Microeconomics – Application & International Trade

EQUILIBRIUM WITHOUT INTERNATIONAL TRADE

Assume: an isolated country only produces steel. Imports and exports of steel are prohibited. Results: domestic price adjusts to clear market. The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive. If country begins international trade, will it be an importer or exporter of steel?

THE WORLD PRICE & COMPETITIVE ADVANTAGE

Compare the good’s domestic price without trade to the world price (that which prevails in the good’s world market) to see if country is an importer or exporter. If a country has a competitive advantage the domestic price < world price, and it is an exporter. If a country hasn’t got a competitive advantage the domestic price > world price, and it is an importer.

THE WINNERS & LOSERS FROM TRADE

Trade increases national wellbeing. Domestic consumers are better off, while domestic producers are worse off. Gain in surplus to winners is greater than the fall in surplus to losers. Trade always generates a net increase in total surplus.

THE GAINS & LOSSES OF AN IMPORTING COUNTRY

World price < domestic price, country becomes an importer. Domestic consumers buy at world price. Domestic price moves to world price and domestic producers lower output.

THE EFFECT 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. Tariff cause dead-weight losses. Domestic market shifts closer to no-trade equilibrium. Total surplus decreases and a deadweight loss is generated.

THE EFFECTS OF AN IMPORT QUOTA

An import quota is a limit on the quantity of a good produced abroad that can be sold domestically. A quota moves the demand curve to the left. Domestic price > world price, domestic consumers are worse off. Domestic sellers are better off. License holders are better off as they buy at world price and sell at domestic price. A deadweight loss occurs reducing total surplus. Deadweight loss increases if a mechanism such as lobbying is employed to allocate import licenses.

LESSONS OF TRADE POLICY

If government sells import licenses for full value, revenue equals that of an equivalent tariff and the results of tariffs and quotas are identical. Tariff and import quotas: raise domestic prices, reduce the welfare of domestic consumers, increase the welfare of domestic producers, and cause deadweight losses. Benefits of international trade are increased variety of goods, enhanced flow of ideas, lower costs through economies of scale, and increased competition. Whereas, the argument for restricting trade is to protect local jobs, infant industry, common protectionist arguments, protection as a bargaining chip, unfair competition, and national security. 

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