Lesson 9 Trade Theories Flashcards
World Price
1) price of good that prevails in world market for that good
2) If world price for x greater than domestic price –> export good x
3) If world price lower than domestic price –> import good x
Domestic price represents
1) opportunity cost
2) low domestic price –> country has comparative advantage and should specialize
Small economy assumption
1) Isoland’s (any country) actions have negligible effect on world markets
2) useful assumption that simplifies analysis
Price takers
1) take prices given by forces of supply/demand in world market
What happens once a country starts exporting
1) domestic price rises to equal world price
2) no seller would accept less than world price, no buyer would pay more than world price
3) horizontal area btwn supply and demand represents exports
Winners and losers from exporting
1) trade forces domestic price to rise –> consumers are worse off
2) domestic producers better off –> sell at higher price
3) Sellers gain producer surplus (new area above equilibrium + below world price + to right of consumer/producer surplus)
Analysis of exporting:
1) when a country becomes an exporter –> domestic producers better off + domestic consumers worse off
2) raises economic well-being of nation (gains of winners exceeds loss of buyers)
Winners and losers from importing
1) domestic consumers better off –> buy at a lower price
2) domestic producers –> worse off since MUST sell at world price which is lower
3) Consumers gain the area above world price + below equilibrium + to right of consumer/producer surplus
Analysis of importing effects
1) consumer surplus increases, producer surplus decreases
2) overall –> raises economic well-being of nation since gains of winners exceeds losses of losers
Tariff
1) tax on imported goods
2) only matters if a country is importing goods
Tariff effect on graph
1) raises world price (horizontal line) up by the tariff
2) reduces quantity of imports + moves domestic market closer to equilibrium without trade
Tariff gains + losses explained
1) Raises domestic price –> domestic sellers better off BUT domestic buyers worse off
2) govt gets tariff revenue
3) deadweight loss (two triangles) on either side of govt revenue from trade (rectangle)
4) Losses suffered by consumers outweighs improved welfare of domestic producers + govt revenue
Benefits of trade
1) increased variety of goods –> each country producers slightly diff goods i.e. german vs american beer
2) lower costs through economies of scale –> economy of scale means in a larger market –> sell goods more cheaply SO if they trade they have access to larger market
3) increased competition –> companies have less market power bc trade –> more competitors
4) increased productivity –> resources move towards more productive firms that can expand to other nations
5) enhanced idea flow –> transfer of tech advances + ideas
Why would people oppose free trade
1) Free trade destroys jobs
2) Industry threatened –> harms national security
3) young/old industry needs protection to become competitive
4) unfair competition bc of diff laws in diff countries
5) trade restrictions good bargaining chip
Jobs Argument against trade
1) Claims that free trade destroys jobs
2) BUT creates new jobs –> displaced workers can move into industries where Isoland has comparative advantage
3) gains from trade based on comparative advantage NOT absolute advantage –> there will be an industry Isoland will be better at
National Security Argument against free trade
1) Says that if you trade –> limit the amount of resources you may need in event of war
2) valid claim BUT companies often exaggerate their importance for national security
3) military’s generals may be fine getting steel from another country if it is cheaper
Infant Industry Argument against trade
1) claim that infant/old industries need extra protection to get them started
2) Hard to implement bc then govt needs to pick which companies will be successful + which won’t be –> very difficult to choose PLUS temporary policy often becomes permanent
Unfair competition argument against free trade
1) says free trade only good if all countries play by same rules, may not be if diff countries have diff laws
2) May harm producers BUT low prices would help consumers –> idea that overall benefits outweigh losses
Trade restrictions = Protection as bargaining Chip argument
1) say trade restrictions good tactic to get concessions from trading partners
2) problem = may not actually work –> trade restriction could harm the country implementing it OR it may back down from threat + lose prestige and future bargaining power
Unilateral vs multilateral approach to free trade
1) Unilateral = removes trade restrictions on its own
2) multilateral = bargains with trading partners to reduce trade restrictions around world (NAFTA)
Advantages to multilateral approach:
1) result in freer trade than unilateral approach because it reduces trade restrictions both at home + abroad
2) political advantage –> give/take in both countries so more people willing to support
