INTERNATIONAL TRADE

1. INTERNATIONAL TRADE • Principles of Microeconomic Theory, ECO 284 • John Eastwood • CBA 247 • 523-7353 • John.Eastwood@nau.edu • Harmonized tariff schedule (HTS) of the United States:http://www.usitc.gov/taffairs.htm#HTS

2. Static Gains from Trade • Specialization along the lines of comparative advantage increases world output. • Trade raises consumption beyond autarky. • Greater variety of goods and services • Imported resources

3. Dynamic Gains from Trade • Trade speeds economic growth • When more K goods are imported than produced in autarky, PPF shifts out. • Trade diffuses new technology. • Trade raises real income. Savings rise. • Free trade an effective anti-trust policy • Trade expands the market; firms achieve economies of scale.

4. Commercial Policy • Governments action that may change the composition and volume of trade flows • Tariffs • Quotas • Other non-tariff barriers • Subsidies

5. Tariffs • Taxes on • Imports • Exports • Components • Ad valorem-- % of value • Specific -- flat fee per unit • Compound -- both

6. Positive Effects of Tariffs • Revenue Effect -- provide tax revenue • Protective Effect -- shelter domestic producers from foreign competition

7. Tariffs as tools of int’l policy • Most Favored Nation status, MFN • granted as a reward, withheld as a punishment • Generalized System of Preferences, GSP • Most developed countries have GSP as means of helping developing countries • access to markets of developed countries

8. Non-tariff Barriers • Voluntary export restraints (VER) • Tariff-rate quotas (TRQs), • WTO members are replacing existing quotas with TRQs • Quotas (on apparel and textiles) are to be phased out by 2005

9. Welfare Cost Analysis • Use Supply and Demand • One import or export good • Measure Changes in Consumer Surplus and Producer Surplus • Start with a small country • Its trade is too small to affect terms of trade

10. Consumers’ Surplus • Consumers’ Surplus is the difference between consumers’ maximum willingness-to-pay and the amount they actually paid. • The amount actually paid equals PQ. • Graphically, Consumers’ Surplus (CS) is the area under the demand curve above P.

11. Producer Surplus • Producer surplus is the price of a good minus the opportunity cost of producing it. • Graphically, Producers’ Surplus (PS) is the area under the Price line and above Supply.

12. An Efficient Market for Pizza Consumer surplus S 25 20 Price (dollars per pizza) 15 10 Producer surplus 5 D 0 5 10 15 20 Quantity (thousands of pizzas per day)

13. Gains from free trade -- imports Domestic Supply of grapes 10 Price ($ per bushel of grapes) 6 a b c 3 World price of grapes 2 Domestic demand for grapes 0 4 1 7 10 Quantity (millions bushels of grapes per year)

14. Welfare of a Move to Free TradeA Small Country’s Imports

15. Gains from free trade -- exports Domestic Supply of honey 10 9 World price of honey Price ($ per jar of honey) g e f 6 2 Domestic demand for honey 0 4 1 7 10 Quantity (millions jars of honey per year)

16. Welfare of a Move to Free TradeA Small Country’s Exports

17. Welfare Cost of a Tariffon Imports -- Small Country Domestic Supply of grapes 10 Price ($ per bushel of grapes) World price + tariff $2/bu 5 c a d b 3 World price of grapes 2 Domestic demand for grapes 0 1 3 5 7 10 Quantity (millions bushels of grapes per year)

18. Welfare Cost of a Tariffon Imports -- Small Country Loss = 0.5 x tariff x change in imports

19. Exhibit 6: Effect of a Quota In panel a, D is the U.S. demand curve and S is the supply curve of U.S. producers. The world price of sugar is $0.10 (the price that would prevail in the U.S. market) and a total of 70 million pounds would be demanded  U.S. producers would supply 20 million pounds and importers 50 million pounds. (a) S Price per pound Now suppose that U.S. officials impose a quota of 30 million pounds per month 0.10 As long as the U.S. price is at or above the world price of $0.10 per pound, foreigners supply 30 million pounds  the total supply of sugar to the U.S. market is found by adding 30 million pounds of imported sugar to the amount supplied by U.S. producers D 0 20 70 Sugar (millions of pounds per month)

20. Exhibit 6: Effect of a Quota Thus, the supply curve that sums domestic production and imports is horizontal at the world price of $0.10 per pound and remains so until the quantity supplied reaches 50 million pounds. (a) S +30 S For prices above $0.10, the new supply curve, S + 30, adds horizontally the 30 million pound quota to S, the supply curve of U.S. producers as shown by the dark red line. The U.S. price is found where this new supply curve intersects the domestic demand curve  point e  an effective quota, by limiting imports, raises the price of domestic sugar above the world price and reduces quantity below the free trade level. e Price per pound $0.15 0.10 D 0 20 50 70 Sugar (millions of pounds per month)

21. Exhibit 6: Effect of a Quota (a) (b) The right panel shows the distribution and efficiency aspects of the quota. As a result of the quota, U.S. consumer surplus declines by the blue and pink shaded areas. S S +30 S +30 S Price per pound e $0.15 $0.15 a c b d 0.10 0.10 D D 0 70 20 50 70 30 60 0 20 Sugar (millions of pounds per month) Sugar (millions of pounds per month) Area a becomes producer surplus  no loss of U.S. welfare. The blue rectangle, c, shows the increased profit to those permitted by the quota to sell Americans 30 million pounds at $0.15 per pound. To the extent that foreign exporters rather than U.S. importers reap this profit, area c reflects a net loss in domestic welfare.

22. Exhibit 6: Effect of a Quota The pink triangle, b, shows by how much the marginal cost of producing another 10 million pounds in the U.S. exceeds the world price  a welfare loss to the U.S. economy because sugar could have been purchased abroad for $0.10 and the resources employed to increase sugar production could have been used more efficiently to produce other goods. (a) (b) S S +30 S +30 S Price per pound e $0.15 $0.15 a c b d 0.10 0.10 D D 0 70 20 50 70 30 60 0 20 Sugar (millions of pounds per month) Sugar (millions of pounds per month) The pink triangle, d, is also a welfare loss, because it reflects a reduction in consumer surplus with no offsetting gain to anyone  the two pink shaded areas measure the minimum welfare cost imposed on the domestic economy by an effective quota. To the extent that the profit from quota rights, area c, accrues to foreigners, this increases the U.S. welfare loss resulting from the quota

23. Welfare effects of a domestic production subsidy Domestic supply of small cars Domestic supplywith subsidy 20 Subsidy = $T Price ($1000 per car) 12 10 World price + new equivalent tariff a b 6 World price of small cars 4 Domestic demand 0 2 4 6 8 10 14 18 Quantity (thousands of cars per year)

24. Welfare effects of a domestic production subsidy

25. Welfare Cost of Tariffs as a Percentage of GDP • Tariffs & NTBs often exclude new goods • e.g., computers, just-in-time inventory processes • GDP loss almost twice the tariff rate • Ten percent tariff lowers GDP by 19.8% • Twenty-five percent tariff lowers GDP by 47%

26. Review homework