1INTERNATIONAL TRADE

• Principles of Microeconomic Theory, ECO 284

• John Eastwood• CBA 247• 523-7353• John.Eastwood@nau.edu

• Harmonized tariff schedule (HTS) of the United States:http://www.usitc.gov/taffairs.htm#HTS

3Static Gains from Trade

• Specialization along the lines of comparative advantage increases world output.

• Trade raises consumption beyond autarky.• Greater variety of goods and services• Imported resources

4Dynamic Gains from Trade

• Trade speeds economic growth– When more K goods are imported than

produced in autarky, PPF shifts out.– Trade diffuses new technology.– Trade raises real income. Savings rise.– Free trade an effective anti-trust policy– Trade expands the market; firms achieve

economies of scale.

5Commercial Policy

• Governments action that may change the composition and volume of trade flows

– Tariffs

– Quotas

– Other non-tariff barriers

– Subsidies

6Tariffs

• Taxes on– Imports– Exports

• Components– Ad valorem-- % of value– Specific -- flat fee per unit– Compound -- both

7Positive Effects of Tariffs

• Revenue Effect -- provide tax revenue

• Protective Effect -- shelter domestic producers from foreign competition

8Tariffs as tools of int’l policy

• Most Favored Nation status, MFN– granted as a reward, withheld as a punishment

• Generalized System of Preferences, GSP– Most developed countries have GSP as means

of helping developing countries• access to markets of developed countries

9Non-tariff Barriers

• Voluntary export restraints (VER)

• Tariff-rate quotas (TRQs),

• WTO members are replacing existing quotas with TRQs

• Quotas (on apparel and textiles) are to be phased out by 2005

10Welfare Cost Analysis

• Use Supply and Demand– One import or export good

• Measure Changes in Consumer Surplus and Producer Surplus

• Start with a small country– Its trade is too small to affect terms of trade

11Consumers’ Surplus

• Consumers’ Surplus is the difference between consumers’ maximum willingness-to-pay and the amount they actually paid.

• The amount actually paid equals PQ.• Graphically, Consumers’ Surplus (CS) is the area

under the demand curve above P.

12Producer Surplus

• Producer surplus is the price of a good minus the opportunity cost of producing it.– Graphically, Producers’ Surplus (PS) is the area

under the Price line and above Supply.

13

Quantity (thousands of pizzas per day)0 5 10 15 20

Pric

e (d

olla

rs p

er p

izza

)

S

Producersurplus

Consumersurplus

5

10

15

20

25

D

An Efficient Market for Pizza

14Gains from free trade -- imports

3

6

10

0 1 4 10

b

Domestic demand for grapes

Domestic Supplyof grapes

ac

Quantity (millions bushels of grapes per year)

Pri

ce ($

per

bu

shel

of

gra

pes

)

World price of grapes

7

2

15Welfare of a Move to Free Trade

A Small Country’s Imports

Change in Consumer Surplus +a +b +c

Change in Producer Surplus -a

Net Welfare Change +b +c

16Gains from free trade -- exports

9

6

10

0 1 4 10

f

Domestic demand for honey

Domestic Supplyof honey

g

Quantity (millions jars of honey per year)

Pri

ce ($

per

jar

of

hon

ey)

World price of honey

7

e

2

17Welfare of a Move to Free Trade

A Small Country’s Exports

Change in Consumer Surplus -e -f

Change in Producer Surplus +e +f +g

Net Welfare Change +g

19Welfare Cost of a Tariff on Imports -- Small Country

3

5

10

0 1 10

b

Domestic demand for grapes

Domestic Supplyof grapes

a c

Quantity (millions bushels of grapes per year)

Pri

ce ($

per

bu

shel

of

gra

pes

)

World price of grapes

7

2

World price + tariff $2/bu

3 5

d

20Welfare Cost of a Tariff on Imports -- Small Country

Change in Consumer Surplus -a -b -c -d

Change in Producer Surplus +a

Change in Gov't Revenue +c

Net Welfare Change(a.k.a. Deadweight loss)

-b -d

Loss = 0.5 x tariff x change in imports

21Exhibit 6: Effect of a Quota

0

D

Sugar(millions of pounds per month)

Pri

ce p

er p

ou

nd

20 70

S

(a)

0.10

In panel a, D is the U.S. demand curve and S is the supply curve of U.S. producers. The world price of sugar is $0.10 (the price that would prevail in the U.S. market) and a total of 70 million pounds would be demanded U.S. producers would supply 20 million pounds and importers 50 million pounds.

Now suppose that U.S. officials impose a quota of 30 million pounds per month

As long as the U.S. price is at or above the world price of $0.10 per pound, foreigners supply 30 million pounds the total supply of sugar to the U.S. market is found by adding 30 million pounds of imported sugar to the amount supplied by U.S. producers

22Exhibit 6: Effect of a Quota

0

D

Sugar(millions of pounds per month)

Pri

ce p

er p

ou

nd

20 70

S

(a)

0.10

$0.15 e

S +30

50

Thus, the supply curve that sums domestic production and imports is horizontal at the world price of $0.10 per pound and remains so until the quantity supplied reaches 50 million pounds.

For prices above $0.10, the new supply curve, S + 30, adds horizontally the 30 million pound quota to S, the supply curve of U.S. producers as shown by the dark red line. The U.S. price is found where this new supply curve intersects the domestic demand curve point e an effective quota, by limiting imports, raises the price of domestic sugar above the world price and reduces quantity below the free trade level.

23Exhibit 6: Effect of a Quota

Pri

ce p

er p

ou

nd

0 Sugar (millions of pounds per month)

0

D

Sugar(millions of pounds per month)

20 70

D

S

70

S

0.10

20

(a) (b)

0.10

S +30

ab

cd

30 60

$0.15e

S +30

50

$0.15

The right panel shows the distribution and efficiency aspects of the quota. As a result of the quota, U.S. consumer surplus declines by the blue and pink shaded areas.

Area a becomes producer surplus no loss of U.S. welfare. The blue rectangle, c, shows the increased profit to those permitted by the quota to sell Americans 30 million pounds at $0.15 per pound. To the extent that foreign exporters rather than U.S. importers reap this profit, area c reflects a net loss in domestic welfare.

24Exhibit 6: Effect of a Quota

Pri

ce p

er p

ou

nd

0 Sugar (millions of pounds per month)

0

D

Sugar(millions of pounds per month)

20 70

D

S

70

S

0.10

20

(a) (b)

0.10

S +30

ab

cd

30 60

$0.15e

S +30

50

$0.15

The pink triangle, b, shows by how much the marginal cost of producing another 10 million pounds in the U.S. exceeds the world price a welfare loss to the U.S. economy because sugar could have been purchased abroad for $0.10 and the resources employed to increase sugar production could have been used more efficiently to produce other goods.

The pink triangle, d, is also a welfare loss, because it reflects a reduction in consumer surplus with no offsetting gain to anyone the two pink shaded areas measure the minimum welfare cost imposed on the domestic economy by an effective quota. To the extent that the profit from quota rights, area c, accrues to foreigners, this increases the U.S. welfare loss resulting from the quota

25Welfare effects of a domestic production subsidy

6

10

20

0 2 18

b

Domestic supplyof small cars

a

Quantity (thousands of cars per year)

Pri

ce ($

1000

per

car

)

World price of small cars

14

4

World price + new equivalent tariff

6 10

Domestic supplywith subsidy

4

Subsidy = $T

8

12

Domestic demand

26Welfare effects of a domestic

production subsidyChange in Consumer Surplus

Change in Producer Surplus +a

Change in Gov't Revenue -a -b

Net Welfare Change (a.k.a. Deadweight loss)

-b

27Welfare Cost of Tariffs as a

Percentage of GDP• Tariffs & NTBs often exclude new goods

– e.g., computers, just-in-time inventory processes

• GDP loss almost twice the tariff rate– Ten percent tariff lowers GDP by 19.8%– Twenty-five percent tariff lowers GDP by 47%

28Review homework