BackInternational Trade: Economic Effects, Tariffs, and Trade Policy
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International Trade
Introduction
International trade allows countries to exchange goods and services, leading to increased economic welfare. This chapter explores the determinants of trade, the effects of trade on economic welfare, the impact of tariffs and quotas, and the main arguments for and against restricting trade.
The Determinants of Trade
Equilibrium without Trade
Domestic Market Only: When a country does not engage in international trade, the equilibrium price and quantity are determined solely by domestic supply and demand.
Total Benefits: The sum of consumer surplus and producer surplus represents the total benefits to society.
Domestic Price and World Price
World Price: The price of a good that prevails in the world market.
Domestic Price: The price of a good in the domestic market without trade.
Comparative Advantage
If world price > domestic price, the country has a comparative advantage and will export the good.
If world price < domestic price, the country does not have a comparative advantage and will import the good.
The Winners and Losers from Trade
Small-Economy Assumption
A small economy is a price taker in world markets; its actions do not affect the world price.
With free trade, the world price becomes the relevant price for domestic buyers and sellers.
The Gains and Losses of an Exporting Country
Before trade: Domestic equilibrium price is lower than the world price.
After trade: Domestic price rises to the world price; domestic quantity supplied exceeds domestic quantity demanded, and the difference is exported.
Welfare Effects:
Consumer surplus decreases (buyers are worse off).
Producer surplus increases (sellers are better off).
Total surplus increases; the gains to producers exceed the losses to consumers.
The Gains and Losses of an Importing Country
Before trade: Domestic equilibrium price is higher than the world price.
After trade: Domestic price falls to the world price; domestic quantity demanded exceeds domestic quantity supplied, and the difference is imported.
Welfare Effects:
Consumer surplus increases (buyers are better off).
Producer surplus decreases (sellers are worse off).
Total surplus increases; the gains to consumers exceed the losses to producers.
Summary Table: Welfare Effects of Trade
Country Type | Consumer Surplus | Producer Surplus | Total Surplus |
|---|---|---|---|
Exporter | Decreases | Increases | Increases |
Importer | Increases | Decreases | Increases |
The Effects of a Tariff
Definition and Impact
Tariff: A tax on imported goods.
With free trade: Domestic price equals world price.
With a tariff: Domestic price equals world price plus the tariff amount.
Economic Effects of a Tariff
Reduces the quantity of imports.
Raises government revenue.
Decreases total surplus due to deadweight loss.
Deadweight Loss from a Tariff
Deadweight loss is represented by the loss in total surplus (areas D + F in standard supply and demand diagrams).
Tariffs move the market closer to the no-trade equilibrium, reducing the gains from trade.
Summary Table: Effects of a Tariff
Group | Effect |
|---|---|
Domestic Producers | Better off (higher price, more sales) |
Domestic Consumers | Worse off (higher price, less consumption) |
Government | Receives tariff revenue |
Society | Worse off (deadweight loss) |
Other Benefits of International Trade
Increased variety of goods for consumers.
Lower costs through economies of scale.
Increased competition, leading to greater efficiency.
Increased productivity and innovation.
Enhanced flow of ideas and technology.
The Arguments for Restricting Trade
The Jobs Argument
Trade can lead to job losses in some industries, but it also creates new jobs in export sectors.
Overall, job losses are offset by job gains.
The National-Security Argument
Some industries are vital for national security and may warrant protection.
However, firms may exaggerate their importance to gain protection.
The Infant-Industry Argument
New industries may need temporary protection to become established.
In practice, it is difficult to remove protection once granted, and not always necessary for growth.
The Unfair-Competition Argument
Some argue that trade is only fair if all countries play by the same rules.
Even if foreign governments subsidize exports, importing countries can still benefit overall.
The Protection-as-a-Bargaining-Chip Argument
Trade restrictions may be used to gain concessions from other countries.
However, threats may not work and can reduce economic welfare if implemented.
Conclusion
Public opinion is mixed on trade, but economists generally support free trade for its efficiency and welfare gains.
Free trade allocates resources efficiently and raises living standards both domestically and internationally.
Key Formulas and Concepts
Consumer Surplus: The area below the demand curve and above the price.
Producer Surplus: The area above the supply curve and below the price.
Total Surplus:
Tariff Effect on Price:
Deadweight Loss from Tariff: The sum of the losses in total surplus due to reduced trade (areas D + F in standard diagrams).
Example: Tariff Impact
Suppose the world price of a good is $10, and the domestic price without trade is $15. If a country opens to trade, it will import the good at $10. If a $2 tariff is imposed, the domestic price rises to $12, imports decrease, and deadweight loss occurs.
Additional info: In practice, the size of the deadweight loss depends on the elasticities of supply and demand. The more elastic the curves, the greater the deadweight loss from a tariff.
