ECON 205 1st Edition Lecture 5 Outline of Last Lecture Market Allocation of Resources Customer s Willingness to Pay Free Market vs Government Intervention Costs of Taxation Outline of Current Lecture What determines how much of a good is exported or imported Who gains and losses from trade What is the effect of tariffs Current Lecture Comparative Advantage Comparative advantage country produces a good at lower opportunity costs than other nations Pw world price of a good the price that prevails in the world market Pd domestic price of a good without trade If Pd Pw o The nation has a comparative advantage o Under free trade the country should will export this good Small economies are price takers in world markets o Actions have no real impact on Pw When small economy engages in free trade Pw is the only relevant price o No seller accepts less than Pw o No buyer pays more than Pw Pd P w Pd P w Direction of trade exports Imports Consumer Surplus Falls Rises Producer Surplus Rises Falls Total Surplus Rises Rises Overall The gains of trade exceed the losses Benefits of International Trade Consumers enjoy increased variety of goods Producers sell to a larger market o May achieve lower costs by producing on a larger scale in mass Foreign competition may decrease the market power of domestic firms o Causes an increase in total welfare Increases the flow of ideas and facilitates the spread of technology around the world Opposition to Trade Winners do not compensate for losers Losses often highly concentrated and harshly felt among small groups Gains often spread thinly over large groups Tariffs Tariff tax on imports Free trade o CS A B C D E F o PS G o Total Surplus CS PS With Tariff o CS A B o PS C G o Government Revenue E o Total A B C E G o D is deadweight loss from overproduction o F is deadweight loss from under consumption Import Quotas Import Quota quantitative limit on import of goods Has the same effect as a tariff Arguments for Restricting Trade 1 Destroys jobs in industries that compete with imports a Economist s answer look to data to confirm whether an increase in imports positively correlates with an increase in unemployment b Economist s answer job losses from imports are offset by job gains in export industries 2 National Security an industry vital to national security should be protected from foreign competition to prevent overdependence on imports 3 Infant Industry temporary protection of a new industry is needed until it is mature and can compete with foreign firms a Economist s answer difficult for the government to determine which industries will eventually be competitive b Economist s answer industry will be profitable in the long run anyway 4 Unfair Competition producers argue that foreign competitors have an unfair advantage for example a lack of child labor laws which drives down production costs a Economist s answer our citizens can import good extra cheap now b Economist s answer gains to consumers will exceed the losses to our producers 5 Protection as bargaining chip for example the US can threaten to limit imports of French wine if French does not lift quotas on American beef a Economist s answer If France says no then US must limit imports of wine hurts consumers or not restrict wine imports hurts US cred