Comparative Advantage and the Gains from International Trade

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Comparative Advantage and the Gains from
International Trade

• Chapter 9

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Relative Importance of International Trade to US
Economy
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Year GDP (Mill) ExportImport XM/GDP()
2013 16,168.2 5036.6 31.15
2014 17,419.0 5195.9 29.83

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1. Why Do Nations Trade?

• Trade is a means of getting some vital resources
  (Chromium-for surgical instruments )
• Trade helps nations to focus on what do best
  (Brazilian coffee, American airplanes Saudi
  Arabian oil Cuban cigars, etc. )
• Trade increases total world production and
  consumption due to specialization

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2. The Law of Comparative Advantage

• Trade is based on the concept of comparative
  advantage.
• The producer who has the smaller opportunity
  cost of producing a good is said to have a
  comparative advantage in producing the good.

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3. Why Trade?

• There are mutual gains from trade
• Trade increases total world production and
  consumption
• Trade improves the standard of living of trading
  partners
• Trade helps the transfer of technical know-how

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4. Determinants of International Trade

• The world price of goods
• The domestic price of goods or simply,
• The difference in the relative price of one
  good in terms of another gt comparative advantage
  
• If the world price gt the domestic price, then
  producers have the incentive to export the good.
• If the world pricelt the domestic price, then
  consumers will import the good from abroad

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5. Equilibrium without Trade

• Assume
• A country that is isolated from rest of the world
  and produces steel.
• The market for steel consists of the buyers and
  sellers of the country.
• Suppose the country is Korea.
• Show the Consumer Surplus, Producer Surplus, and
  the Total Surplus before trade.

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5. Equilibrium Without Trade
Steel Market
Domestic Supply
Price
Consumer Surplus
Pe
Producer Surplus
Domestic Demand
Quantity
Qe
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5. Equilibrium without Trade

• Domestic Price adjusts to balance Demand and
  Supply.
• The sum of consumer and producer surplus measures
  the total benefits.

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5a. The welfare effect of trade on an exporter of
steel-Korea

• If a country has a comparative advantage, its
  domestic price will be below the world price, and
  it will be an exporter of the good.
• If other countries (the rest of the world) have a
  comparative advantage, then the domestic price in
  a given country will be higher than the world
  price and it will be an importer of the good.

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5a. International Trade Example Exporter
Domestic Supply
Steel Market
Price
World Price
PD
Domestic Demand
Quantity
QD
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5a. International Trade Example - Exporter
Domestic Supply
Steel Market
Exports
Price w/trade
World Price
Price
Domestic Demand
QD
Quantity
QS
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5a. International Trade Example - Exporter

• When an exporter sells on the world market, its
  price rises to the world price.
• At the world price, there is an excess supply.
  Domestic producers produce more than domestic
  buyers want to buy at that price.
• The excess supply is exported.

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5a. International Trade Example - Exporter
Domestic Supply
Steel Market
Exports
A
Price w/trade
World Price
D
B
Price
C
Domestic Demand
Quantity
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5a. International Trade Example - Exporter
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5a. Gains and Losses From Trade of an
exporter-Korea

• Domestic consumers of the exported good may be
  worse off from trade. Consumer surplus declined
  from AB to A.
• Domestic producers of the exported good will be
  better off as a result of trade. Producer surplus
  increased from C to BCD.
• In the net, the exporting country is better off
  after trade. Total surplus increased from ABC
  to ABCD.

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5b. International Trade Example Importer-US

• When the domestic price is higher than the world
  price, the country will be an importer of the
  good.

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5b. International Trade Example - Importer-US
Domestic Supply
Steel Market
Price
PD
World Price
Domestic Demand
Quantity
QD
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5b. International Trade Example - Importer-US
Domestic Supply
Steel Market
Price
Quantity Imported
World Price
Domestic Demand
Quantity
QD
QS
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5b. International Trade Example - Importer-US

• When US buys on the world market its price falls
  to the world price.
• At the world price, there is an excess demand.
  Domestic producers produce less than domestic
  consumers want to buy at that price.
• The excess demand is imported.

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5b. International Trade Example - Importer-US
Domestic Supply
Steel Market
Price
A
PD
B
D
World Price
C
imports
Domestic Demand
Quantity
QD
QS
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5b. International Trade Example - Importer.
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5b. Gains and Losses From Trade

• Domestic consumers of the imported good will be
  better off from trade. Consumer surplus increased
  from A to ABD.
• Domestic producers of the imported good will be
  worse off as a result of trade. Producer surplus
  decreased from BC to C.
• Collectively, the importing country is better
  off. Total surplus increased from ABC to
  ABCD.

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6. Barriers to Trade

• a.Tariffs
• A tariff is a tax on imported goods
  HO, p. 287

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6a. Examples of U.S. Tariffs

• Brooms 32 cents each
• Fishing reels 24 cents each
• Electrical motors 2.4 of value
• Automobiles 2.9 of value
• Bicycles 5.5 of value

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a. Examples of U.S. Tariffs
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a. The Impact of a Tariff

• Suppose the government imposes a tariff on
  imported steel.
• Recall from Chapter 4 that
• a tax raises prices consumers pay.
• Consumers buy less of the good.
• Consumer surplus declines.

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a. The Impact of a Tariff

• A tariff reduces the price that exporting
  producers receive for their products and the
  quantity they sell.
• In this case, the tariff raises the price for
  domestic producers which import the product
  allowing them to increase their output.
• Consumer surplus falls, producer surplus rises.

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a.The Welfare Effects of a Tariff
Domestic Supply
Steel Market
Price
Tariff

World Price
Domestic Demand
Quantity
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a.The Welfare Effects of a Tariff
Domestic Supply
Steel Market
Price
Tariff

World Price
Domestic Demand
Quantity
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a. The Welfare Effects of a Tariff

• The net effect of the tariff is that total
  surplus declines.
• Like the taxes considered in Chap. 4, there is a
  deadweight loss resulting from the imposition of
  the tariff.

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b. Quotas

• An import quota is a limit on the
• quantity of an imported good HO, p. 251
• Examples Quota on sugar import Quota on lumber
  import Quota on steel import

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b. Impact of an Import Quota

• The import quota restricts supply with the result
  that the domestic price increases.
• At the higher price, domestic consumers buy less.
  Consumer surplus declines.
• At the higher price, domestic producers increase
  production and producer surplus increases.

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6b. Impact of an Import Quota

• Just as in the case of the tariff, import quotas
  result in a deadweight loss (perhaps even greater
  loss).
• One important difference in the impacts of
  tariffs and quotas is that there is a transfer of
  income (consumer surplus) from consumers to the
  holders of import quota license holders.

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7.Tariffs Versus Quotas

• In the case of tariffs, some of the increased
  revenues go to the government of the importing
  country. Governments have always regarded
  tariffs as a legitimate means of raising tax
  revenues.
• Tariffs impose the highest penalty on the least
  efficient foreign producers. Quotas, on the
  other hand, do not guarantee that result.

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8. Arguments Against Free Trade (Protectionism)

• The Jobs Loss argument (saving jobs) NAFTA as
  Giant sucking sound, - Ross Perot 1994
  election.
• The National Security Argument Be selective of
  exports.
• The Infant Industry Argument (HDTV)
• The Unfair-Competition Argument - Retaliate
  against those who restrict their own trade.
• Antidumping - Dumping is selling a product below
  its cost of production in another country.

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Dumping Example

• http//www.npr.org/programs/morning-edition/
• Fla. Tomato Growers Say Mexico Trade Deal Is
  Rotten
• January 23, 2013

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9. Has NAFTA been a Success or a Failure?

• NAFTA is A trilateral trade which increased US
  exports to Mexico by 90 and Mexican exports to
  US by 140 (1994-2000).
• Mexico lowered duties on US exports to 1.6 from
  10. US lowered duties on Mexican goods from 4
  to .4 (1994-2000).
• US exports to Canada increased by 55 and US
  imports from Canada increased by 56.
• There are arguments about job losses in the US,
  Canada, and Mexico, however.

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10a. General Agreements on Tariffs and Trade
(GATT)

• First signed in 1947 among 10 countries
• Designed to provide an international forum that
  would encourage free trade by
• -regulating and reducing tariffs
  -providing a common mechanism for resolving
  disputes - environmental, intellectual property
  rights, subsidies, etc.

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10b. World Trade Organization (WTO)

• An international organization dealing with rules
  of trade among nations
• Created in 1995 by the Uruguay round of
  negotiations (86-94) by 146 countries
• Functions are
• Administering trade agreements
• Providing forum for trade negotiations
• Monitoring national trade policies
• Handling trade disputes
• Giving technical assistance and training for
  developing countries to improve trade relations