International Trade

1
International Trade

• Countries can consume beyond their own PPF if
  they trade each specialise in goods with
  comparative advantage
• The rate of exchange will be somewhere between
  their opportunity cost ratios)
• The rate of exchange is measured by the terms of
  trade an index of export prices divided by
  index of import prices (the greater a quantity of
  imports a country can acquire for a given
  quantity of exports, the higher the terms of
  trade)

2
The Importance of International Trade
Bananas
Bananas
B
C
C
A
A
B
Wine
Wine
EU
USA

• Without trade, each produces at A
• With complete specialisation, each produces at B
• Trade occurs at an exchange rate somewhere
  between opportunity costs (same slope for both
  countries) therefore both can consume greater
  quantity of Bananas and Wine

3
Welfare Gain From Trade
S domestic
P domestic
A
B
C
P world
D domestic
Q s domestic
Q d domestic
Imports
Consumer surplus gain A B C Producer
surplus loss A Total welfare gain B C
4
Welfare Loss from Trade?

• Assumes trade based on current comparative
  advantage may be too static not flexible
  enough
• Looks at overall welfare, but not at individual
  winners losers (ie. unemp.)
• Infant industries do newly emerging businesses
  and industries have the chance to grow in global
  competition perhaps they should be protected
  until strong enough?
• Assumes all trade based on comparative adv. but
  lots based on consumer preference for choice
• Free trade is corrosive to cultural practices
  not taken into account (an external cost)

5
Trade Protection Options

• Tariffs taxes on imports
• Quotas quantity restrictions on imports
• Subsidies given to domestic firms to help them
  compete in foreign markets
• Regulations can make it very difficult or
  expensive for foreign products to comply

6
Tariffs A Loss of Welfare
S domestic
P tariff
A
B
D
C
P world
D domestic
Q s with tariff
Q d with tariff
Q s free trade
Q d free trade
Less Imports
Consumer surplus reduced by A B C
D Producer surplus increased by A (domestic
producers expand production at ? price) Govt tax
revenue C Total loss of welfare B D
7
Welfare loss from quota
Quota amount decided, added to domestic production
SD1
Price
Loss in consumer surplus is ABCD
Gain in producer surplus is A
PW q
A
C
B
D
SW
PW
Who receives C?
Generally importers, so welfare loss is BCD
D
If the government sold licences to import,
welfare loss is between BD and BCD
QS1
QD1
QD2
QS2
Quantity
So tariffs are better than quotas
8
Welfare loss from subsidy
Original producer surplus is A
SD1
Price
New producer surplus is ABCD
SD2
Gain in producer surplus is BCD
SW
PW
A
C
Subsidy costs taxpayers ABCE
B
E
D
PW - S
So loss from subsidy is ABCE minus BCD Which
is AE-D
D
QS1
QD1
QS2
Quantity
Since A is the same as D the loss is E
9
Advantages of free trade

• Advantages of free trade

• Disadvantages of free trade

• Specialisation leading to increased output
• Trade allows economies of scale (larger market to
  sell to)
• Lower price and increased choice
• Competition and innovation

• Risk interdependence, over-reliance on trade,
  loss of control
• Unemployment (perhaps)
• Income inequality
• Environmental impact
• Culture

10
Why have trade restrictions?

• If countries specialise according to comparative
  advantage there are major gains from trading
• Tariffs, quotas and other restrictions lead to
  welfare loss, so why do some countries have
  protectionist policies?

11
Outward Orientation

• Concentrating on exports primarily from the
  industrial sector
• Adam Smith, 1776 The Wealth of Nations was
  limited by the extent of the market
• Especially relevant for smaller countries
• Could make income more unequal relies on
  low-wages
• Puts country at mercy of world markets
• Loans for investment to industrialise may be hard
  to repay
• MDCs may make allegations of dumping

12
Inward Orientation

• Until early 90s, larger countries (China,
  India) able to export less replace imports with
  domestic production
• Makes economy self-sufficient can control every
  aspect (necessary in communism)
• Avoids problem of international debt
  vulnerability to world mkts
• Country may lack resources to provide everything
• Consumers begin to demand access to international
  goods services
• Smaller countries cannot satisfy their needs
  efficiently