ECON 4321
Module 6B: Nontariff Distortions To
Trade
Corresponding Chapter in the Book: 9
INTRODUCTION
In general, tariffs have declined over the years but have been
replaced by other forms of protectionism.
Nontariff barriers to trade (NTBs) are government policies
other than tariffs that tend to distort trade.
Less visible than tariffs, but have a significant impact on
trade
They can reduce or prevent trade
2
Econ 4321: International Trade
IMPORT QUOTAS
On January 1, 2005, China was about to become the world’s
largest exporter of textiles and apparel products (Feenstra
and Taylor, 2008)
On that date, the Multifibre Arrangement (MFA) was
abolished
Under the MFA, import quotas restricted the amount of
nearly every textile and apparel product imported to
Canada, the European Union, and the U.S.
The quotas were intended to protect their own domestic firms
that produced those products.
With the end of the MFA, China was ready to enjoy
increased imports.
The threat of import competition from China led the U.S.
and Europe to negotiate new quotas with China.
Econ 4321: International Trade 3
IMPORT QUOTAS 2
There are other examples of quotas.
Europe had a quota on banana imports that allowed a
greater number of bananas to enter from its former
colonies in Africa than from Latin America.
In 2005, this quota was replaced with a tariff.
The proposal was to implement one import tariff but
no quotas on bananas except for the former French,
British, and Portuguese colonies, which will continue
to enjoy duty-free access.
Econ 4321: International Trade 4
SWEET OPPORTUNITY
The U.S. sugar program guarantees that American sugar
producers receive a set price for their product (Feenstra and
Taylor, 2008)
If they cannot sell all their sugar at the “break-even” price
after accounting for their loans, they can sell the excess to the
U.S. Department of Agriculture.
The U.S. regulates supply by imposing import quotas on
sugar to prevent the accumulation of a large sugar stock.
Econ 4321: International Trade 5
SWEET OPPORTUNITY 2
However, the U.S. price of sugar has been two to three times
higher than the global price of sugar for years.
The longer the protection holds, the more inefficient the U.S.
producers become and the more powerful they become as a
particular interest group (FT, 2008)
Econ 4321: International Trade 6
QUOTAS
Quota
A government policy that limits imports of a product to a
certain number of units
It is considered harmful
The WTO bans it, but it still exists
However, there are five reasons why they still exist in
various forms.
7
Econ 4321: International Trade
QUOTAS 2
1. Not all countries are members of the WTO
They are, therefore, free to impose quotas
Developing countries are reluctant to join the WTO
because they would have to eliminate quotas
2. Members of the WTO are allowed to maintain quotas for a
specified period of time
When joining, an agreement is made for a transition period
to eliminate quotas
The transition period allows time to implement trade
regulations consistent with the WTO
Transition periods are usually long, 15 years for Mexico
3. Some countries implement quotas in defiance of WTO rules-
refuse to obey
France is the world leader
8
Econ 4321: International Trade
QUOTAS 3
4. International trade in textiles and apparel is profoundly
distorted by the Multifibre Arrangement (MFA):
MFA manages trade in textile and apparel markets by
enforcing quota by-products by the country
Uruguay Round negotiations have led to the phasing out of
the MFA
5. WTO standards have not previously covered agricultural
products
9
Econ 4321: International Trade
QUOTAS 4
Table 9.1 Number of import quotas in theQuotas
major onindustrialized countries
Quotas on
Total number of agricultural industrial
Country import quotas products products
US 7 1 6
Canada 5 4 1
UK 3 1 2
France 46 19 27
Germany 4 3 1
Italy 8 3 5
Benelux 5 2 3
Japan 27 22 5
Econ 4321: International Trade 10
QUOTAS 5
Voluntary Export Restraint (VER)
Until 1999, a form of protection known as a voluntary export
restraint (VER) was employed by some countries.
It is an agreement by a country to limit its exports to another
country to a specified quantity.
It differs from a quota regarding who administers the
restraint – the importing or exporting country.
Since it is “voluntary,” it is legal under WTO regulations
But violates the spirit of WTO regulations
VER is difficult to negotiate
Distribution of exports among exporting firms
Exporting countries are likely not happy with the
restraint.
Important VERs in the U.S. are on steel and autos.
11
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA
We want to separate the effect a quota has on
producers and consumers
We will use the supply and demand model to
illustrate the effects
A country with a comparative disadvantage in cloth
production decides to open its borders to trade
Econ 4321: International Trade 12
THE ECONOMIC EFFECTS OF A QUOTA 2
The total supply of cloth in the importing country is illustrated by the supply curve S+Q. So,
for all prices above the world price, Pw, the total supply of cloth in the importing country
would be equal to the domestic supply (S) plus the quota amount.
Domestic Effects of a Quota
Price of Cloth
S
P1
S+Q
E
P
G
Pq
a b c d F
Pw
D
Quota
Q1 Q3 Q4 Q2 Quantity of Cloth 13
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 3
In the absence of trade, the equilibrium point is point E, with
the domestic price of cloth equaling P
Now suppose the country opens its borders to trade.
The country imports cloth at a price of Pw, and the free trade
equilibrium is located at point F
So, the price falls from P to Pw.
Q1 amount of cloth is domestically produced, and the amount
Q1 to Q2 is imported.
14
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 4
Suppose the government imposes an import quota restricting
the supply of imported cloth to X units.
The total supply of cloth in the importing country is illustrated
by the supply curve S+Q. So, for all prices above the world
price, Pw, the total supply of cloth in the importing country
would be equal to the domestic supply (S) plus the quota
amount.
Because the supply of imported cloth is reduced at the world
price of Pw, the price of cloth will begin to rise until a new
equilibrium is reached at G.
Domestic consumers are harmed as consumer surplus
declines by areas (a+b+c+d)
15
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 5
a: the increase in producer welfare (surplus) by imposing a
quota
b: represents the cost of resources transferred from their best
use to the production of more cloth (the country has a
comparative DISADVANTAGE in the production of cloth)
d: consumption effect caused by a quota as consumers
purchase less cloth
c: accrues to the foreign producers and makes them more
profitable
Note that country loses areas (b+c+d) under a quota but only 16
areas (b+d) under a tariff. Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 6
With a tariff, area ‘c’ was government revenue from the tariff.
With a quota, higher prices to foreign producers provide
benefits, so ‘c’ is a transfer of welfare from domestic
consumers to foreign producers.
17
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 7
The quota won’t change, so the price increases.
Domestic suppliers produce additional cloth.
Foreign producers get a higher price for cloth.
Consumers pay a higher price for cloth.
18
Econ 4321: International Trade
THERE ARE TWO METHODS AVAILABLE FOR A GOVERNMENT TO
CAPTURE AREA C UNDER A QUOTA
A domestic country can gain area ‘c’.
Auction quota
First, the government could auction quotas to foreign producers in
a free market.
The advantage to this auction quota method is that the domestic
government would gain area c, which now accrues to foreigners,
and the limited quota supply would go to those importers most in
need of the product who would pay the highest prices.
Equivalent tariff
The replacement of a quota with a tariff that restricts imports to the
same level
Tariffs are legal under the WTO.
Calculating tariff equivalent is easy – the difference between the
good’s world price and domestic price under a quota.
A tariff is less restrictive.
19
Econ 4321: International Trade
The conversion of quotas into a tariff has several advantages
First, tariffs are legal under the WTO, and quotas are not
If foreign firms find the quota sufficiently burdensome,
they can perhaps get their government to complain to the
WTO for a remedy
Second, calculating a tariff equivalent for an existing quota is
easy to do
To calculate a tariff equivalent, take the difference
between the good's world market price and the good's
quota-constrained domestic price and divide that
difference by the good's world market price
A tariff equivalent refers to the tariff that would be necessary
to afford the same level of protection as a quota
It is the difference between the world market price and
the quota-constrained price in the domestic market 20
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 8
SHOW WHY A QUOTA IS WORSE THAN A TARIFF
IF THE DEMAND FOR THE PRODUCT INCREASES.
Domestic Effects of a Quota When Demand Increases
Price of Cloth
P1 S
S+Q
E
P
Pq’
Pt = Pq H
Tariff b c d
Pw D’
D
P2
Q1 Q3Econ 4321: International TradeQ4 Q2 Quantity of Cloth 21
THE ECONOMIC EFFECTS OF A QUOTA 9
Assume that the demand for cloth increases from D to D’ after
a quota has been imposed
As a result of the quota, the quantity imported, Q3 to Q4,
cannot increase when there is an increase in demand and the
price of cloth rises from Pq to Pq’
Note that in the case of a tariff, the price would remain
constant at Pt, and the additional demand for cloth would
cause additional imports of cloth, assuming that the supply of
imports is horizontal.
However, in the presence of a quota, the domestic producer
supplies the increased demand. In this case, the foreign
producer also gains as the price they receive for their
product increases.
So, the losses for consumers and society are much larger in
the case of a quota than in the case of a tariff when demand
increases.
These losses are shown by area (b+c+d)
The losses to society increase as the demand for the product
increases. Econ 4321: International Trade
22
THE ECONOMIC EFFECTS OF A QUOTA 10
Under a tariff, there is no restriction on quantity, so the price
stays the same
Increased quantity comes from imports
No change in supply from domestic producers
Consumers keep lower prices.
Losses to society and consumers are much greater with a
quota than with a tariff when demand increases.
Losses increase as demand increases.
Long-run anti-competitive effects of quotas may be
significantly diminished.
23
Econ 4321: International Trade
THE ECONOMIC EFFECTS OF A QUOTA 11
We have assumed that the demand for the product increases
from D to D' after a quota has been placed in the market.
As a result of the quota, the quantity imported cannot increase
when demand increases.
As a result, the price of the product continues to rise
In the case of a tariff, the price would remain constant at P’, and the
additional demand for cloth would be supplied with additional
imports of cloth
However, when a quota is present in the domestic market, the
domestic producers supply the increase in domestic demand
The foreign producers of cloth also gain in this case, as the price
they receive for their product increases
The important point is that the losses for consumers and society
are much larger in the case of a quota than in the case of a tariff
when the demand increases.
The shaded area shows these losses, and as the figure indicates,
losses to society increase as the demand for the product increases. 24
OTHER NONTARIFF DISTORTIONS
Quotas reduce foreign competition in the short run, but the
long-run anticompetitive impact may be diminished for
several reasons.
First, quotas may entice foreign exporters to engage in
foreign direct investment in the quota-constrained market.
Suppose the domestic market in the importing country is
large enough, and the barriers to exporting are sufficiently
high. In that case, foreign firms may find it profitable to build
production facilities in the importing country.
Second, when an importing country enforces a quota, the
quota is stated as a specific number of units without regard
to their price.
In this case, exporters have the incentive to export the highest-quality
and most expensive version of the product.
25
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 2
Industrial Policy
Every country conducts an industrial policy
There are many possible regulations, but taxes and
labor regulations are two examples.
National differences in business taxes can distort trade
flows between countries.
National differences in labor laws may make it more
difficult or expensive to schedule workers or change
workforce levels, giving one country an advantage.
26
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 3
As tariffs have declined, national differences in industrial
policy have a greater chance of altering the pattern of world
production and trade.
If a country enters a free-trade agreement, differences in
business regulations become more important.
As traditional trade barriers fall, industrial policy becomes
more important.
27
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 4
“Hard Industrial Policy (tariffs, subsidies to specific sectors,
tax breaks for foreign investors, domestic content
requirements)
Soft Industrial Policy (special economic zones offering
lower cost infrastructure, roads, and ports designed to
improve trade, special credit for exporters, promoting
clusters to export.”
“Industrial policy leads to more innovation and growth when
it is implemented either in competitive sectors or in a way
that promotes competition.”
Industrial Policy and Competition (by A. Harrison, P.
Aghion, J. Cai, M. Dewatripont, L. Du, and P. Legros,
American Economic Journal: Macroeconomics,2015)
28
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 5
As tariffs have declined, national differences in industrial policy
have a greater chance of altering the pattern of world production
and trade.
This is especially true given the increasing number of free-trade
agreements between countries.
Once countries have entered into a free-trade agreement that
abolishes tariffs and quotas, then differences in business
regulations among the countries become more important.
For example, as Canada and the U.S. have abolished trade
restrictions, the resulting differences in each country's
regulation of an industry can have noticeable effects on the
trade flows between the two countries.
If Canada decides to regulate an industry that the U.S. does not
heavily, then the industry will likely shrink in Canada and
expand in the U.S.
The result is that as traditional trade barriers fall, the
industrial policy takes on increasing importance. 29
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 6
Technical Barriers to Trade
Technical barriers refer to a country’s national regulations and
standards for consumer safety, protection of the environment,
national security, product labeling, and quality.
They can distort international trade.
Exported goods may have to meet different labeling and
technical standards
Differences in the degree of regulation can affect services
The Technical Barriers to Trade Agreement of the WTO
requires that the member countries make their
regulations and standards public
Governments should be nondiscriminatory when using
these policies and are expected to use the international
standards
The member countries are also required to inform the
WTO when changing these policies 30
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 7
If the intent of the regulations is an expression of national
preference and the adverse effects are a byproduct of this, it
is difficult to complain to the WTO.
If the regulations are intended to protect an industry,
countries can complain to the WTO or threaten retaliation.
Intervention by the WTO in these disputes has NOT
generally been successful.
31
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 8
Government procurement is one of the most apparent cases of
government rules and regulations that distort trade.
Government procurement laws require a government to buy
domestically made products unless comparable foreign-made
products are substantially cheaper.
“Buy American” act, for instance, directs government agencies
to buy domestically produced products unless the price of
domestic products is higher than the foreign price of these
products by more than 12%
Government purchases of goods and services are subject to
constraints, and frequently, governments have regulations that
give preferences to domestic firms.
The rationale for these regulations is that purchasing domestic
products is more beneficial to the country than importing them.
The issue of government procurement has become important
because, in most countries, government purchases account for 10
to 15 percent of the GDP Econ 4321: International Trade
32
OTHER NONTARIFF DISTORTIONS 9
Health and Safety Standards
Governments expect food and medicines to be safe
The use of growth hormones by the beef producers
All countries can legitimately prohibit imports that pose a risk
to the health and safety of consumers.
However, it is fairly straightforward in some cases to construct
health and safety regulations that would not be expensive for
domestic producers to comply with but would be costly for
foreign producers.
The Sanitary and Phytosanitary Agreement (SPA), a WTO
agreement, provides rules for food safety and health standards.
The rules imposed by the countries are required to be based on
science.
33
Econ 4321: International Trade
INTELLECTUAL PROPERTY RIGHTS
❖ The level of enforcement of intellectual property rights varies
across countries
❖ Patent, copyright, and trademark laws
❖ The Trade Related Intellectual Property Rights (TRIPs) agreement of
WTO involves the protection of intellectual property rights (patents,
copyrights, trademarks, industrial design)
❖ Visit [Link]
trips_01_e.htm
34
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 10
Subsidies
Subsidies are common and becoming more important
They can be explicit, as in direct payments of money
to an industry
They can be indirect as reduced taxes, lower utility
rates, or a lower level of business regulation
Subsidies have the potential to change the pattern of
trade among countries
35
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 11
The two types of government subsidies that affect
international trade are direct export subsidies and domestic
subsidies as part of a country's industrial policy.
Domestic subsidies are given to a firm or industry to
accomplish domestic policy objectives.
Trying to eliminate the domestic subsidy is a complicated
problem, as it requires a country to adjust its industrial
policy objectives.
36
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 12
Direct subsidies are illegal under WTO rules and can be
offset by domestic tariffs.
As a result, they are uncommon.
Indirect subsidies are more troublesome as they are
intended to address a domestic policy objective.
These subsidies can also distort trade.
37
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 13
An export subsidy is a government payment (direct or
indirect) to firms or industries.
Tax rebates, subsidized loans, guarantees against losses,
insurance guarantees, government support for research
and development, and grants
It allows the exporting firms to charge a lower price than they
would without the subsidy.
Lower prices would allow the firms to increase their market
share in the world market.
These subsidies on manufactured products are illegal under
WTO rules
WTO allows subsidies on primary products (e.g., agricultural)
Countries can impose a tariff on subsidized exports (a
countervailing duty) to offset the foreign subsidies
38
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 14
With the tariffs, the production or output of the import-
competing sector increases.
With export subsidies, export increases, but the cost
associated with the additional export sales via subsidies
will be higher than the associated revenue – limited
resources are diverted.
The export subsidies also allow for turning away sales from
the domestic market to the international market, and thus
the prices of the products in the home market increase.
Furthermore, governments may need to increase various
taxes (such as the sales tax) to finance the export subsidies.
Thus, the effects on the consumers are similar to the
impact of tariffs.
39
Econ 4321: International Trade
OTHER NONTARIFF DISTORTIONS 15
In some countries, the government may own a portion of
a particular industry, which can be a significant barrier
to trade.
The discrimination against foreign firms is much larger.
The WTO has a voluntary code to address this issue, but
governments are reluctant to relinquish this particular
form of protectionism.
40
Econ 4321: International Trade
CORRUPTION AND INTERNATIONAL TRADE
❖ Corruption means the use of public office for private gain as
it relates to international trade
❖ The passing of money from the private sector into the
hands of a government employee
❖ Facilitation payments are a common practice and have
little impact on trade
❖ Bribes can influence a government employee to do
something illegal
❖ This may involve tariffs or quotas
41
Econ 4321: International Trade
CORRUPTION AND INTERNATIONAL TRADE 2
❖ High tariffs and quotas often lead to the payment of
bribes.
❖ Lacking a profit motive, government officials may be
bribed to purchase higher-priced or lower-quality products
that they would not have otherwise purchased.
❖ Bribes are generally illegal in the country where they are
made.
❖ Developed countries have also moved to make it illegal to
bribe foreign officials, with 35 countries committed to the
principle.
42
Econ 4321: International Trade
CORRUPTION AND INTERNATIONAL TRADE 3
Corruption can potentially influence international
trade through government procurement.
Firms may attempt to export products purchased by
foreign governments by bribing government officials
in these countries to buy them.
43
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CORRUPTION AND INTERNATIONAL TRADE 4
Table 9.2 Corruption perceptions index for selected countries, 2013
Rank Country CPI score Rank Country CPI score
1 Denmark 91 163 Guinea-Bissau 19
1 New Zealand 91 163 Haiti 19
3 Finland 89 167 Yemen 18
4 Sweden 89 168 Syria 17
5 Norway 86 168 Uzbekistan 17
6 Singapore 86 168 Turkmenistan 17
7 Switzerland 85 171 Iraq 16
8 Netherlands 83 172 Libya 15
9 Australia 81 173 South Sudan 14
9 Canada 8.7 174 Sudan 11
Econ 4321: International Trade 44
ECONOMIC SANCTIONS
Sanctions frequently involve both international
economics and international finance.
Economic sanctions are a government's deliberate
withdrawal of normal trade or financial relationships
to achieve foreign policy goals.
As the private sector would not withdraw from a
profitable economic relationship, it takes the coercive
power of a government to effect this change.
45
Econ 4321: International Trade
ECONOMIC SANCTIONS 2
The government imposing the sanction is referred
to as the sender, and the country that is the object of
the sanction is the target.
The idea is that the cost of the sanction will induce the
target to change its policies.
It is necessary to distinguish between actual
sanctions and the threat of sanctions, which may be
as effective as actual sanctions.
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Econ 4321: International Trade
ECONOMIC SANCTIONS 3
Sanctions can take on many forms.
Sanctions do not usually end all trade between countries
Sanctions may be imposed on only the part of the trade
that is important to the target country
Sanctions may involve a suspension of imports or a
suspension of exports.
Sanctions may be imposed on FDI.
Sanctions may include movements of portfolio capital.
47
Econ 4321: International Trade
ECONOMIC SANCTIONS 4
In some cases, sanctions are legitimized by a
multilateral organization, such as the U.N., and may be
imposed on the target country by multiple countries.
The WTO has the authority to impose economic
sanctions on members that violate international trade
rules.
Historically, sanctions were an adjunct to actual war.
In the past 50 years, they emerged as a distinct foreign
policy tool.
48
Econ 4321: International Trade
ECONOMIC SANCTIONS 5
Sanctions are attractive because they occupy the middle
ground between simple complaints and outright warfare.
However, sanctions usually fail to change a target
country’s behavior
• Sanctions may be too weak a response
• Given globalization, sanctions may not be effective
• Sanctions may invoke support for the target country from its
population and allies
• Costs imposed on the sender’s population may weaken
domestic support
49
Econ 4321: International Trade
LABOR AND ENVIRONMENTAL STANDARDS
Labor and environmental standards are controversial
aspects of international trade.
Intense global competition drives companies to cut costs
aggressively.
This forces companies to reduce labor costs in any way
possible.
Companies may locate in areas with lower environmental
regulations.
Both situations create a “race to the bottom” as
companies try to cut costs. 50
Econ 4321: International Trade
LABOR AND ENVIRONMENTAL STANDARDS 2
Over time, this would result in even poorer working
conditions and a more polluted environment.
The solution would be a global standard concerning
labor and environmental regulations.
Such a standard would constitute a nontariff barrier to
trade, as developing countries would struggle to meet
the standards of developed countries.
51
Econ 4321: International Trade
LABOR AND ENVIRONMENTAL STANDARDS 3
All countries have regulations for workers concerning
wages, safety, and work conditions.
These labor standards and their enforcement vary from
country to country.
Wages and working conditions are positively correlated
with GDP per capita.
Developed countries argue that they cannot compete with
wages and standards in countries with lower standards.
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LABOR AND ENVIRONMENTAL STANDARDS 4
Developing countries view such regulations as
protectionism and tend to view them as hindrances to their
efforts to reduce poverty.
The same type of argument applies to national differences
in environmental standards.
Pollution-intensive industries will likely relocate to
countries with lower environmental standards.
Countries with high standards are disadvantaged.
53
Econ 4321: International Trade
LABOR AND ENVIRONMENTAL STANDARDS 5
Pollution levels appear to be correlated with GDP per
capita.
But this relationship is quadratic.
At the lower levels of income, pollution increases as
income increases, but beyond a turning point (about
$15000 of GDP per capita), pollution decreases as
income increases (See Grossman and Kreuger, 1993)
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LABOR AND ENVIRONMENTAL STANDARDS 6
Both of these reasons would slow the growth of
developing countries.
This would increase the pollution level in that country.
The WTO is unlikely to establish global standards on
labor and environmental issues.
One promising development is trade negotiations
between countries.
Parties commit to rigorous enforcement of their own
appropriate standards.
55
Econ 4321: International Trade
TRANSPORTATION COST AND TRADE
Transportation costs are not zero, as simple supply and
demand models assume.
Transportation costs tend to reduce the quantity of trade
between countries by raising the price of imported
goods.
Products will be traded internationally if transportation
costs are low enough so that it is profitable to trade the
goods between countries.
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TRANSPORTATION COST AND TRADE 2
Effects of Transportation Costs on International Trade
Price of SUS Price of SINDIA
Cloth Cloth
E
PUS
P1
P* T P*
P2 P2
PINDIA F
DUS DINDIA
Q1 Q5 Q6 Q2 Quantity of Cloth Q3 Q7 Q8 Q4 Quantity of Cloth
U.S. Cloth Market India’s Cloth Market
57
Econ 4321: International Trade
TRANSPORTATION COST AND TRADE 3
Suppose that transportation costs per unit of cloth are
equal to T
This means that
The price of imported cloth will rise from P* to P1
The quantity of imported cloth falls from the horizontal
difference Q1 to Q2 to the smaller amount Q5 to Q6
Also, the net price (the price of imported cloth in the U.S.
minus transportation costs) of exported cloth from India falls
The price of cloth in India falls from P* to P2
India’s price of cloth will fall until U.S. imports of cloth (Q5 to
Q6) equal India’s exports of cloth (Q7 to Q8). The difference
between the U.S. price, P1, and India’s price, P2, equals the
transportation cost, T.
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TRANSPORTATION COST AND TRADE 4
With positive transportation costs, the quantity of goods
traded declines as the price of imported goods increases and
the price of exported goods falls.
Additionally, in the importing country, the consumption of
imports declines while domestic production of import-
competing goods increases.
For the exporting country, the consumption of the exported
goods increases while the production of the exported goods
decreases.
Thus, transportation costs affect the price of cloth and the
quantities traded partially back toward the no-trade
situation.
Transportation costs act as a barrier to trade, much like tariffs
and other non-tariff barriers.
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TRANSPORTATION COST AND TRADE 5
Nontradable goods are those whose transportation
costs are so high that they make trade unprofitable.
Tradable goods have transportation costs low enough
to make it profitable to trade goods between
countries.
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SOURCES
Robert C. Feenstra and Alan M. Taylor, International Trade,
1st edition, 2008. Econ 5321 Slides, FA 2009
W. Charles Sawyer and Richard L. Sprinkle, International
Economics, 2nd edition, 2006.
Harrison and Rodriguez Clare (2010) in Handbook of
Development Economics
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