Chapter 9

1. Chapter 9 Application: International trade

2. Outline • Trade can make everyone better off • Principle of comparative advantage • Gains and losses from trade • Effects of a tariff and import quota on trade • Implications for trade policy • Arguments for restricting trade

3. Recap: Gains from Trade • The gains from trade are less obvious when one person/country is better at producing both goods. • Principle of absolute advantage compares producers of a good according to their productivity • Principle of comparative advantage compares producers of a good according to their opportunity cost • With trade, both countries can produce more of one commodity and consume more of both commodities (founded upon principle of comparative advantage)

4. Gains from Trade • It is impossible for a producer to have a comparative advantage in the production of both the goods. Why? • If two producers have different opportunity costs they gain from trade as the price of the good they buy is less than their opportunity cost for that good

5. Interdependence and the gains from trade • To summarize: Comparative advantage Specialization Economic well-being Increase in production Gains from trade Trade

6. The Determinants of Trade • Equilibrium with out trade: • Economy is closed. • Domestic supply and domestic demand determine equilibrium price. • Equilibrium with trade: • Principle of comparative advantage involves comparison of domestic price and world price for the traded good. • If domestic price is less than world price, then the country becomes an exporter of the good. • If domestic price is greater than world price then country becomes and importer of the good.

7. Winners and losers from trade • Gains and losses of an exporting country • The country is a price taker in the world economy. • Exports= domestic supply at world price- domestic demand at world price. • Increase in domestic producer surplus • Decrease in domestic consumer surplus • However trade raises the total surplus in the economy

8. Winners and losers from trade • Gains and losses of an importing country • The country is a price taker in the world economy. • Imports= domestic demand at world price- domestic supply at world price. • Decrease in domestic producer surplus • Increase in domestic consumer surplus • However trade raises the total surplus in the economy