Lecture 6

• Imports are the good and services that people and firms in one country buy from firms in other countries
• Exports are the goods and services firms in one country sell to people and firms in other countries
• Comparative advantage

  The fundamental force that generates trade between nations
• Opportunity cost

  The basis for comparative trade is divergent opportunity costs between countries
• National comparative advantage

  The ability of a nation to perform an activity or produce a good or service at a lower opportunity cost than any other nation
• Comparative trade

  • China has a comparative advantage in producing T-shirts
  • United States has a comparative advantage in producing airplanes
• Why the United States imports T-shirts

  1. No international trade: US demand and supply determine price and quantity

  2. With international trade: World price is lower, US price falls, US increases quantity bought, US decreases quantity produced, US imports T-shirts

  
• Why the United States exports airplanes

  1. No international trade: US price and quantity determined

  2. With international trade: World price is higher, US price rises, US increases quantity produced, US decreases quantity bought, US exports airplanes

  
• Winners and losers from trade

  • International trade lowers the price of an imported good and raises the price of an exported good
  • Buyers of imported goods benefit from lower prices
  • Sellers of exported goods benefit from higher prices
  • Not everyone gains from international competition
• Measuring gains and losses

  Effects on consumer surplus, producer surplus, and total surplus
• Gains and losses from imports

  1. No trade: Consumer surplus, producer surplus

  2. With trade: Consumer surplus expands, producer surplus shrinks, net gain in total surplus
• Gains and losses from exports

  1. No trade: Consumer surplus, producer surplus

  2. With trade: Consumer surplus shrinks, producer surplus expands, net gain in total surplus
• Tools used by governments to restrict international trade

  • Tariffs
  • Import quotas
  • Other import restrictions
  • Export subsidies
• Tariff

  A tax on a good that is imposed by the importing country when an imported good crosses its international boundary
• Effect of a tariff

  1. Before tariff: World price, imports

  2. With tariff: Price rises, imports decrease, government collects tariff revenue
• Winners and losers from a tariff

  • US producers of the good gain
  • US consumers of the good lose
  • Consumers lose more than producers gain
• Total surplus with free trade

  1. Imports, consumer surplus, producer surplus, gains from free trade

  2. Total surplus is maximized
• Total surplus with a tariff

  1. Price rises, quantity produced increases, quantity bought decreases

  2. Consumer surplus shrinks, producer surplus expands, tariff revenue collected

  3. Deadweight loss from tariff
• Consumer surplus

  The loss of consumer surplus is the loss to U.S. consumers from the tariff
• Total surplus with free international trade

  • Imports
  • Consumer surplus
  • Producer surplus
  • Gains from free trade
• Total surplus is maximized with free international trade
• Tariff

  $2 tariff is added to the world price, increasing the U.S. price of a T-shirt to $7

  
• Tariff is added

  Quantity of T-shirts produced in the U.S. increases, quantity bought decreases

  
• Consumer surplus

  Shrinks to the green area
• Producer surplus

  Expands to the blue area
• Area B

  Transfer from consumer surplus to producer surplus
• Tariff revenue

  Equals the imports of T-shirts multiplied by the tariff, area C

  
• Deadweight loss

  The sum of the two areas labeled D
• Import quota

  A quantitative restriction on the import of a good that limits the maximum quantity that may be imported in a given period
• Market before import quota

  • World price is $5
  • U.S. imports 40 million T-shirts

  
• Import quota of 10 million T-shirts

  Supply of T-shirts in the U.S. becomes S + quota, price rises to $7

  
• Higher price

  Americans decrease the number of T-shirts they buy to 45 million, U.S. garment makers increase production to 35 million T-shirts, imports decrease to the quota of 10 million

  
• Winners and losers from import quota

  U.S. producers of T-shirts gain, U.S. consumers of T-shirts lose, importers of T-shirts gain, U.S. consumers lose more than U.S. producers gain and importers gain

  
• Export subsidy

  A payment made by the government to a domestic producer of an exported good
• Three traditional arguments for restricting international trade

  • National security argument
  • Infant industry argument
  • Dumping argument
• National security argument

  A country must protect industries that produce defense equipment and armaments and those on which the defense industries rely
• Infant industry argument

  It is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets
• Dumping

  When a foreign firm sells its exports at a lower price than its cost of production, either through predatory pricing or receiving a subsidy
• Four newer arguments for protection

  • Saves jobs
  • Allows us to compete with cheap foreign labor
  • Brings diversity and stability
  • Penalizes lax environmental standards
• The idea that buying foreign goods costs domestic jobs is wrong