Application:
International Trade
PowerPoint Slides prepared by:
Andreea CHIRITESCU
Eastern Illinois University
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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
The Equilibrium without International Trade
Price of
textiles Domestic
Supply
Consumer
Equilibrium surplus
price Producer
surplus
Domestic
Demand
0 Equilibrium Quantity of textiles
quantity
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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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
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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
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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 = world price
• Domestic quantity supplied > domestic
quantity demanded
• The difference = exports
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Figure 2
International Trade in an Exporting Country
Once trade is allowed, the domestic
Price Domestic
price rises to equal the world price.
of textiles Exports Supply
The supply curve shows the quantity
A of textiles produced domestically, and
Price World the demand curve shows the quantity
after trade D Price consumed domestically. Exports from
B
Price Isoland equal the difference between
the domestic quantity supplied and
before trade
the domestic quantity demanded at
C the world price. Sellers are better off
Domestic (producer surplus rises from C to B +
Demand C + D), and buyers are worse off
Exports
(consumer surplus falls from A + B to
A). Total surplus rises by an amount
equal to area D, indicating that trade
0 Domestic Domestic Quantity
raises the economic well-being of the
Quantity Quantity of textiles
country as a whole.
Demanded Supplied
The area D shows the
increase in total surplus
and represents the gains
from trade
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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
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Winners and Losers From Trade
• Importing country
– Domestic equilibrium price before trade is
above world price
– Once trade is allowed
• Domestic price drops to = world price
• Domestic quantity supplied < domestic
quantity demanded
• The difference = imports
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Figure 3
International Trade in an Importing Country
Price of Once trade is allowed, the domestic
Domestic
textiles price falls to equal the world price.
Supply
The supply curve shows the amount
produced domestically, and the
A demand curve shows the amount
consumed domestically. Imports
Price
equal the difference between the
before trade
domestic quantity demanded and the
B D
Price World domestic quantity supplied at the
after trade Price world price. Buyers are better off
C (consumer surplus rises from A to A +
Imports Domestic B + D), and sellers are worse off
Demand (producer surplus falls from B + C to
C). Total surplus rises by an amount
0 Domestic Domestic Quantity equal to area D, indicating that trade
Quantity Quantity of textiles raises the economic well-being of the
Supplied Demanded country as a whole
The area D shows the
increase in total surplus
and represents the gains
from trade
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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
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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
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Figure 4
The Effects of a Tariff
Price of
Domestic A tariff reduces the
textiles
Supply quantity of imports and
moves a market closer to
the equilibrium that
would exist without trade.
A Tariff Total surplus falls by an
B amount equal to area D +
Price with tariff F. These two triangles
C D E F represent the deadweight
Price without tariff World Price
loss from the tariff.
G Imports
with tariff Domestic
Demand
0 Q1S Q2S Q2D Q1D Quantity of
textiles
Imports without tariff
The area D + F
shows the fall in
total surplus and
represents the
deadweight loss
of the tariff.
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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
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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
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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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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
– 153 countries; 97 % of world trade
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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 - fewer and better organized than
consumers
• Greater political influence
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