International Trade

1. 7 International Trade

2. Exam • Date: Tuesday, February 13, 2007 • Time: 15:15 – 16:45 (90 minutes) • Place: HG E 7 • For those who canNOT register via eDoz, please register via email: • introecon@kof.ethz.ch • Deadline: Thursday, 21. December 2006

3. General Information

4. What determines whether a country imports or exports a good?

5. Who gains and who loses from free trade among countries?

6. What are the arguments that people use to advocate trade restrictions?

7. THE DETERMINANTS OF TRADE • Equilibrium Without Trade • Assume: • A country is isolated from rest of the world and produces steel. • The market for steel consists of the buyers and sellers in the country. • No one in the country is allowed to import or export steel.

8. Domestic supply Consumer surplus Equilibrium Producer price surplus Domestic demand Equilibrium quantity Figure 1The Equilibrium without International Trade Price of Steel 0 Quantity of Steel

9. The Equilibrium Without International Trade • Equilibrium Without Trade • Results: • Domestic price adjusts to balance demand and supply. • The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.

10. The World Price and Comparative Advantage • If the country decides to engage in international trade, will it be an importer or exporter of a good?

11. Comparative Advantage • Differences in the costs of production determine the following: • Who should produce what? • How much should be traded for each product?

12. Comparative Advantage • Differences in Costs of Production • Two ways to measure differences in costs of production: • The number of hours required to produce a unit of output. • The opportunity cost of sacrificing one good for another.

13. Absolute Advantage • The comparison among producers of a good according to their productivity—absolute advantage • Describes the productivity of one person, firm, or nation compared to that of another. • The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.

14. Absolute Advantage • Labour Cost of Production

15. Absolute Advantage • The Dutch need only 10 units of labor to produce one kilo of cheese, whereas the Swiss need 15 minutes. • The Dutch need only 20 units of labor to produce a kilo of tomatoes, whereas the Swiss need 60 units of labor. The Dutch have an absolute advantage in the production of both tomatoes and cheese.

16. Opportunity Cost and Comparative Advantage • Compares producers of a good according to their opportunity cost. • Whatever must be given up to obtain some item • The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

17. Comparative Advantage and Trade • Who has the absolute advantage? • The Swiss or the Dutch? • Who has the comparative advantage? • The Swiss or the Dutch?

18. Comparative Advantage • Labour Cost of Production • Opportunity Cost

19. Comparative Advantage and Trade • The Swiss opportunity cost of a kilo of cheese is a ¼ kg of tomatoes, whereas the Dutch opportunity cost of a kilo of cheese is ½ a kg of tomatoes. • The Swiss opportunity cost of a kilo of tomatoes is 4 kilos of cheese, while the Dutch opportunity cost of a kilo of tomatoes is 2 kilos of cheese...

20. Comparative Advantage and Trade …so, the Swiss have a comparative advantage in the production of cheese but the Dutch have a comparative advantage in the production of tomatoes.

21. Comparative Advantage and Trade • Comparative advantage and differences in opportunity costs are the basis for specialized production and trade. • Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade. • Hence, the Swiss will export cheese to the Netherlands, and the Dutch will export tomatoes to Switzerland.

22. Comparative Advantage and Trade • Benefits of Trade • Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.

23. The World Price and Comparative Advantage • The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good.

24. The World Price and Comparative Advantage • If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporter of the good.

25. The World Price and Comparative Advantage • If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good.

26. Domestic Price supply after trade World price Price before trade Domestic Exports demand Domestic Domestic quantity quantity demanded supplied Figure 2 International Trade in an Exporting Country Price of Steel 0 Quantity of Steel

27. Domestic supply Price Exports after A trade World D B price Price before C trade Domestic demand Figure 3 How Free Trade Affects Welfare in an Exporting Country Price of Steel 0 Quantity of Steel

28. Consumer surplus before trade Domestic supply Price Exports after A trade World D B price Price before C trade Producer surplus before trade Domestic demand Figure 3 How Free Trade Affects Welfare in an Exporting Country Price of Steel 0 Quantity of Steel

29. How Free Trade Affects Welfare in an Exporting Country

30. THE WINNERS AND LOSERS FROM TRADE • The analysis of an exporting country yields two conclusions: • Domestic producers of the good are better off, and domestic consumers of the good are worse off. • Trade raises the economic well-being of the nation as a whole.

31. The Gains and Losses of an Importing Country • International Trade in an Importing Country • If the world price of steel is lower than the domestic price, the country will be an importer of steel when trade is permitted. • Domestic consumers will want to buy steel at the lower world price. • Domestic producers of steel will have to lower their output because the domestic price moves to the world price.

32. Domestic supply Price before trade Price World after price trade Domestic Imports demand Domestic Domestic quantity quantity supplied demanded Figure 4 International Trade in an Importing Country Price of Steel Quantity 0 of Steel

33. Domestic supply A Price before trade B D Price World after trade price C Imports Domestic demand Figure 5 How Free Trade Affects Welfare in an Importing Country Price of Steel 0 Quantity of Steel

34. Consumer surplus before trade Domestic supply A Price before trade B Price World after trade price C Producer surplus before trade Domestic demand Figure 5 How Free Trade Affects Welfare in an Importing Country Price of Steel 0 Quantity of Steel

35. Consumer surplus after trade Domestic supply A Price before trade B D Price World after trade price C Imports Producer surplus after trade Domestic demand Figure 5 How Free Trade Affects Welfare in an Importing Country Price of Steel 0 Quantity of Steel

36. How Free Trade Affects Welfare in an Importing Country

37. THE WINNERS AND LOSERS FROM TRADE • How Free Trade Affects Welfare in an Importing Country • The analysis of an importing country yields two conclusions: • Domestic producers of the good are worse off, and domestic consumers of the good are better off. • Trade raises the economic well-being of the nation as a whole because the gains of consumers exceed the losses of producers.

38. THE WINNERS AND LOSERS FROM TRADE • The gains of the winners exceed the losses of the losers. • The net change in total surplus is positive.

39. The Effects of a Tariff • A tariff is a tax on goods produced abroad and sold domestically. • Tariffs raise the price of imported goods above the world price by the amount of the tariff.

40. Domestic supply Equilibrium without trade Price with tariff Price World without tariff price Imports Domestic with tariff demand S S D D Q Q Q Q Imports without tariff Figure 6 The Effects of a Tariff Price of Steel Tariff Quantity 0 of Steel

41. Consumer surplus before tariff Domestic supply Producer surplus before tariff Equilibrium without trade Price World without tariff price Domestic demand S D Q Q Imports without tariff Figure 6 The Effects of a Tariff Price of Steel Quantity 0 of Steel

42. Consumer surplus with tariff Domestic supply A Equilibrium without trade B Price with tariff Price World without tariff price Imports Domestic with tariff demand S S D D Q Q Q Q Imports without tariff Figure 6 The Effects of a Tariff Price of Steel Tariff Quantity 0 of Steel

43. Domestic supply Producer surplus after tariff Equilibrium without trade Price with tariff C Price World G without tariff price Imports Domestic with tariff demand S S D D Q Q Q Q Imports without tariff Figure 6 The Effects of a Tariff Price of Steel Tariff Quantity 0 of Steel

44. Domestic supply Tariff Revenue Price with tariff E Price without tariff Imports Domestic with tariff demand S S D D Q Q Q Q Imports without tariff Figure 6 The Effects of a Tariff Price of Steel Tariff World price Quantity 0 of Steel

45. Domestic supply A Deadweight Loss B Price with tariff C D E F Price G without tariff Imports Domestic with tariff demand S S D D Q Q Q Q Imports without tariff Figure 6 The Effects of a Tariff Price of Steel Tariff World price Quantity 0 of Steel

46. The Effects of a Tariff

47. The Effects of a Tariff • A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. • With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.

48. The Effects of an Import Quota • An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

49. Domestic supply Equilibrium without trade Domestic supply + Import supply Isolandian price with Equilibrium quota with quota Price World World without = price price Imports quota Domestic with quota demand S S D D Q Q Q Q Imports without quota Figure 7 The Effects of an Import Quota Price of Steel Quota Quantity 0 of Steel

50. The Effects of an Import Quota • Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off. • License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.