surplus. Revenue repre- sented by the areas b plusf merely offsets the higher

marginal cost U.S. producers face in expanding ,rrg"i ortprrt from zo million to 3o million pounds

per month. Area b represents part of the net welfare

ioss to the domestic economy because those ro mi1-

iion pounds could have been imported for $o'ro per

po.rrna rather than produced domestically at a higher

marginal cost. Government revenue from the tariff is identified

by area c, which equals the tariff of $o'o5 per pound multiplied by the 3o miliion pounds imported, for tariff revenue of $l.5 million per month' Tariff rev- enue is a loss to consumers' but because the tariff goes to the government' it can be used to lower taxes

) - U U N a Eu t-uL o

* 'i*

264 PART 4 lntet

or to increase public sewices' so it's not a loss to the

;.t. ";;;"*y.^Area

a shows a loss in corrsumer sur-

plus because less sugar is consumed -1:^t:" higher

iri.u. rho ioss is not iedistributed to anyone else' so

5t"la't"n*ts part of the net welfare loss of the tar-

inlir,".uror", ","ut b and d show the domestic econ-

;;;;-;;t*elfare loss of the tariff; the two triansles measureo loss in consumer surplus

that is not offsetby a

gain to anyane in the domestic economy'

In summary:Of the total loss in U'S' consumer sur-

p1";i;;";; ; ,u' ', andd) resulting from the tariff' area

I'g""t ," u.s produce", u'"u c becomes government revenue, but areas b and d are net

josses in domestic

social welfare.

Frwpor* ffiustes

r=l

t;l ri iti.:t

q.

.Lx,

ll '?

i; .:,,

i t::

.1tf ?i ::t:

T +.i:

t?g

:! :ii!

Animport quoia is a legal limit on the amount of a com-

;;t,u that can be imported' Quotas usually target

;;;;;it it""t certain countries' For example' a quota

ilt timit iurniture from china or shoes from Brazil'

To have an impact on the domestic market' a quota

r""tiU" set beiow what would be imported with free

trade. Consider a quota on the U'S' market for sugar'

i" p"""il"l of s*ltiUit 8, D is the U'S' demand curve

;;; i is the supply curve of u's' sugar producers' i"oo"J "g"i"

i"itlte world price of sugar is $o'ro p"ii,"""i. *rth free trade, that price would

prevaii

in the U.S. market as well' and a total of 7o miliion

;;;;;t ;."1d be demanded per month' u's' produc-

irs would suppiy zo million pounds and importers'

so *iflior-t pounis. with " q"o1" of 5o million pounds

or more per month, the U'S' price would remain the

i,xlrii.:ii i:l Effect of a 0uota

b)

$o.t s

0.10

SameaStheworldpriceof$o.loperpound,andquan- .d;il;e 7o million pounds per month' tn-th:Tl

" 6""o of at least so million poundswould

not rarse

the U.S. price above ttt" *otfi price because 5o mii-

lion pounds were lmported without a quota' A more

stringent quota, r'o*!'"u'' *::ld tY:^t*po*t' which'

", *in see, wouid raise the U'S' Pnce' Suppose U'S' trade officials

impose an import

quo"tJ?3o miilion pounds per month' As long as

the U.S. price is ut oi"bot'" tire world price of $o'ro

o"l n""tiu, foreign producers wiii supply 3o million

P o,r'' a r. t : " t f ':'.: :: : f il: ?: 1::f"Tti ?::i t'i;total suPPIY ot suga:

ozlrlino rn million pounds of imported sugar to the

qqsrlrb J-

amount supplied by U'S' producers' !tS- ana foreign

;;;;; would ''e"er s"tt in the u's' market for

less than $o'ro per pound because they can always

;";t;;;^;;;" o'' tr'"'*"rld market' rhus' the supplv

curve that sums Gomestic production and imports

is horizontal ai 1:he ;;rld price of $o'ro.per pound

and remains so until the quantity supplied reaches

5o million Pounds''" ;;;i;, io, prices above $o'ro per pound' the new

,"o;i;'.;;",'s', "dd' horizontilly the 3o-miliion-

;il; quota to s, the suppiy cuwe of u's,

lroducers' ii" u.s' price is found *tt"i" this new supply

curve'

S'. intersects the domestic demand curve' which in

i;J*t";; "iiJut8 occurs atpointe' Bv limitins

i^r"rrt, tn" quota raises the domestic price of sugar above

';;:;;;;;;ri;, and reduces quantitv betow.th,e free

trade

leuel. (Note that to to-pui" more easily the effects

of tariffs "rrd

q"otu', thi' q"ota is designed to yield

the same equilibrium price'and quantity as the tanff

examined earlier')

b)

!q

o_ L q) g

c oo 0)a c) ,9 o-

$0.1 5

0.10

20 50 70 Sugar (millions of Pounds Per month)

30 60 -0 S-g:- (millions of Poreds s€r '=:!i:r

L o-

20

as5