Theory Guest Lecture 10 Trade

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Theory Guest Lecture 10Trade

• Introductory Economics for the Treasury
• Dr. Paul Frijter

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Contents

• Some basic stats
• The reasons to trade
• Trade barrier 1 trade tariffs
• Trade barriers 2 trade quotas
• Arguments used against trade
• The infant industry argument and economies to
  scale.

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Basic trade stats
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.
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(No Transcript)
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Australian stats
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Basic facts of trade

• 1. The vast majority of trade is between
  developed countries and is regional.
• By and large, Africa is a net exporter of primary
  commodities, Asia exports manufacturing, Europe
  and the US export manufacturing services,
  Australia is in the middle.
• In recent years, Australia has imported more than
  its been exporting

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International Trade

• How does international trade affect economic
  well-being?

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Learning Objectives Trade

• Understand what determines whether a country
  imports or exports a good
• Consider the winners and losers from
  international trade
• Understand how the gains from trade generally
  exceed the loses
• Analysis the welfare effects of tariffs and
  import quotas
• Outline the arguments used to advocate trade
  restrictions

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The Principle of Comparative Advantage

• Comparative advantage compares producers of a
  good according to their opportunity costs -
  specialisation
• The producer who has the smaller opportunity cost
  of producing a good is said to have a comparative
  advantage in producing that good.

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Determinants of International Trade

• The effects of free trade can be shown by
  comparing the domestic price of a good without
  trade and the world price of the good.
• A country will either be an exporter or an
  importer of the good.

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Equilibrium Without Trade

• Assume
• A country that is isolated from rest of the world
  and produces steel.
• The market for steel consists of the buyers and
  sellers in the country.

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Equilibrium Without International Trade
Domestic Supply
Consumer
surplus
Equilibrium price
Producer
surplus
Domestic Demand
0
Quantity
Equilibrium
of Steel
quantity
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Equilibrium Without International Trade

• When an economy cannot trade in world markets,
  the price adjusts to balance domestic supply and
  demand.
• The sum of consumer and producer surplus measures
  the total benefits that buyers and sellers
  receive from the steel market.

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An Important Example of the Impact of
International Trade

• If the country decides to engage in international
  trade, will it be an importer or exporter of
  steel?
• Who will gain from free trade in steel and who
  will lose?
• Will the gains from trade exceed the losses?

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World Price and Comparative Advantage

• If a country has a comparative advantage, then
  the domestic price will be below the world price
  - EXPORTER
• If the country does not have a comparative
  advantage, then the domestic price will be higher
  than the world price - IMPORTER

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International Trade and the Exporting Country

• If the world price of steel is higher than the
  domestic price, the country will be an exporter
  of steel when trade is permitted.
• Producers of steel will want to sell their steel
  at the world price, hence output will increase,
  and the domestic price will rise.
• Exports equal the difference between the domestic
  quantity supplied and the domestic quantity
  demanded at the world price.

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International Trade and the Exporting Country
Price
of Steel
Price
after trade
Price
before trade
Domestic
demand
0
Quantity
of Steel
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International Trade and the Exporting Country
Once trade is allowed, the domestic price rises
to equal the world price. Exports equal the
difference between the quantity supplied and
demanded at the world price
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How does Free Trade Affects Welfare in an
Exporting Country?

• We will see that permitting international trade
  for an exporting country raises the economic
  well-being of the country as a whole by
  increasing total surplus
• Buyers in the exporting country are worse off.
• Sellers in the exporting country are better off.
• However, we will see that Producer surplus rises
  by more than consumer surplus falls.

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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Price
after trade
Price
before trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Price
after trade
Price
before trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Consumer surplus before trade
A
Price
after trade
B
Price
before trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Consumer surplus before trade
A
Price
after trade
B
Price
before trade
C
Producer surplus before trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Consumer surplus after trade
A
Price
after trade
Price
before trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
Consumer surplus after trade
A
Price
after trade
D
B
Price
before trade
C
Producer surplus after trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
A
Price
after trade
D
B
Price
before trade
Total surplus gained after trade
C
Domestic
demand
0
Quantity
of Steel
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Summary of Welfare Changes of Trade from an
Exporting Country
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International Trade and the Importing Country

• Suppose that the world price of steel is lower
  than the domestic price, the country will be an
  importer of steel when trade is permitted no
  comparative advantage.
• Now domestic consumers will want to buy steel at
  the lower world price.
• Domestic producers of steel will have to lower
  their output until the supply price is equal to
  the world price (in the short-run at least).

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International Trade and the Importing Country

• The domestic price falls to equal the world
  price, and domestic consumption increases.
• Because domestic production decreases, the
  domestic country becomes an importer of steel.
• Imports equal the difference between the domestic
  quantity demanded and the domestic quantity
  supplied at the world price.

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International Trade and the Importing Country
Domestic
supply
Price
before trade
World
price
Domestic
demand
0
Quantity
of Steel
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International Trade and the Importing Country
Domestic
supply
World
price
Domestic
demand
0
Quantity
Domestic
Domestic
of Steel
quantity
quantity
supplied
demanded
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International Trade and the Importing Country
Once trade is allowed, the domestic price falls
to equal the world price. Imports equal the
difference between domestic quantity demanded and
supplied at the world price.
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How does Free Trade Affects Welfare in an
Importing Country?
Domestic
supply
Price
before trade
Price
World
after trade
price
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Importing
Country
Domestic
supply
Price
before trade
Price
World
after trade
price
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Importing
Country
Consumer surplus before trade
Domestic
supply
A
Price
before trade
Price
World
after trade
price
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Importing
Country
Consumer surplus before trade
Domestic
supply
A
Price
before trade
B
Price
World
after trade
price
C
Producer surplus before trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Importing
Country
Consumer surplus after trade
Domestic
supply
A
Price
before trade
B
D
Price
World
after trade
price
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Importing
Country
Consumer surplus after trade
Domestic
supply
A
Price
before trade
B
D
Price
World
after trade
price
C
Producer surplus after trade
Domestic
demand
0
Quantity
of Steel
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How Free Trade Affects Welfare in an Importing
Country
Consumer surplus after trade
Domestic
supply
A
Total surplus gained after trade
Price
before trade
B
D
Price
World
after trade
price
C
Producer surplus after trade
Domestic
demand
0
Quantity
of Steel
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Summary of Welfare Changes for an Importing
Country
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Summary of Main Results

• When a country allows trade and becomes an
  exporter of a good, domestic producers of the
  good are better off.
• When a country allows trade and becomes an
  importer of a good, domestic consumers of the
  good are better off.
• In both cases, total welfare increases from
  allowing international trade

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Winners and Losers From Free International Trade

• The gains of the winners exceed the losses of the
  losers.
• The net change in total surplus is positive.

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What is the Effect of Introducing a Tariff on a
Good?

• A tariff is a tax on goods produced abroad and
  sold domestically.
• It raises the price of imported goods above the
  world price by the amount of the tariff.
• Domestic sellers of protected goods are better
  off while domestic buyers of the good are worse
  off.

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The Effects of a Tariff
Domestic
supply
World
price
Domestic
demand
0
Quantity
QS1
Q
Q
QD1
of Steel
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The Effects of a Tariff
Consumer surplus without tariff
Domestic
supply
World
Producer surplus without tariff
price
Domestic
demand
0
Quantity
QS1
Q
Q
QD1
of Steel
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The Effects of a Tariff
Domestic
supply
Tariff
World
price
Domestic
demand
0
Quantity
Q
QS2
QS1
Q
Q
QD2
Q
QD1
of Steel
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The Effects of a Tariff
Domestic
supply
Tariff
World
price
Domestic
demand
0
Quantity
Q
QS2
QS1
Q
Q
QD2
Q
QD1
of Steel
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The Effects of a Tariff
Consumer surplus with tariff
Domestic
supply
Tariff
World
Producer surplus with tariff
price
Domestic
demand
0
Quantity
Q
QS2
QS1
Q
Q
QD2
Q
QD1
of Steel
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The Effects of a Tariff
Consumer surplus with tariff
Domestic
supply
Government revenue
Tariff
World
Producer surplus with tariff
price
Domestic
demand
0
Quantity
of Steel
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The Effects of a Tariff
Consumer surplus with tariff
Domestic
supply
Government revenue
Total surplus lost due to tariff
Tariff
World
Producer surplus with tariff
price
Domestic
demand
0
Quantity
of Steel
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Summary of the Welfare Changes of Introducing a
Tariff
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Summary of the Welfare Changes of Introducing a
Tariff

• Like any tax on the sale of a good, a tariff
  distorts incentives and pushes the allocation of
  scarce resources away from the optimum.

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What is the Effect of Introducing a Quota on
Welfare?

• An import quota is a limit on the quantity of a
  good that can be produced abroad and sold
  domestically.
• Prevents domestic consumers from purchasing as
  much of a good (e.g. steel) as they want from
  abroad

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What is the Effect of Introducing a Quota on
Welfare?
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Summary of the Welfare Changes of Introducing a
Quotas
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Both tariffs and import quotas...

• ...raise domestic prices.
• ...reduce the welfare of domestic consumers.
• ...increase the welfare of domestic producers.
• ...cause deadweight losses.

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What are the Most Commonly used Arguments for
Restricting Trade?

• Jobs
• National Security
• Infant Industry
• Unfair Competition
• Protection as a Bargaining Chip

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Infant industries returns to scale

• Argument because of economies to scale in a
  certain good, all production of that good will
  tend to become concentrated in one place. The
  process of concentration can involve large
  initial losses private firms cannot bear. The
  government can help it overcome it.
• Pros economies of scale exist and are strong at
  the micro-level, especially in manufacturing.

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Manufacturing productivity in Australia
ICOP Estimates of comparative labour productivity
in manufacturing 1960 - 2000 USA100
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Implication

• Relative Australian manufacturing productivity is
  indeed very low, meaning Australia has a
  comparative advantage elsewhere (services,
  primary good production).
• The low productivity may well reflect the small
  size of manufacturing here, implying Australia is
  not able to be big enough in manufacturing to
  take advantage of the economies of scale.

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Big question

• Does this mean the infant industry argument is
  relevant for Australia?
• Probably not Australia has specialised in other
  fields of activity and enjoys economies of scale
  in those activities. Examples financial
  intermediation, tourism, services in general.

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And so .

• The existence of economies of trade at the level
  of a single product, industry, or even whole
  sector is important in understanding trade flows,
  but does NOT mean the infant industry argument is
  valid.
• Why at the level of the country there are
  usually no economies of scale a country
  specialises in a whole set of activities,
  monopolising the world in those but enjoying no
  economies of scale by being big. I.e. a country
  twice as big would simply monopolise twice as
  many products in the world.
• If you attempt world monopoly of one good by
  taxing existing production you win one market
  and loose another.

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Conclusion

• In countries exporting a good, producers are
  better off and consumers are worse off.
• In countries importing a good, consumers are
  better off and producers are worse off.
• The winners gains are greater than the losers
  losses in either case. Via domestic state
  transfers, one can make both parties win from
  trade.

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Conclusion

• Tariffs and quotas...
• Raise domestic prices.
• Reduce the welfare of domestic consumers.
• Increase the welfare of domestic producers.
• Cause deadweight losses.
• Protection for one home industry ...
• Reduces consumer and total surplus by increased
  prices.
• Ultimately comes at the expense of another,
  already competitive industry without guaranteeing
  the new industry any long term future.