Week 7: Global Markets

Question 1

What is an autarky?

Answer 1

An economically self-sufficient country with no international trade. Quantity bought equals quantity produced.

Question 2

What is the difference between a domestic market and a world market?

Answer 2

A domestic market exists or occurs within a particular country. A world market is where international trade takes place between importers and exporters.

Question 3

What is free trade?

Answer 3

No prohibitions, restrictions, or policies that inhibit the amount of a good that can be bought and sold in international markets

Question 4

What is the situation in the market for a good or service that a country imports when moving from autarky to free trade?

Answer 4

The autarky price of the good is greater than its world price, so the country has a comparative disadvantage in producing it. Price in the domestic market will decrease to the world price and the country will import the good.

Question 5

What happens to the quantities bought and produced in a market with imports?

Answer 5

Quantity demanded by domestic consumers increases and the quantity supplied by domestic firms decreases. The excess demand is met by importing the good from foreign suppliers.

Question 6

What is the situation in the market for a good or service that a country exports when moving from autarky to free trade?

Answer 6

The autarky of the good is smaller than its world price, so the country has a comparative advantage in producing it. Price in the domestic market will increase to the world price and the country will export the good.

Question 7

What happens to the quantities bought and produced in a market with exports?

Answer 7

Quantity demanded by domestic consumers decreases and quantity supplied by domestic firms increases. The excess supply is met by exporting the good to foreign buyers.

Question 8

How do we determine the welfare effects of allowing free trade in the domestic market?

Answer 8

Measure the gains and losses from imports/exports by examining their effect on consumer surplus, producer surplus, and total surplus. Compare the surpluses enjoyed by domestic participants under autarky and under free trade.

Question 9

What are the gains and losses from imports?

Answer 9

Increase in quantity bought expands the domestic consumer surplus and decrease in quantity supplied shrinks the domestic producer surplus. Gains to domestic consumers (part of which is transferred from producers) exceeds losses of domestic producers. Net gain increases total surplus.

Question 10

What are the gains and losses from exports?

Answer 10

Decrease in quantity bought shrinks the domestic consumer surplus and increase in quantity supplied expands the domestic producer surplus. Gains to domestic producers (part of which is transferred from consumers) exceeds losses of domestic consumers. Net gain increases total surplus.

Question 11

Why is the net gain from international trade positive?

Answer 11

Both imports (lower price and increased purchases) and exports (higher price and increased production) bring gains. One country’s exports are other countries’ imports so international trade brings gain for all countries.

Question 12

What are international trade restrictions?

Answer 12

Policies used to influence international trade and protect domestic industries from foreign competition.

Question 13

What is a tariff?

Answer 13

Tax imposed by an importing country when an imported good enters the country

Question 14

What is the difference between an ad valorem tariff and a specific tariff?

Answer 14

a) Ad valorem tariff- tax rate charged is a percentage of the price of the product being imported
b) Specific tariff- tax rate charged is a fixed amount per quantity of the good imported

Question 15

What are the effects of imposing a constant-per-unit tariff on an imported good?

Answer 15

a) Price of the good increases by the full amount of the tariff (buyer pays entire tariff because supply from the rest of the world is perfectly elastic)
b) Decrease in purchases/quantity demanded so consumer surplus falls
c) Increase in domestic production/quantity supplied so producer surplus increases
d) Decrease in imports
e) Government gains tariff revenue so government surplus rises (amount of tariff x amount of imports)

Question 16

Who are the winners and losers from a tariff?

Answer 16

Domestic consumers lose. Domestic producers and the government gain and win. Society loses due to deadweight loss.

Question 17

What is the social loss from a tariff?

Answer 17

Losses suffered by consumers exceeds combined gains of producers and the government. Some CS is transferred to producers and government. Some gains from free trade are lost. Increase in production cost and decrease in imports creates a deadweight loss. Total surplus decreases.

Question 18

What is an import quota?

Answer 18

A restriction that limits the quantity of a good that can be imported in a given period

Question 19

What is the distribution of quota licenses?

Answer 19

Government distributes quota licenses by either giving them away for free or auctioning them to the highest bidder. Holders of quota licenses have the right to import some fraction of the total quota, buy each unit of the good at world market price, and sell the good at domestic market price.

Question 20

What are the effects of an import quota?

Answer 20

a) Domestic price rises above world price and supply curve becomes SC + quota.
b) Domestic purchases/quantity demanded decreases so domestic consumer surplus decreases
c) Domestic production/quantity supplied increases and quota licenses will be used to import the good so domestic producer surplus increases and importers gain
d) Quantity of the good imported decreases to the import quota quantity

Question 21

Who are the winners and losers from an import quota?

Answer 21

Domestic consumers lose. Domestic producers and the importers gain and win. Society loses due to deadweight loss.

Question 22

What is the social loss from an import quota?

Answer 22

Losses suffered by domestic consumers exceeds the combined gains enjoyed by the domestic producers and importers. Part of the consumer surplus is transferred to producers and importers. Part of consumer surplus is lost to due to increased production cost and decrease in imports and creates a deadweight loss.

Question 23

What are other import barriers and export subsidies?

Answer 23

Health, safety, and regulation barriers, Voluntary export restraints (quota allocated to foreign exporter of a good), and Export subsidies (payment by the government to the producer of an exported good)

Question 24

Why is international trade restricted despite arguments against it?

Answer 24

1. Tariff revenue- Collection of taxes by governments in developing countries is costly except for tariffs on international trade, where transactions are well-recorded.
2. Rent-seeking- lobbying for special treatment by the government; winners from free trade have too little gains per person to make cost of political activity worth bearing and losers who are willing to incur the costs lobby against free trade (but are not fully compensated)

Question 25

Argument: Protection counteracts dumping (when a foreign firm sells its exports at a lower price than its cost of production).

Answer 25

Counterargument: Dumping is virtually impossible to detect because it’s hard to determine a firm’s costs. Test for dumping (whether a firm’s export price is below domestic price) is weak.

Question 26

Argument: Protection saves domestic jobs.

Answer 26

Counterargument: Protection can save certain jobs but at a large expense. Free trade destroys some jobs but also creates other jobs e.g. retailers and firms that sell/service imported goods.

Question 27

Argument: Protection allows us to compete with cheap foreign labour.

Answer 27

Counterargument: Comparative advantage, not wage differences, drives international trade and enables competition with cheap foreign labour.

Question 28

Argument: Protection penalizes lax environmental standards and provides an incentive to raise them.

Answer 28

Counterargument: Poor countries need rapid income growth, which free trade promotes, to raise their environmental standards.

Question 29

Argument: Protection prevents rich countries from exploiting developing countries.

Answer 29

Counterargument: Rather than exploiting people from developing countries, trade can improve their opportunities and increase their income.

Question 30

Argument: Protection reduces offshore outsourcing (buying from firms in other countries) that sends good jobs to other countries.

Answer 30

Counterargument: Offshore outsourcing also brings costs that eat up the gains. Displaced workers need education and training more than just short-term relief from unemployment benefits.

Question 31

Argument: Protection helps in avoiding trade wars.

Answer 31

Counterargument: Protection invites retaliation and can trigger a trade war (when one country raises its import tariffs, other countries retaliate by increasing their own).