Chapter 16 “Policy Toward Trade”

1 ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e

Chapter 16Chapter 16“Policy Toward Trade”“Policy Toward Trade”

Chapter 16Chapter 16“Policy Toward Trade”“Policy Toward Trade”

MACROECONOMICS: MACROECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge

MACROECONOMICS: MACROECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

1.1. Use the concept of a world price to explain Use the concept of a world price to explain imports, exports, and the gains from trade.imports, exports, and the gains from trade.

2.2. Discuss the GATT and other trade Discuss the GATT and other trade arrangements among countries.arrangements among countries.

3.3. Distinguish among the various barriers to Distinguish among the various barriers to trade that countries might impose.trade that countries might impose.

4.4. Assess the arguments for and against Assess the arguments for and against protectionist policies.protectionist policies.

5.5. Examine whether an oil import fee can Examine whether an oil import fee can promote energy security.promote energy security.

1.1. Use the concept of a world price to explain Use the concept of a world price to explain imports, exports, and the gains from trade.imports, exports, and the gains from trade.

2.2. Discuss the GATT and other trade Discuss the GATT and other trade arrangements among countries.arrangements among countries.

3.3. Distinguish among the various barriers to Distinguish among the various barriers to trade that countries might impose.trade that countries might impose.

4.4. Assess the arguments for and against Assess the arguments for and against protectionist policies.protectionist policies.

5.5. Examine whether an oil import fee can Examine whether an oil import fee can promote energy security.promote energy security.


• International trade occurs in response to International trade occurs in response to differences between the domestic price of goods differences between the domestic price of goods and the and the world priceworld price of goods. of goods.

• When a country opens it doors to international When a country opens it doors to international trade, the price in the domestic market will trade, the price in the domestic market will come to equal that of the world price.come to equal that of the world price.

• If this adjustment means that the domestic If this adjustment means that the domestic price rises to meet the world price, the country price rises to meet the world price, the country will exports the good.will exports the good.

• If the world price causes the domestic price to If the world price causes the domestic price to drop, then the country import the good.drop, then the country import the good.

• International trade occurs in response to International trade occurs in response to differences between the domestic price of goods differences between the domestic price of goods and the and the world priceworld price of goods. of goods.

• When a country opens it doors to international When a country opens it doors to international trade, the price in the domestic market will trade, the price in the domestic market will come to equal that of the world price.come to equal that of the world price.

• If this adjustment means that the domestic If this adjustment means that the domestic price rises to meet the world price, the country price rises to meet the world price, the country will exports the good.will exports the good.

• If the world price causes the domestic price to If the world price causes the domestic price to drop, then the country import the good.drop, then the country import the good.

16.116.1ASSESSING THE GAINS FROM TRADEASSESSING THE GAINS FROM TRADE

16.116.1ASSESSING THE GAINS FROM TRADEASSESSING THE GAINS FROM TRADE


o Free tradeFree trade implies that a country’s producers implies that a country’s producers must accept world market prices, which would must accept world market prices, which would entail a higher price for some goods and a entail a higher price for some goods and a lower price for others.lower price for others.

o Imports allow domestic consumers to pay a Imports allow domestic consumers to pay a lower price for goods.lower price for goods.o They also gain by consuming more of the good.They also gain by consuming more of the good.

o The gains to consumers from imports more The gains to consumers from imports more than offsets the losses to producers, which than offsets the losses to producers, which reveals that the country as a whole is better off reveals that the country as a whole is better off allowing imports.allowing imports.

o Free tradeFree trade implies that a country’s producers implies that a country’s producers must accept world market prices, which would must accept world market prices, which would entail a higher price for some goods and a entail a higher price for some goods and a lower price for others.lower price for others.

o Imports allow domestic consumers to pay a Imports allow domestic consumers to pay a lower price for goods.lower price for goods.o They also gain by consuming more of the good.They also gain by consuming more of the good.

o The gains to consumers from imports more The gains to consumers from imports more than offsets the losses to producers, which than offsets the losses to producers, which reveals that the country as a whole is better off reveals that the country as a whole is better off allowing imports.allowing imports.

Gains From ImportsGains From ImportsGains From ImportsGains From Imports


Imports – Effects on Price and Imports – Effects on Price and QuantityQuantity


Domestic Demand

Domestic Supply

WorldPrice

Price if no trade

QuantityQuantity Demanded

Quantity Supplied

Equilibrium if no trade

Imports

•

• •

Imports result from a world price that is below the country’s price prior to trade. The lower price causes consumption to rise and production to fall , with the difference being the amount imported.

$


Gains and Losses from ImportsGains and Losses from ImportsGains and Losses from ImportsGains and Losses from Imports

Domestic Demand

Domestic Supply

WorldPrice

Price if no trade

QuantityQuantity Demanded

Quantity Supplied

Imports

•

• • D

A

C B

Loss to producers

Gain to consumers

$

The consumer surplus The consumer surplus rises from area A to rises from area A to area A + B + C. Thearea A + B + C. Theproducer surplus dropsproducer surplus dropsfrom areas B+ D downfrom areas B+ D downto area D.to area D.


Gains from ExportsGains from ExportsGains from ExportsGains from Exports

In the case of exports, producers win and In the case of exports, producers win and consumers lose.consumers lose.Producers win because they sell more at a higher Producers win because they sell more at a higher

price.price.

Consumers lose because they must pay a higher Consumers lose because they must pay a higher world price, and thus consume less.world price, and thus consume less.

On balance, the country as a whole gains from On balance, the country as a whole gains from international trade by allowing exports.international trade by allowing exports.

Both imports and exports lead to more gains Both imports and exports lead to more gains than losses.than losses.

In the case of exports, producers win and In the case of exports, producers win and consumers lose.consumers lose.Producers win because they sell more at a higher Producers win because they sell more at a higher

price.price.

Consumers lose because they must pay a higher Consumers lose because they must pay a higher world price, and thus consume less.world price, and thus consume less.

On balance, the country as a whole gains from On balance, the country as a whole gains from international trade by allowing exports.international trade by allowing exports.

Both imports and exports lead to more gains Both imports and exports lead to more gains than losses.than losses.


Gains from ExportsGains from ExportsGains from ExportsGains from ExportsImports – Effects on Price and Imports – Effects on Price and QuantityQuantity


Domestic Demand

Domestic Supply

WorldPrice

Price if no trade

Quantity

Equilibrium if no trade

Quantity Supplied

Quantity Demanded

Exports

•

• •

$

Exports result from aExports result from aworld price that is aboveworld price that is abovea country’s price prior toa country’s price prior totrade. The higher pricetrade. The higher pricecauses a country’scauses a country’sproduction to rise andproduction to rise andconsumption to fall by theconsumption to fall by theamount being exported.amount being exported.


Gains from ExportsGains from ExportsGains from ExportsGains from ExportsGains from ExportsGains from ExportsGains from ExportsGains from Exports

Domestic Demand

Domestic Supply

WorldPrice

Price if no trade

QuantityQuantity Supplied

Quantity Demanded

Exports

•

• •

$

D

A

C B

Gain to producers

Loss to producers

The country’s consumerThe country’s consumersurplus drops from areassurplus drops from areasA+B to only area A. TheA+B to only area A. TheProducer surplus rises Producer surplus rises From area D to areas B+From area D to areas B+C+D.C+D.


16.216.2TRADE AGREEMENTSTRADE AGREEMENTS16.216.2TRADE AGREEMENTSTRADE AGREEMENTSCountries must choose how wide to open their Countries must choose how wide to open their

doors to international trade.doors to international trade.An open economy is one that erects no barriers An open economy is one that erects no barriers

to international trade and investment. to international trade and investment. A closed economy shuts itself off from foreign A closed economy shuts itself off from foreign

investment and trade.investment and trade.Countries design their trade policies with an Countries design their trade policies with an

eye towards their own self interest.eye towards their own self interest.Most countries have learned from the Great Most countries have learned from the Great

Depression of the 1930’s that their interest are Depression of the 1930’s that their interest are best served with free trade.best served with free trade.

Countries must choose how wide to open their Countries must choose how wide to open their doors to international trade.doors to international trade.

An open economy is one that erects no barriers An open economy is one that erects no barriers to international trade and investment. to international trade and investment.

A closed economy shuts itself off from foreign A closed economy shuts itself off from foreign investment and trade.investment and trade.

Countries design their trade policies with an Countries design their trade policies with an eye towards their own self interest.eye towards their own self interest.

Most countries have learned from the Great Most countries have learned from the Great Depression of the 1930’s that their interest are Depression of the 1930’s that their interest are best served with free trade.best served with free trade.


Most countries have signed the Most countries have signed the General Agreement General Agreement on Tariffs and Trade (GATT),on Tariffs and Trade (GATT), which aims to avoid which aims to avoid trade wars and promote free trade.trade wars and promote free trade.

The GATT has been administered by the The GATT has been administered by the World World Trade Organization,Trade Organization, an arm of the GATT created to an arm of the GATT created to settle trade disputes among GATT members and settle trade disputes among GATT members and monitor compliance with provisions of the GATT.monitor compliance with provisions of the GATT.

The Smoot-Hawley Act of 1930The Smoot-Hawley Act of 1930 was passed by the was passed by the U.S. Congress and imposed high tariffs an U.S. Congress and imposed high tariffs an imported goods to save jobs.imported goods to save jobs.The surprising result of the act was that unemployment The surprising result of the act was that unemployment

was even higher after its imposition.was even higher after its imposition.

Most countries have signed the Most countries have signed the General Agreement General Agreement on Tariffs and Trade (GATT),on Tariffs and Trade (GATT), which aims to avoid which aims to avoid trade wars and promote free trade.trade wars and promote free trade.

The GATT has been administered by the The GATT has been administered by the World World Trade Organization,Trade Organization, an arm of the GATT created to an arm of the GATT created to settle trade disputes among GATT members and settle trade disputes among GATT members and monitor compliance with provisions of the GATT.monitor compliance with provisions of the GATT.

The Smoot-Hawley Act of 1930The Smoot-Hawley Act of 1930 was passed by the was passed by the U.S. Congress and imposed high tariffs an U.S. Congress and imposed high tariffs an imported goods to save jobs.imported goods to save jobs.The surprising result of the act was that unemployment The surprising result of the act was that unemployment

was even higher after its imposition.was even higher after its imposition.

Trade AgreementsTrade AgreementsTrade AgreementsTrade Agreements


The GATT negotiations required significant The GATT negotiations required significant tariff reductions.tariff reductions.They have also placed restrictions on They have also placed restrictions on quotas,quotas,

which limit the quantity of imported products a which limit the quantity of imported products a country allows.country allows.

Other Other non-tariff barriersnon-tariff barriers are also restricted, are also restricted, which is a catch all phrase for the variety of which is a catch all phrase for the variety of actions a country can take to restrict trade.actions a country can take to restrict trade.

The GATT negotiations required significant The GATT negotiations required significant tariff reductions.tariff reductions.They have also placed restrictions on They have also placed restrictions on quotas,quotas,

which limit the quantity of imported products a which limit the quantity of imported products a country allows.country allows.

Other Other non-tariff barriersnon-tariff barriers are also restricted, are also restricted, which is a catch all phrase for the variety of which is a catch all phrase for the variety of actions a country can take to restrict trade.actions a country can take to restrict trade.



The Uruguay Round of GATT was ratified The Uruguay Round of GATT was ratified by the U.S. and other nations in 1994.by the U.S. and other nations in 1994.

It established the WTO, and dealt with the It established the WTO, and dealt with the following thorny issues.following thorny issues.TariffsTariffsAgricultural subsidiesAgricultural subsidiesServicesServicesIntellectual property rightsIntellectual property rights

The Uruguay Round of GATT was ratified The Uruguay Round of GATT was ratified by the U.S. and other nations in 1994.by the U.S. and other nations in 1994.

It established the WTO, and dealt with the It established the WTO, and dealt with the following thorny issues.following thorny issues.TariffsTariffsAgricultural subsidiesAgricultural subsidiesServicesServicesIntellectual property rightsIntellectual property rights



Regional Trade BlocsRegional Trade BlocsRegional Trade BlocsRegional Trade Blocs

The European Union is an example of a regional The European Union is an example of a regional trading bloc, which is an agreement that lowers trading bloc, which is an agreement that lowers trade barriers among member countries.trade barriers among member countries.

The U.S., Canada, and Mexico have also formed a trading The U.S., Canada, and Mexico have also formed a trading bloc by signing the North American Free Trade bloc by signing the North American Free Trade Agreement (NAFTA).Agreement (NAFTA).

Trading blocs allows countries to specialize Trading blocs allows countries to specialize according to comparative advantage, and have a according to comparative advantage, and have a trade creation effect.trade creation effect.Trading blocs also have a trade diversion effect, as Trading blocs also have a trade diversion effect, as product flow between trade bloc countries, that may product flow between trade bloc countries, that may have been traded with non trade bloc countries.have been traded with non trade bloc countries.

The European Union is an example of a regional The European Union is an example of a regional trading bloc, which is an agreement that lowers trading bloc, which is an agreement that lowers trade barriers among member countries.trade barriers among member countries.

The U.S., Canada, and Mexico have also formed a trading The U.S., Canada, and Mexico have also formed a trading bloc by signing the North American Free Trade bloc by signing the North American Free Trade Agreement (NAFTA).Agreement (NAFTA).

Trading blocs allows countries to specialize Trading blocs allows countries to specialize according to comparative advantage, and have a according to comparative advantage, and have a trade creation effect.trade creation effect.Trading blocs also have a trade diversion effect, as Trading blocs also have a trade diversion effect, as product flow between trade bloc countries, that may product flow between trade bloc countries, that may have been traded with non trade bloc countries.have been traded with non trade bloc countries.


16.316.3TRADE POLICY OPTIONSTRADE POLICY OPTIONS16.316.3TRADE POLICY OPTIONSTRADE POLICY OPTIONS

A A tarifftariff is a tax on an imported product. is a tax on an imported product.Demand for imported products is sometimes Demand for imported products is sometimes referred to as residual demand, since it referred to as residual demand, since it represents what is left over after consumers represents what is left over after consumers have bought from domestic suppliers.have bought from domestic suppliers.Tariffs increase the cost of selling imported Tariffs increase the cost of selling imported products.products.

This in turn increases the cost of imported This in turn increases the cost of imported goods in the domestic market, and reduces goods in the domestic market, and reduces the quantity demanded.the quantity demanded.

A A tarifftariff is a tax on an imported product. is a tax on an imported product.Demand for imported products is sometimes Demand for imported products is sometimes referred to as residual demand, since it referred to as residual demand, since it represents what is left over after consumers represents what is left over after consumers have bought from domestic suppliers.have bought from domestic suppliers.Tariffs increase the cost of selling imported Tariffs increase the cost of selling imported products.products.

This in turn increases the cost of imported This in turn increases the cost of imported goods in the domestic market, and reduces goods in the domestic market, and reduces the quantity demanded.the quantity demanded.


• By raising the barriers to entry of foreign By raising the barriers to entry of foreign products, tariffs can be viewed as a for of price products, tariffs can be viewed as a for of price support for domestic producers.support for domestic producers.

• The higher price of imports causes the demand The higher price of imports causes the demand curve to shift to the right for domestic products curve to shift to the right for domestic products that are close substitutes.that are close substitutes.

• Tariffs are said to be transparent, meaning that Tariffs are said to be transparent, meaning that their effects on prices are clear for all to see.their effects on prices are clear for all to see.

• Tariff rates are kept low by GATT.Tariff rates are kept low by GATT.

• By raising the barriers to entry of foreign By raising the barriers to entry of foreign products, tariffs can be viewed as a for of price products, tariffs can be viewed as a for of price support for domestic producers.support for domestic producers.

• The higher price of imports causes the demand The higher price of imports causes the demand curve to shift to the right for domestic products curve to shift to the right for domestic products that are close substitutes.that are close substitutes.

• Tariffs are said to be transparent, meaning that Tariffs are said to be transparent, meaning that their effects on prices are clear for all to see.their effects on prices are clear for all to see.

• Tariff rates are kept low by GATT.Tariff rates are kept low by GATT.

Tariffs Tariffs Tariffs Tariffs


TariffsTariffs TariffsTariffs

U.S. demand for imports

Supply for abroad

Quantity

Tariff raises price and lowers quantity

•

$Supply plus tariff

Tariff

Price rises

•

Imports decline

A tariff on importsA tariff on importshelps U.S. producershelps U.S. producerswho can sell at higher who can sell at higher prices, but hurts consumerprices, but hurts consumerwho must pay the higherwho must pay the higherprice.price.


Effective U.S. Tariff Rates 1992-2000Effective U.S. Tariff Rates 1992-2000Effective U.S. Tariff Rates 1992-2000Effective U.S. Tariff Rates 1992-2000

SECTOR 1992 1993 1994 1995 1996 1997 1998 1999 2000

Food and live animals 1.99 2.07 1.81 1.42 1.41 1.19 1.34 1.36 1.18

Beverages and tobacco 3.33 3.66 2.71 1.76 1.90 2.04 1.10 1.21 0.95

Crude materials, inedible, except fuels 0.36 0.36 0.32 0.24 0.21 0.20 0.20 0.16 0.16Mineral fuels, lubricants and related materials 0.47 0.48 0.50 0.42 0.35 0.32 0.42 0.35 0.20Animal and vegetable oils, fats and waxes 1.05 1.19 0.91 0.64 0.53 0.70 0.84 0.76 1.05

Chemicals and related products, n.e.s. 3.64 3.95 3.81 2.23 1.93 1.73 1.56 1.24 1.03Manufactured goods classified chiefly by material 3.47 3.31 3.16 2.71 2.56 2.42 2.14 1.91 1.76Machinery and transport equipment 2.00 2.02 1.86 1.53 1.35 1.14 0.94 0.85 0.73Miscellaneous manufactured articles 8.41 7.81 7.70 6.86 6.45 6.18 5.88 5.54 5.49Commodities and transactions not classified elsewhere in the SITC 0.02 0.03 0.03 0.05 0.07 0.06 0.10 0.09 0.03

All sectors 3.15 3.07 2.91 2.43 2.20 2.07 1.95 1.76 1.59


o Import quotasImport quotas are an alternative to imports are an alternative to imports tariffs and can accomplish the same goals.tariffs and can accomplish the same goals.

o An import quota restricts the quantity of An import quota restricts the quantity of imports directly, and thus cuts off supply from imports directly, and thus cuts off supply from abroad at the quota quantity.abroad at the quota quantity.

o The truncated supply from abroad under a The truncated supply from abroad under a quota leads to an increase in prices at home.quota leads to an increase in prices at home.

o GATT limits the extent to which quotas can be GATT limits the extent to which quotas can be imposed by countries.imposed by countries.o It does allow quotas for agricultural products to It does allow quotas for agricultural products to

avoid disruption to countries’ domestic economies.avoid disruption to countries’ domestic economies.

o Import quotasImport quotas are an alternative to imports are an alternative to imports tariffs and can accomplish the same goals.tariffs and can accomplish the same goals.

o An import quota restricts the quantity of An import quota restricts the quantity of imports directly, and thus cuts off supply from imports directly, and thus cuts off supply from abroad at the quota quantity.abroad at the quota quantity.

o The truncated supply from abroad under a The truncated supply from abroad under a quota leads to an increase in prices at home.quota leads to an increase in prices at home.

o GATT limits the extent to which quotas can be GATT limits the extent to which quotas can be imposed by countries.imposed by countries.o It does allow quotas for agricultural products to It does allow quotas for agricultural products to

avoid disruption to countries’ domestic economies.avoid disruption to countries’ domestic economies.

QuotasQuotasQuotasQuotas


QuotasQuotasQuotasQuotas

U.S. demand for imports

Unrestricted import supply

Quantity

A quota can have the same effect as a tariff

•

$

Price rises

•

Imports decline

Import supply with quota

Quantity allowed by quota

Quotas reduce the supply ofQuotas reduce the supply ofimports and increase theimports and increase thedomestic price. The quotadomestic price. The quotatruncates supply at the truncates supply at the allowable import quantity,allowable import quantity,causing import supply to becausing import supply to bevertical at that point.vertical at that point.


Voluntary Export RestraintsVoluntary Export RestraintsVoluntary Export RestraintsVoluntary Export Restraints

As an alternative to tariffs and import quotas, As an alternative to tariffs and import quotas, the U.S. and some other countries have chosen to the U.S. and some other countries have chosen to negotiate negotiate voluntary export restraints (VER’s).voluntary export restraints (VER’s).

With VER’s, individual exporting countries With VER’s, individual exporting countries agree to limit the quantities they export.agree to limit the quantities they export.

The multi-fiber agreementThe multi-fiber agreement currently scheduled currently scheduled for elimination in 2004, sets country by country for elimination in 2004, sets country by country quotas on clothing exports to the U.S. and some quotas on clothing exports to the U.S. and some other countries.other countries. The U.S. offers to forego quotas in favor of VER’s to The U.S. offers to forego quotas in favor of VER’s to

maintain good relations with other governments.maintain good relations with other governments.

As an alternative to tariffs and import quotas, As an alternative to tariffs and import quotas, the U.S. and some other countries have chosen to the U.S. and some other countries have chosen to negotiate negotiate voluntary export restraints (VER’s).voluntary export restraints (VER’s).

With VER’s, individual exporting countries With VER’s, individual exporting countries agree to limit the quantities they export.agree to limit the quantities they export.

The multi-fiber agreementThe multi-fiber agreement currently scheduled currently scheduled for elimination in 2004, sets country by country for elimination in 2004, sets country by country quotas on clothing exports to the U.S. and some quotas on clothing exports to the U.S. and some other countries.other countries. The U.S. offers to forego quotas in favor of VER’s to The U.S. offers to forego quotas in favor of VER’s to

maintain good relations with other governments.maintain good relations with other governments.


An Assortment of Non-tariff An Assortment of Non-tariff Barriers to Trade.Barriers to Trade.

An Assortment of Non-tariff An Assortment of Non-tariff Barriers to Trade.Barriers to Trade.

Most Most non-tariff barriersnon-tariff barriers to trade do not to trade do not restrict imports explicitly.restrict imports explicitly.

Their effects are less obvious than Their effects are less obvious than quotas.quotas.

Paperwork and red tape can inhibit Paperwork and red tape can inhibit trade.trade.

Inspections, which include sampling of Inspections, which include sampling of imported products can inhibit trade.imported products can inhibit trade.

Most Most non-tariff barriersnon-tariff barriers to trade do not to trade do not restrict imports explicitly.restrict imports explicitly.

Their effects are less obvious than Their effects are less obvious than quotas.quotas.

Paperwork and red tape can inhibit Paperwork and red tape can inhibit trade.trade.

Inspections, which include sampling of Inspections, which include sampling of imported products can inhibit trade.imported products can inhibit trade.


16.416.4THE FREE-TRADE DEBATETHE FREE-TRADE DEBATE16.416.4THE FREE-TRADE DEBATETHE FREE-TRADE DEBATEThe objections to free trade commonly have The objections to free trade commonly have

limited applicability or are based on limited applicability or are based on questionable logic.questionable logic.

The national defense argumentThe national defense argument is valid but is valid but overused.overused.Translating national defense into policy requires Translating national defense into policy requires

judgments and debate. judgments and debate. Trade sanctionsTrade sanctions restrict trade with nations that restrict trade with nations that

have policies that our government opposes.have policies that our government opposes.Do trade sanctions punish the wrong people?Do trade sanctions punish the wrong people?

The objections to free trade commonly have The objections to free trade commonly have limited applicability or are based on limited applicability or are based on questionable logic.questionable logic.

The national defense argumentThe national defense argument is valid but is valid but overused.overused.Translating national defense into policy requires Translating national defense into policy requires

judgments and debate. judgments and debate. Trade sanctionsTrade sanctions restrict trade with nations that restrict trade with nations that

have policies that our government opposes.have policies that our government opposes.Do trade sanctions punish the wrong people?Do trade sanctions punish the wrong people?


The Free-Trade DebateThe Free-Trade DebateThe Free-Trade DebateThe Free-Trade Debate

Some U.S. products are more expensive than Some U.S. products are more expensive than foreign products because of the added cost of foreign products because of the added cost of complying with environmental, health , and safety complying with environmental, health , and safety standards.standards. The U.S. imposes a tariff to achieve a level playing field.The U.S. imposes a tariff to achieve a level playing field.

Higher level of pollution for some countries is a Higher level of pollution for some countries is a normal good, since more environmental quality is normal good, since more environmental quality is demanded as the income in a country rises.demanded as the income in a country rises.

Poorer countries have a higher opportunity cost of Poorer countries have a higher opportunity cost of environmental quality, and might specialize in environmental quality, and might specialize in industries with a higher pollution content.industries with a higher pollution content.

Some U.S. products are more expensive than Some U.S. products are more expensive than foreign products because of the added cost of foreign products because of the added cost of complying with environmental, health , and safety complying with environmental, health , and safety standards.standards. The U.S. imposes a tariff to achieve a level playing field.The U.S. imposes a tariff to achieve a level playing field.

Higher level of pollution for some countries is a Higher level of pollution for some countries is a normal good, since more environmental quality is normal good, since more environmental quality is demanded as the income in a country rises.demanded as the income in a country rises.

Poorer countries have a higher opportunity cost of Poorer countries have a higher opportunity cost of environmental quality, and might specialize in environmental quality, and might specialize in industries with a higher pollution content.industries with a higher pollution content.


DumpingDumping is defined as the selling of a good for is defined as the selling of a good for less than it cost to produce.less than it cost to produce.

Dumping may occur for many reasons.Dumping may occur for many reasons. A company may have overestimated demand for its A company may have overestimated demand for its

product, and so for itself stuck with too much product, and so for itself stuck with too much product and have a clearance sale.product and have a clearance sale.

It may be covering its operating expenses, but not It may be covering its operating expenses, but not the cost of capital or other fixed cost.the cost of capital or other fixed cost.

In these cases, even though the company loses In these cases, even though the company loses money, it would lose more if it did not sell.money, it would lose more if it did not sell.

DumpingDumping is defined as the selling of a good for is defined as the selling of a good for less than it cost to produce.less than it cost to produce.

Dumping may occur for many reasons.Dumping may occur for many reasons. A company may have overestimated demand for its A company may have overestimated demand for its

product, and so for itself stuck with too much product, and so for itself stuck with too much product and have a clearance sale.product and have a clearance sale.

It may be covering its operating expenses, but not It may be covering its operating expenses, but not the cost of capital or other fixed cost.the cost of capital or other fixed cost.

In these cases, even though the company loses In these cases, even though the company loses money, it would lose more if it did not sell.money, it would lose more if it did not sell.



Dumping occurs within a country, as well as in Dumping occurs within a country, as well as in international trade.international trade.

Dumping is illegal across countries according Dumping is illegal across countries according to the GATT.to the GATT.

The U.S. presumes dumping whenever The U.S. presumes dumping whenever whenever a foreign company charges less in the whenever a foreign company charges less in the U.S. than it does at home, irrespective of its U.S. than it does at home, irrespective of its cost.cost.

Strategic dumping is dumping that aims to Strategic dumping is dumping that aims to drive the competition out of business so that the drive the competition out of business so that the firms doing the dumping can monopolize firms doing the dumping can monopolize output and drive prices up in the future.output and drive prices up in the future.

Dumping occurs within a country, as well as in Dumping occurs within a country, as well as in international trade.international trade.

Dumping is illegal across countries according Dumping is illegal across countries according to the GATT.to the GATT.

The U.S. presumes dumping whenever The U.S. presumes dumping whenever whenever a foreign company charges less in the whenever a foreign company charges less in the U.S. than it does at home, irrespective of its U.S. than it does at home, irrespective of its cost.cost.

Strategic dumping is dumping that aims to Strategic dumping is dumping that aims to drive the competition out of business so that the drive the competition out of business so that the firms doing the dumping can monopolize firms doing the dumping can monopolize output and drive prices up in the future.output and drive prices up in the future.



• Developing countries often try to nurture new Developing countries often try to nurture new industries they hope will one day become the source industries they hope will one day become the source of export earnings. of export earnings.

• These These infant industriesinfant industries are thought to need are thought to need protection in the rough world marketplace.protection in the rough world marketplace.

• The infant industry argument unconvincing if The infant industry argument unconvincing if markets function efficiently.markets function efficiently.

• In the free marketplace, venture capitalist and In the free marketplace, venture capitalist and other private investors will often support firms other private investors will often support firms through many years of losses.through many years of losses.

• Governments around the world support infant Governments around the world support infant industries that never grow up.industries that never grow up.

• Developing countries often try to nurture new Developing countries often try to nurture new industries they hope will one day become the source industries they hope will one day become the source of export earnings. of export earnings.

• These These infant industriesinfant industries are thought to need are thought to need protection in the rough world marketplace.protection in the rough world marketplace.

• The infant industry argument unconvincing if The infant industry argument unconvincing if markets function efficiently.markets function efficiently.

• In the free marketplace, venture capitalist and In the free marketplace, venture capitalist and other private investors will often support firms other private investors will often support firms through many years of losses.through many years of losses.

• Governments around the world support infant Governments around the world support infant industries that never grow up.industries that never grow up.



• By requiring government subsidies to stay By requiring government subsidies to stay afloat, and by charging prices above those in afloat, and by charging prices above those in the rest of the world, such infant industries the rest of the world, such infant industries have proven to be expensive for governments have proven to be expensive for governments and consumers alike.and consumers alike.



28.4 EXPLORE & APPLY28.4 EXPLORE & APPLYEnergy SecurityEnergy Security28.4 EXPLORE & APPLY28.4 EXPLORE & APPLYEnergy SecurityEnergy Security

o The U.S. economy consumes tremendous The U.S. economy consumes tremendous amounts of oil. amounts of oil. o About 777 million gallons per day as of January About 777 million gallons per day as of January

2002.2002.

o The U.S. is vulnerable to political instability in The U.S. is vulnerable to political instability in the middle east and in other oil-exporting the middle east and in other oil-exporting countries.countries.

o The U.S. is a source of income to Middle The U.S. is a source of income to Middle Eastern countries with interest hostile to those Eastern countries with interest hostile to those of the U.S. of the U.S.

o The U.S. economy consumes tremendous The U.S. economy consumes tremendous amounts of oil. amounts of oil. o About 777 million gallons per day as of January About 777 million gallons per day as of January

2002.2002.

o The U.S. is vulnerable to political instability in The U.S. is vulnerable to political instability in the middle east and in other oil-exporting the middle east and in other oil-exporting countries.countries.

o The U.S. is a source of income to Middle The U.S. is a source of income to Middle Eastern countries with interest hostile to those Eastern countries with interest hostile to those of the U.S. of the U.S.


• The external cost of imports are not The external cost of imports are not reflected in the price paid by importers.reflected in the price paid by importers.

• To internalize them, the U.S. could To internalize them, the U.S. could impose an impose an oil import fee.oil import fee.– An oil import fee is a common name for a An oil import fee is a common name for a

tariff when applied to oil.tariff when applied to oil.

• Since oil is a non-renewable resource, Since oil is a non-renewable resource, opponents of oil import fees say such a opponents of oil import fees say such a fee would “drain” America first.fee would “drain” America first.

• The external cost of imports are not The external cost of imports are not reflected in the price paid by importers.reflected in the price paid by importers.

• To internalize them, the U.S. could To internalize them, the U.S. could impose an impose an oil import fee.oil import fee.– An oil import fee is a common name for a An oil import fee is a common name for a

tariff when applied to oil.tariff when applied to oil.

• Since oil is a non-renewable resource, Since oil is a non-renewable resource, opponents of oil import fees say such a opponents of oil import fees say such a fee would “drain” America first.fee would “drain” America first.

Energy SecurityEnergy SecurityEnergy SecurityEnergy Security


Energy SecurityEnergy SecurityEnergy SecurityEnergy Security


Terms Along the WayTerms Along the WayTerms Along the WayTerms Along the Way

free tradefree trade open economyopen economy General Agreement General Agreement

on Tariffs and Trade on Tariffs and Trade (GATT)(GATT)

World Trade World Trade Organization (WTO)Organization (WTO)

tariff tariff

free tradefree trade open economyopen economy General Agreement General Agreement

on Tariffs and Trade on Tariffs and Trade (GATT)(GATT)

World Trade World Trade Organization (WTO)Organization (WTO)

tariff tariff

Smoot-Hawley ActSmoot-Hawley Act quotasquotas non-tariff barriersnon-tariff barriers trading bloctrading bloc North American Free North American Free

Trade AgreementTrade Agreement trade creation effecttrade creation effect

Smoot-Hawley ActSmoot-Hawley Act quotasquotas non-tariff barriersnon-tariff barriers trading bloctrading bloc North American Free North American Free

Trade AgreementTrade Agreement trade creation effecttrade creation effect


Terms Along the Way (continued)Terms Along the Way (continued)Terms Along the Way (continued)Terms Along the Way (continued)

trade diversion effecttrade diversion effect voluntary export voluntary export

restraintsrestraints DumpingDumping strategic dumpingstrategic dumping infant industriesinfant industries

trade diversion effecttrade diversion effect voluntary export voluntary export

restraintsrestraints DumpingDumping strategic dumpingstrategic dumping infant industriesinfant industries


Test YourselfTest YourselfTest YourselfTest Yourself

1.1. When a country imports a good, it will When a country imports a good, it will a.a. gain more in consumer surplus than it loses in gain more in consumer surplus than it loses in

producer surplus.producer surplus.b.b. gain more in producer surplus than it loses in gain more in producer surplus than it loses in

consumer surplus.consumer surplus.c.c. find that its gain of consumer surplus is exactly find that its gain of consumer surplus is exactly

offset by its loss of producer surplus.offset by its loss of producer surplus.d.d. Find that its gain of producer surplus is exactly Find that its gain of producer surplus is exactly

offset by its loss of consumer surplus.offset by its loss of consumer surplus.

1.1. When a country imports a good, it will When a country imports a good, it will a.a. gain more in consumer surplus than it loses in gain more in consumer surplus than it loses in

producer surplus.producer surplus.b.b. gain more in producer surplus than it loses in gain more in producer surplus than it loses in

consumer surplus.consumer surplus.c.c. find that its gain of consumer surplus is exactly find that its gain of consumer surplus is exactly

offset by its loss of producer surplus.offset by its loss of producer surplus.d.d. Find that its gain of producer surplus is exactly Find that its gain of producer surplus is exactly

offset by its loss of consumer surplus.offset by its loss of consumer surplus.



2.2. The GATT was created in response to The GATT was created in response to a.a. the Great Depression of the 1930’s.the Great Depression of the 1930’s.b.b. the cold war of the 1950’s and 1960’s.the cold war of the 1950’s and 1960’s.c.c. Reagonomics, the economic policies of Reagonomics, the economic policies of

President Regan in the 1980’s.President Regan in the 1980’s.d.d. President Clinton’s desire to forge closer President Clinton’s desire to forge closer

relationships with China in the 1990’s.relationships with China in the 1990’s.

2.2. The GATT was created in response to The GATT was created in response to a.a. the Great Depression of the 1930’s.the Great Depression of the 1930’s.b.b. the cold war of the 1950’s and 1960’s.the cold war of the 1950’s and 1960’s.c.c. Reagonomics, the economic policies of Reagonomics, the economic policies of

President Regan in the 1980’s.President Regan in the 1980’s.d.d. President Clinton’s desire to forge closer President Clinton’s desire to forge closer

relationships with China in the 1990’s.relationships with China in the 1990’s.



3.3. The World Trade OrganizationThe World Trade Organizationa.a. is a trading bloc that consist of the United is a trading bloc that consist of the United

States and the countries of Japan and China.States and the countries of Japan and China.b.b. has many member countries, but not the has many member countries, but not the

United States.United States.c.c. competes with GATT for members, with competes with GATT for members, with

about half the world’s countries belonging to about half the world’s countries belonging to the GATT and the other half belonging to the the GATT and the other half belonging to the World Trade Organization. World Trade Organization.

d.d. is a component of the GATT that administers is a component of the GATT that administers the GATT Agreement.the GATT Agreement.

3.3. The World Trade OrganizationThe World Trade Organizationa.a. is a trading bloc that consist of the United is a trading bloc that consist of the United

States and the countries of Japan and China.States and the countries of Japan and China.b.b. has many member countries, but not the has many member countries, but not the

United States.United States.c.c. competes with GATT for members, with competes with GATT for members, with

about half the world’s countries belonging to about half the world’s countries belonging to the GATT and the other half belonging to the the GATT and the other half belonging to the World Trade Organization. World Trade Organization.

d.d. is a component of the GATT that administers is a component of the GATT that administers the GATT Agreement.the GATT Agreement.



4.4. An import tariff shifts the _________ An import tariff shifts the _________ curve of imports upward and curve of imports upward and __________ the price of the good paid __________ the price of the good paid by the consumer.by the consumer.

a.a. supply;increasessupply;increasesb.b. supply;decreasessupply;decreasesc.c. demand;decreasesdemand;decreasesd.d. demand;increasesdemand;increases

4.4. An import tariff shifts the _________ An import tariff shifts the _________ curve of imports upward and curve of imports upward and __________ the price of the good paid __________ the price of the good paid by the consumer.by the consumer.

a.a. supply;increasessupply;increasesb.b. supply;decreasessupply;decreasesc.c. demand;decreasesdemand;decreasesd.d. demand;increasesdemand;increases



5.5. Which is an example of a voluntary Which is an example of a voluntary export restraint?export restraint?

a.a. A tariff.A tariff.

b.b. A quota.A quota.

c.c. The multi-fiber agreement.The multi-fiber agreement.

d.d. The GATT.The GATT.

5.5. Which is an example of a voluntary Which is an example of a voluntary export restraint?export restraint?

a.a. A tariff.A tariff.

b.b. A quota.A quota.

c.c. The multi-fiber agreement.The multi-fiber agreement.

d.d. The GATT.The GATT.



6.6. Which of the following is NOT offered Which of the following is NOT offered as a reason to restrict trade?as a reason to restrict trade?

a.a. Infant industries.Infant industries.

b.b. Dumping.Dumping.

c.c. Level playing field.Level playing field.

d.d. Comparative advantage.Comparative advantage.

6.6. Which of the following is NOT offered Which of the following is NOT offered as a reason to restrict trade?as a reason to restrict trade?

a.a. Infant industries.Infant industries.

b.b. Dumping.Dumping.

c.c. Level playing field.Level playing field.

d.d. Comparative advantage.Comparative advantage.


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Chapter 16 “Policy Toward Trade”

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