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UNC-Chapel Hill ECON 101 - LECTURE NOTES

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Let's think of a world in which trade is perfectly free between countries and within countries, andtry to determine the level of the price of one of the commoditieswith which we've been dealing, say wheat.In the United States, which should be a wheat exporter, the domestic demand for wheat has to beless than the total amount of wheat supplied by American farmers.In that sense, the domestic price of wheat must be higher than theprice that would produce supply-demand equilibrium. {next slide}QuantityPriceSDExcess SupplyPiPdMarket for Wheat in the U.S.On the other hand, the price of wheat in Japan must be lower than the price thatwould produce supply-demand equilibrium in Japan. Otherwise,Japan would not desire to import any wheat {next slide}.QuantityPriceSDPiPdExcess DemandMarket for Wheat in Japan<<Would the price in Japan have to be the same as the price in the U.S.?>> Yes.<<Why?>> If there was a price differential between the U.S. and Intl_Trade.lwp International Trade Theory Page 8Japan (excluding transport costs) it would pay someone in the lowprice country to buy wheat there and sell it in Japan? <<What isthis process called?>> Arbitrage.<<Since there must be the same price in both countries (we'reignoring transport costs here), what must that price achieve?>> The total international demand for wheat must just equal the totalinternational supply of wheat at the equilibrium world price.Consequently, the excess supply of wheat in the U.S. must just equal the excess demand forwheat in Japan. {next slide}QuantityQuantityPricePricePiPiImportsExportsSDSDDomestic Market: USA Domestic Market: JapanIn equilibrium the international price of wheat servesto equate the total quantity of world exports with thetotal quantity of world imports.4 Comparative Advantage and "Cheap" Foreign Labor Intl_Trade.lwp International Trade Theory Page 9Our example of U.S. -- Japanese trade has assumed that the U. S. has an absolute advantage overthe Japanese in the production of both autos and wheat.Presumably, therefore, U. S. workers are paid more than theirJapanese counterparts. <<Would not the American workers be hurt, by the opening of Americanmarkets to Japanese automobiles produced by that underpaidlabor?>> No, because of the principle of comparative advantage,workers in both countries will be better off than before, becausethe total value of consumption in both countries will have risen.(This assumes, of course, that the benefits of trade are actuallydistributed to the workers!)5 Restraints to Trade: Tariffs, Quotas & Others5.1. Types of RestraintsTariffs: Is a tax on imports. Serves to increase the price to domesticconsumers, thereby reducing domestic demand for importsvis-á-vis domestic products. Most U. S. tariff rates are below 10percent, but tariffs in other countries are often 100 percent orhigher.Quotas: Legal limit on the quantity of goods that can be imported per year.The quota could be zero. The U. S. imposes quotas on suchproducts as sugar, Japanese automobiles, textiles, and meat. Mostimports are free of quotas. Intl_Trade.lwp International Trade Theory Page 10Export Subsidies: Payment by a government to one of its own exporters. This isreally a negative tariff. These are rare in the U. S., but are usedextensively in other countries (particularly, I think, in the EU) tohelp their exporters.5.2. How Restraints WorkBoth quotas and tariffs have the same goal: to reduce the quantity of a commodity imported intothe country. They achieve this objective in different ways.Quotas put physical limitations on the quantity of the import. This has theeffect of reducing the gap between supply and demand in theimporting country. In order for this to happen the price of thecommodity must rise. In the exporting country, on the other hand, the reduction in export means that theexcess supply of the product must fall to equal the import demandof its trading partner . This means that the price must fall from theprevious international equilibrium. In the end, the quota leads to ahigher price in the importing country and a lower price in theexporting country. {next slide} Intl_Trade.lwp International Trade Theory Page 11QuantityQuantityPricePricePiPiImports (Free Trade)Exports (Free Trade)SDSDDomestic Market: USADomestic Market: JapanImposition of a quota reduces the physical quantity ofimports in Japan and raises the domestic price. In the U.S. exports have to fall to the same amount, leadingto a fall in the domestic price. Prices in the two coun-tries are no longer equal.Exports (Quota)Imports (Quota)Price(Quota)Price(Quota)Tariffs on the other hand raise the price per unit in the importing country. If thetariff is a fixed dollar amount per unit, then in order to reduceimports to the same extent that the quota did, the tariff must behigh enough so that the new domestic price is equal to thedomestic price that would have been achieved under the quota.Likewise, the exporting country's domestic price would have to fallto maintain international price --quantity equilibrium. Both tariffsand quotas can be used to obtain the same result. <<Is there any reason to prefer one over the other?>>1) Profits from the quota go to the domestic (and foreign) sellers of the product. The quotaon Japanese autos raised "profits" for both Japanese and American (and European!)carmakers by billions of dollars per year. Intl_Trade.lwp International Trade Theory Page 122) Under a tariff, some of the profits go instead to the government in the form of taxrevenue. The government gets some of its revenues from its own citizens and some fromforeign producers who must accept lower prices for their product. <<What aboutdomestic producers? Do they benefit?>> Yes, since they can sell more product at ahigher price than under free trade.3) A tariff handicaps all foreign producers equally; therefore, the most efficient producerswill still have an advantage.4) A quota on the other hand awards its licenses


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UNC-Chapel Hill ECON 101 - LECTURE NOTES

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