ECO 201 Ch 22 International Trade 1 International Trade Theory a How Countries Know What to Trade 2 Trade Restrictions comparative advantage the advantage a country has when it can produce a good at lower opportunity cost than another country can No Specialization No Trade NS NT neither countries are specializing in the production of goods and neither are trading with each other Specialization Trade S T countries specialize in the production of goods and trade with each other Countries specialized in the production of the good in which they have a comparative advantage a good that they can produce at lower opportunity cost than the other country Settling on the Terms of Trade After they have determined the goods to specialize in producing the countries must settle on the terms of trade that is how much of one good to trade for another Results of the Specialization Trade A country gains by specializing in producing and trading the good in which it has a comparative advantage b Common Misconceptions About How Much We Can Consume No country can consume beyond its PPF if it doesn t specialize and trade with other countries c How Countries Know When They Have a Comparative Advantage The individual s desire to earn a profit determines what a country specializes in and trades The outcome is brought about spontaneously through the actions of individuals trying to make themselves better off they are simply trying to gain through trade a International trade theory shows that countries gain from free international trade but in the real world there are numerous trade restrictions The Distributional Effects of International Trade Specialization and international trade benefit individuals in different countries but this is a net benefit Not every individual person may gain Introducing foreign goods at a lower price may drive some domestic business owners out of business The benefits are not equally distributed to all individuals in the population b Consumers and Producers Surpluses Consumers Surplus is the difference between the maximum price a buy is willing and able to pay for a good or service and the price actually paid Consumers Surplus Maximum buying price Price paid Dollar measure of the benefit gained by being able to purchase a unit of a good for less Producers Surplus or sellers surplus is the difference between the price sellers receive for a good and the minimum or lowest price for which they would have sold the good Dollar measure of the benefit gained by being able to sell a unit of output for more than Producers Surplus Price received Minimum selling price than one is willing to pay for it Consumers net gain from trade one is willing to sell it Producers net gain from trade c The Benefits and Costs of Trade Restrictions 1 ECO 201 Ch 22 International Trade tariff a tax on imports The primary effect of a tariff is to raise the price of the imported good for the domestic consumer An effect of tariffs is to reduce imports Consumers receive more consumers surplus when tariffs do not exist and less when they do exist Producers receive less producers surplus when tariffs do not exist and more when they do exist The government collects tariff revenue equal to number of imports time the tariff Because the loss to consumers is greater than the gain to producers plus the gain to government a tariff is a net loss quota a legal limit imposed on the amount of a good that may be imported Reduces the supply of a good and raises the price of imported goods for domestic consumers The effects of a quota are a decrease in consumers surplus an increase in producers surplus and an increase in total revenue for the importers who sell the allowed number of imported units Because the loss to consumer is greater than the increase in producers surplus plus the gain to importers there is a net loss as a result of the quota d Why Nations Sometimes Restrict Trade Some persons maintain that at certain times free trade should be restricted or suspended In almost all cases they argue that doing so is in the best interest of the public or country as a whole Others contend this argument is superficial National Defense Argument Even if another country has a comparative advantage in the production of weapons leaving weapons production to another country is too dangerous Argument gets abused by industries that are not really necessary to national defense The Infant Industry Argument Alexander Hamilton the first US secretary of the treasury argued that so called infant or new industries often need protection from older established foreign competitors until they are mature enough to compete on an equal basis Hard to remove this benefit once it is given Industries will argue that they are never old enough to compete Every industry would argue for protection The Antidumping Argument dumping the sale of goods abroad at a price below their cost and below the price charged in the domestic market Puts domestic producers at a disadvantage Drives out domestic producers then raise the price Dumper is experiencing losses after price increases competitors will return domestic consumers actually benefit Foreign Export Subsidies Argument Governments subsidize firms that export goods which cause the domestic country producers to complain about this disadvantage Gift given to foreign consumers at the expense of domestic taxpayers The foreign consumers will benefit The Low Foreign Wages Argument The Saving Domestic Jobs Argument Some argue that American producers can t compete with foreign producers because American producers have to pay high wages to their workers and foreign producers pay low wages However Americans are more productive and result in lower cost goods Foreign producers will drive domestic producers out of business losing domestic jobs Critics counterargue If a domestic producer is being outcompeted by foreign producers and if domestic jobs in an industry are being lost as a result the world market is signaling that those labor resources could be put to better use in an industry in which the country holds a comparative advantage 2