160
WHAT’S NEW IN THE SIXTH EDITION:
A new
In the News
feature on “Trade Skirmishes” has been added.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ what determines whether a country imports or exports a good.
CONTEXT AND PURPOSE:
Chapter 9 is third in a three-chapter sequence dealing with welfare economics. Chapter 7 introduced
welfare economics: the study of how the allocation of resources affects economic well-being. Chapter 8
applied the lessons of welfare economics to taxation. Chapter 9 applies the tools of welfare economics
from Chapter 7 to the study of international trade, a topic that was first introduced in Chapter 3.
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
that the rest of the world has a comparative advantage in producing the good and that the country
will become an importer.
CHAPTER OUTLINE:
I. The Determinants of Trade
A. Example used throughout the chapter: The market for textiles in a country called Isoland.
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.
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?
C. The World Price and Comparative Advantage
1. The first issue is to decide whether Isoland should import or export textiles.
a. The answer depends on the relative price of textiles in Isoland compared with the price
of textiles in other countries.
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.
a. Note that the domestic price represents the opportunity cost of producing textiles in
Isoland, while the world price represents the opportunity cost of producing textiles
abroad.
II. The Winners and Losers from Trade
A. We can use welfare analysis to determine who will gain and who will lose if free trade begins in
Isoland.
Figure 1
Chapter 9/Application: International Trade ❖ 163
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
trade begins, the domestic price will rise to the world price.
3. Welfare without Trade
a. Consumer surplus is equal to: A + B.
Figure 2
164 ❖ Chapter 9/Application: International Trade
4. Welfare with Trade
5. Changes in Welfare
6. When a country exports a good, domestic producers of the good are better off and domestic
consumers of the good are worse off.
D. The Gains and Losses of an Importing Country
1. If the world price is lower than the domestic price, Isoland will import textiles. Once free
trade begins, the domestic price will fall to the world price.
2. As the price of textiles falls, the domestic quantity of textiles demanded will rise and the
domestic quantity of textiles supplied will fall.
Chapter 9/Application: International Trade ❖ 165
3. Welfare without Trade
a. Consumer surplus is equal to: A.
4. Welfare with Trade
a. Consumer surplus is equal to: A + B + D.
5. Changes in Welfare
a. Consumer surplus changes by: +(B + 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.
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.
4. Welfare before the Tariff (with trade)
a. Consumer surplus is equal to: A + B + C + D + E + F.
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.
5. Welfare after the Tariff
a. Consumer surplus is equal to: A + B.
6. Changes in Welfare
a. Consumer surplus changes by: –(C + D + E + F).
G.
FYI: Import Quotas: Another Way to Restrict Trade
1. An import quota is a limit on the quantity of a good that can be produced abroad and sold
domestically.
2. Import quotas are much like tariffs.
a. Both tariffs and quotas raise the domestic price of the good, reduce the welfare of
domestic consumers, increase the welfare of domestic producers, and cause deadweight
losses.
H. The Lessons for Trade Policy
1. If trade is allowed, the price of textiles will be driven to the world price. If the domestic price
2. If a country imports a product, domestic producers are made worse off, domestic consumers
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
3. A tariff would create a deadweight loss because total surplus would fall.
I.
In the News: Trade Skirmishes
J. Other Benefits of International Trade
III. The Arguments for Restricting Trade
A. The Jobs Argument
1. If a country imports a product, domestic producers of the product will have to lay off workers
because they will decrease domestic output when the price declines to the world price.
B. The National-Security Argument
1. Certain industries may produce key resources needed to produce products necessary for
national security.
C. The Infant-Industry Argument
1. New industries need time to establish themselves to be able to compete in world markets.
Chapter 9/Application: International Trade ❖ 169
D. The Unfair-Competition Argument
1. It is unfair if firms in one country are forced to comply with more regulations than firms in
E. The Protection-as-a-Bargaining-Chip Argument
1. Threats of protectionism can make other countries more willing to reduce the amounts of
protectionism they use.
F.
In the News: Second Thoughts about Free Trade
1. Some economists worry about the impact of international trade on the distribution of income.
G.
Case Study: Trade Agreements and the World Trade Organization
2. A unilateral approach occurs when a country lowers its trade restrictions on its own. A
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.
170 ❖ Chapter 9/Application: International Trade
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. Since wool suits are cheaper in neighboring countries, Autarka would import suits if it were to
allow free trade.
3. Lobbyists for the textile industry might make five arguments in favor of a ban on the import
of wool suits: (1) imports of wool suits destroy domestic jobs; (2) the wool-suit industry is
vital for national security; (3) the wool-suit industry is just starting up and needs protection
from foreign competition until it gets stronger; (4) other countries are unfairly subsidizing
their wool-suit industries; and (5) the ban on the importation of wool suits can be used as a
bargaining chip in international negotiations.