160
WHAT’S NEW IN THE SEVENTH EDITION:
A new
In the News
feature on “Threats to Free Trade” has been added.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
who wins and who loses from international trade.
that the gains to winners from international trade exceed the losses to losers.
the arguments people use to advocate trade restrictions.
CONTEXT AND PURPOSE:
develops the conditions that determine whether a country imports or exports a good and discusses who
wins and who loses when a country imports or exports a good. This chapter will show that when free
trade is allowed, the gains of the winners exceed the losses of the losers. Because there are gains from
trade, restrictions on free trade reduce the gains from trade and cause deadweight losses similar to those
generated by a tax.
9
APPLICATION: INTERNATIONAL
TRADE
Chapter 9/Application: International Trade ❖ 161
KEY POINTS:
The effects of free trade can be determined by comparing the domestic price without trade to the
world price. A low domestic price indicates that the country has a comparative advantage in
producing the good and that the country will become an exporter. A high domestic price indicates
will become an importer.
When a country allows trade and becomes an exporter of a good, producers of the good are better
off, and consumers of the good are worse off. When a country allows trade and becomes an importer
of a good, consumers are better off, and producers are worse off. In both cases, the gains from trade
exceed the losses.
There are various arguments for restricting trade: protecting jobs, defending national security,
helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.
Although some of these arguments have merit in some cases, economists believe that free trade is
usually the better policy.
CHAPTER OUTLINE:
I. The Determinants of Trade
B. The Equilibrium without Trade
1. If there is no trade, the domestic price in the textile market will balance supply and demand.
This chapter may be difficult to teach and very difficult for students to understand
and accept. Be prepared for a skeptical reaction from students who have been told
that free international trade is detrimental to a country. For various historical,
cultural, and political reasons, free trade has few defenders outside of the economics
profession.
Point out that international trade issues are no different from trading as it applies to
individuals within a community or between states and regions within a country. The
gains from trade between countries occur for the same reasons that we observe
gains from trade between individuals.
Pick a state adjacent to yours. Ask students why we do not seem to worry about
“importing” goods from other states the same way in which we worry about
importing goods from other countries.
162 ❖ Chapter 9/Application: International Trade
2. A new leader is elected who is interested in pursuing trade. A committee of economists is
organized to determine the following:
a. If the government allows trade, what will happen to the price of textiles and the quantity
of textiles sold in the domestic market?
b. Who will gain from trade, who will lose, and will the gains exceed the losses?
c. Should a tariff (a tax on imported textiles) be part of the new trade policy?
C. The World Price and Comparative Advantage
1. The first issue is to decide whether Isoland should import or export textiles.
of textiles in other countries.
for that good.
2. If the world price is greater than the domestic price, Isoland should export textiles; if the
world price is lower than the domestic price, Isoland should import textiles.
abroad.
b. Thus, if the domestic price is low, this implies that the opportunity cost of producing
II. The Winners and Losers from Trade
Isoland.
Figure 1
Chapter 9/Application: International Trade ❖ 163
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B. We will assume that, because Isoland would be such a small part of the market for textiles, they
will be price takers in the world economy. This implies that they take the world price as given
and must sell (or buy) at that price.
C. The Gains and Losses of an Exporting Country
1. If the world price is higher than the domestic price, Isoland will export textiles. Once free
2. As the price of textiles rises, the domestic quantity of textiles demanded will fall and the
domestic quantity of textiles supplied will rise. Thus, with trade, the domestic quantity
3. Welfare without Trade
Figure 2
Have students come to the board and label the areas of consumer and producer
surplus after you have drawn each of the figures. This should not be a problem as
they are likely familiar enough with consumer and producer surplus after completing
Chapters 7 and 8.
164 ❖ Chapter 9/Application: International Trade
b. Producer surplus is equal to: C.
4. Welfare with Trade
a. Consumer surplus is equal to: A.
c. Total surplus is equal to: A + B + C + D.
5. Changes in Welfare
a. Consumer surplus changes by: –B.
b. Producer surplus changes by: +B + D.
c. Total surplus changes by: +D.
6. When a country exports a good, domestic producers of the good are better off and domestic
consumers of the good are worse off.
7. When a country exports a good, total surplus is increased and the economic well-being of the
country rises.
1. If the world price is lower than the domestic price, Isoland will import textiles. Once free
2. As the price of textiles falls, the domestic quantity of textiles demanded will rise and the
domestic quantity of textiles supplied will fall.
quantity supplied.
b. Isoland will import the difference between the domestic quantity demanded and the
domestic quantity supplied.
Note that there will be both imported and domestically produced textiles sold in this
country. This is true for many imported goods.
Chapter 9/Application: International Trade ❖ 165
3. Welfare without Trade
a. Consumer surplus is equal to: A.
c. Total surplus is equal to: A + B + C.
4. Welfare with Trade
b. Producer surplus is equal to: C.
5. Changes in Welfare
a. Consumer surplus changes by: +B + D.
b. Producer surplus changes by: –B.
c. Total surplus changes by: +D.
6. When a country imports a good, domestic consumers of the good are better off and domestic
producers of the good are worse off.
Figure 3
166 ❖ Chapter 9/Application: International Trade
7. When a country imports a good, total surplus is increased and the economic well–being of the
country rises.
E. Trade policy is often contentious because the policy creates winners and losers. If the losers have
political clout, the result is often trade restrictions such as tariffs and quotas.
F. The Effects of a Tariff
1. Definition of tariff: a tax on goods produced abroad and sold domestically.
2. A tariff raises the price above the world price. Thus, the domestic price of textiles will rise to
the world price plus the tariff.
3. As the price rises, the domestic quantity of textiles demanded will fall and the domestic
quantity of textiles supplied will rise. The quantity of imports will fall and the market will
move closer to the domestic market equilibrium that occurred before trade.
4. Welfare before the Tariff (with trade)
a. Consumer surplus is equal to: A + B + C + D + E + F.
b. Producer surplus is equal to: G.
c. Government revenue is equal to: zero.
d. Total surplus is equal to: A + B + C + D + E + F + G.
Figure 4
Point out that during the 1990s with open trading (for example, the passage of
NAFTA), the U.S. economy achieved and maintained full employment even as large
quantities of imported goods entered the United States. Most of the jobs that “left
the country” were low-skill, low-wage jobs.
Be prepared for students to argue that trade cannot be good for everyone. More than
likely at least one of your students will know an individual who lost his or her job
when a factory closed and moved to another country. Take this opportunity to point
out that this individual is one of the “losers,” but remind the class that the gains from
trade exceed the losses, so the total well-being of society is increased.
Chapter 9/Application: International Trade ❖ 167
5. Welfare after the Tariff
a. Consumer surplus is equal to: A + B.
c. Government revenue is equal to: E.
d. Total surplus is equal to: A + B + C + E + G.
6. Changes in Welfare
b. Producer surplus changes by: +C.
c. Government revenue changes by: +E.
G.
FYI: Import Quotas: Another Way to Restrict Trade
domestically.
2. Import quotas are much like tariffs.
a. Both tariffs and quotas raise the domestic price of the good, reduce the welfare of
losses.
b. However, a tariff raises revenue for the government, whereas a quota creates surplus for
license holders.
H. The Lessons for Trade Policy
2. If a country imports a product, domestic producers are made worse off, domestic consumers
are made better off, and the gains of consumers outweigh the losses of producers. If a
This section provides a good opportunity to review what the students have learned
thus far about trade. You should reinforce the idea that total surplus rises when trade
is introduced, but falls once trade restrictions are imposed.
168 ❖ Chapter 9/Application: International Trade
country exports a product, domestic producers are made better off, domestic consumers are
made worse off, and the gains of producers outweigh the losses of consumers.
I.
In the News: Threats to Free Trade
restrictions.
2. This article from
The
Wall Street Journal
describes the increase in protectionist policies.
J. Other Benefits of International Trade
2. These include an increased variety of goods, lower costs through economies of scale,
increased competition, and an enhanced flow of ideas.
III. The Arguments for Restricting Trade
A. The Jobs Argument
2. Free trade, however, will create job opportunities in other industries where the country
enjoys a comparative advantage.
1. In light of the jobs argument, some people argue for taxpayer-subsidized retraining programs
to help those who lose their jobs due to free trade.
2. This opinion piece from The New York Times focuses on the net gains from trade and argues
C. The National-Security Argument
1. Protecting certain industries may be appropriate if they produce products necessary for
national security.
providing national security is exaggerated.
D. The Infant-Industry Argument
1. New industries need time to establish themselves to be able to compete in world markets.
new conditions.
Chapter 9/Application: International Trade ❖ 169
3. Even if this argument is legitimate, it is nearly impossible for the government to choose
E. The Unfair-Competition Argument
1. It is unfair if firms in one country are forced to comply with more regulations than firms in
another country, or if another government subsidizes the production of a good.
than the domestic producers lose.
F.
In the News: Second Thoughts about Free Trade
2. This article from
The New York Times
expresses such concerns.
G. The Protection–as-a-Bargaining-Chip Argument
protectionism they use.
2. If the threat does not work, the country has to decide if it would rather reduce the economic
well-being of its citizens (by carrying out the threat) or lose credibility in negotiations (by
reneging on its threat).
1. Countries wanting to achieve freer trade can take two approaches to cutting trade
restrictions: a unilateral approach or a multilateral approach.
countries do the same.
3. The North America Free Trade Agreement (NAFTA) and the General Agreement on Tariffs
and Trade (GATT) are multilateral approaches to reducing trade barriers.
5. The functions of the WTO are to administer trade agreements, provide a forum for
negotiation, and handle disputes that arise among member countries.
Make sure that you point out the conclusion in this chapter. The chapter ends with a
very effective parable about the discovery of comparative advantage, its adoption, its
beneficial consequences, and finally, its abandonment for political reasons.