AGEC 340 International Economic Development Week 12: March 31April 2 Trade Policy

1
AGEC 340 International Economic
DevelopmentWeek 12 March 31-April 2Trade
Policy

• Note topics for Weeks 12 13 have been
  switched!
• Reading for this week Chapter 17
• Exercise 4 due Thursday covers this week
• Quiz 5 next Thurs. 4/9 covers weeks 12 13

2
So farweve explained prices and quantities in
terms of market equilibrium between supply and
demand
Price (/lb)
1.25
S
1.00
0.75
D
Quantity (thousands of tons/yr)
10
15
17
3
but usually trade is available, so our price is
determined by equilibrium with trade
For exported goods
For imported goods
Price (/lb)
Price (/lb)
1.25
1.25
S
S
1.00
1.00
0.75
0.75
D
D
10
17
10
17
Imports 7
Exports 7
4
Our production consumption depend on our S D
curves relative to the given world price...
An export
An import
S
S
Pt
Pt
D
D
Q
Q
Qd
Qs
Qd
Qs
Our exports
Our imports
5
So why worry about trade? Who cares about the
WTO or NAFTA?
An export
An import
S
S
Pt
Pt
D
D
Q
Q
Qd
Qs
Qd
Qs
Our exports
Our imports
6
To see the welfare effects of trade, lets
start by looking at a market without trade...
P (/bu)
S
D
Q (bu/yr)
7
What price do we expect to observe?
P (/bu)
S
D
Q (bu/yr)
8
The equilibrium price is the only price where Qs
Qd
P (/bu)
S
Pe
D
Qe
Q (bu/yr)
9
but it is also the price quantity which
maximizes economic surplus, defined as the area
between the supply and demand curves
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
10
at low quantities, theres a big gap, so
increasing quantity is very valuable!
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
a small quantity
11
As production consumption increase, the gain
in economic surplus gets smaller...
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
an increased quantity
12
but stays positive..
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
an increased quantity
13
but stays positive..
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
an increased quantity
14
but stays positive..
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
an increased quantity
15
but stays positive..
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
an increased quantity
16
until it hits the equilibrium quantity!
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Qe
Q (bu/yr)
17
At the equilibrium quantity, consumers are
willing to pay for one more unit exactly what it
costs to produce.
P (/bu)
Sproducers marginal cost
Pe
Dconsumers willingness to pay
Qe
Q (bu/yr)
18
so economic surplus is maximized.
P (/bu)
Smarginal cost of production
Dconsumers willingness to pay
Q (bu/yr)
19
What would happen to economic surplus if
production were higher than Qe?
P (/bu)
Smarginal cost of production
Pe
Dconsumers willingness to pay
Qe
Q (bu/yr)
20
Above Qe, marginal costs would be higher than
willingness to pay, so economic surplus would
fall.
P (/bu)
Smarginal cost of production
Pe
costs exceed benefits
Dconsumers willingness to pay
Qe
above Qe...
Q (bu/yr)
21
How does trade enter the picture?
P (/bu)
Sproducers marginal cost
Pe
Dconsumers willingness to pay
Qe
Q (bu/yr)
22
For an export, Pt exceeds Pe...
P (/bu)
Sproducers marginal cost
Pt
Pe
Dconsumers willingness to pay
Qe
Q (bu/yr)
23
So Qs exceeds Qd by the amount of exports...
P (/bu)
Sproducers marginal cost
Pt
Pe
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
exports
24
Who gains from trade? Who loses?
P (/bu)
Sproducers marginal cost
Pt
the price rises
Pe
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
25
To value gains and losses, we need to distinguish
between consumers economic surplus and
producers economic surplus
P (/bu)
Sproducers marginal cost
Pt
the price rises
Pe
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
26
the change from no-trade to exports reduces
consumers surplus, defined as area between
demand curve and price
loss in consumers surplus due to higher price
P (/bu)
Sproducers marginal cost
Pt
CS loss
Pe
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
27
the change from no-trade to exports increases
producers surplus, defined as area between
supply curve and price
gain in producers surplus due to higher price
P (/bu)
Sproducers marginal cost
Pt
PS gain
Pe
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
28
Which is bigger?Here, PS gain is always larger
than CS loss!
This triangle is a net gain in national economic
surplus
P (/bu)
Sproducers marginal cost
Pt
CS loss
PS gain
Pe
Net gain
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
29
Magic! Exports offer money for nothing,
requiring only that we adjust to the foreigners
prices
This triangle is a net gain in national economic
surplus
P (/bu)
Sproducers marginal cost
Pt
Pe
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
30
OK, so exports create economic gains what
about imports?
P (/bu)
Sproducers marginal cost
Pe
Pt
Dconsumers willingness to pay
Qe
Qs
Qd
Q (bu/yr)
consumption falls
production rises
31
the change from no-trade to imports reduces
producers surplus
P (/bu)
Sproducers marginal cost
PS loss
Pe
Pt
Dconsumers willingness to pay
Qe
Qd
Qs
Q (bu/yr)
production falls
consumption rises
32
but going from no-trade to imports increases
consumer surplus
P (/bu)
Sproducers marginal cost
PS loss
Pe
CS gain
Pt
Dconsumers willingness to pay
Qe
Qd
Qs
Q (bu/yr)
production falls
consumption rises
33
Again magic! Imports also offer money for
nothing, requiring only that we adjust to foreign
prices
This triangle is a net gain in national economic
surplus
P (/bu)
Sproducers marginal cost
PS loss
Pe
CS gain
Pt
Net gain
Dconsumers willingness to pay
Qe
Qd
Qs
Q (bu/yr)
production falls
consumption rises
34
But do governments usually allow completely free
trade?
35
Now, we need to start from free trade, and
askWho gains and who loses what from an import
tariff?
Price
Gains and losses from the tariff Change
in Producer surplus A Consumer surplus
-ABCD Govt. revenue C Natl. econ.
surplus -BD
price in domestic market
Pd
import tariff
t
A
B
C
D
Pt
price in trade, or world price
Supply
Demand
Qty.
Qs
Qs
Qd
Qd
36
How about when government restricts an
export?Who gains and who loses what from an
export tax?
Price
Demand
price in trade, or world price
Supply
Pt
B
D
C
export tax
A
t
Gains and losses from the tax Change
in Producer surplus -ABCD Consumer
surplus A Govt. revenue C
Natl. econ. surplus -BD
Pd
price in domestic market
Qs
Qs
Qd
Qd
37
So is more trade better? What if government
subsidizes exports?Who gains and who loses what
from an export subsidy?
Price
Demand
Supply
price in domestic market
Pd
C
E
A
D
s
export subsidy
B
Gains and losses from the subsidy Change
in Producer surplus ABCDE Consumer
surplus -AB Govt. revenue -BCDEF
Natl. econ. surplus -BF
F
Pt
price in trade, or world price
Qs
Qs
Qd
Qd
Conclusion its not trade that creates value
its free trade
38
Some preliminary conclusions

• The simple bit of economics so far tells us that
• Exports are not better than imports
• More trade is not better than less trade
• Whats best is free trade
• But, from the example of environmental policies
  in week 8, may need plenty of domestic taxes,
  subsidies, or regulations to offset externalities
  in production and consumption.

39
Now, some more detail

• So far we have taken foreign prices as given
  just like in the first half of the semester, the
  household takes market prices as given
• But where do foreign prices come from? We need
  to understand that market too!

40
Start with our countrys SD diagram...
Our country
41
...as compared with the rest of the world
Our country
The rest of the world
42
But the quantity scales are different!
Our country
The rest of the world
Q (thou. tons)
Q (tons)
43
If people in the two markets can trade
Our country
The rest of the world
Intl. Trade
Q (tons)
Q (thou. tons)
Q (tons)
44
...our country wont trade anything at our Pe.
Our country
The rest of the world
Intl. Trade
Pe
Q (tons)
Q (thou. tons)
Q (tons)
45
but at higher prices, wed export the surplus
(production - consumption)
Our country
The rest of the world
Intl. Trade
Q (tons)
Q (thou. tons)
Q (tons)
46
creating a supply of exports curve
Our country
The rest of the world
Intl. Trade
Sexports
Q (tons)
Q (thou. tons)
Q (tons)
47
and similarly for the rest of the world...
Our country
The rest of the world
Intl. Trade
Sexports
Q (tons)
Q (thou. tons)
Q (tons)
48
except that the scale is different!
Our country
The rest of the world
Intl. Trade
Sexports
a small gap here is a large gap here, because
of different scales
Q (tons)
Q (thou. tons)
Q (tons)
49
so their demand for imports curve is very flat
Our country
The rest of the world
Intl. Trade
Sexports
Dimports
Q (tons)
Q (thou. tons)
Q (tons)
50
Lets clean up the diagram a little...
Our country
The rest of the world
Intl. Trade
Sexports
Simports
Q (tons)
Q (thou. tons)
Q (tons)
51
to see the equilibrium point in world trade...
Our country
The rest of the world
Intl. Trade
Sexports
Dimports
Q (tons)
Q (thou. tons)
Q (tons)
52
which shows where trade prices come from!
Our country
The rest of the world
Intl. Trade
Sexports
Pt
Dimports
Q (tons)
Q (thou. tons)
Q (tons)
53
When we have a small share of world production,
our trade prices are fixed by the rest of the
world.
Our country
The rest of the world
Intl. Trade
Sexports
Pt
Dimports
Q (tons)
Q (thou. tons)
Q (tons)
54
Our S D curves do not affect trade prices, but
only the quantities produced, consumed, and
traded.
Our country
The rest of the world
Intl. Trade
Sexports
S
S
Pt
Dimports
D
D
Q
Q
Q
Qd
Qs
Qd
Qs
Their imports
Our exports
55
Trade prices depend on world supply and demand.
For example, if foreign supply demand shift
down...
Our country
The rest of the world
Intl. Trade
S
S
Pt
D
S
D
D
Q
Q
Q
56
Trade prices could fall so much thatour country
begins to import.
Our country
The rest of the world
Intl. Trade
S
S
D
Sexports
Pt
Dimports
D
Q
Q
Q
Qd
Qs
Qd
Qs
Their exports
Our imports
57
in any case, because the rest of the world is so
big, we can draw Pt as an (almost) horizontal
lineand look only at the our country diagram
The rest of the world
Our country
Intl. Trade
Sexports
S
S
Pt
Dimports
D
D
Q
Q
Q
Qd
Qs
Qd
Qs
Their imports
Our exports
58
Our production consumption depend on our S D
curves relative to that fixed world price...
An export
An import
S
S
Pt
Pt
D
D
Q
Q
Qd
Qs
Qd
Qs
Our exports
Our imports
59
This is our pattern of comparative advantage,
using the small country assumption that
foreign prices are fixed
Export this
And import this
S
S
Pt
Pt
D
D
Q
Q
Qd
Qs
Qd
Qs
Our exports
Our imports