Extremely Competitive Markets Part 2 Open Economies Closed

Extremely Competitive Markets Part 2: Open Economies

Closed Economy: Equilibrium Without Trade Price of Steel Domestic Supply Equilibrium Price Domestic Demand 0 Equilibrium Quantity of Steel

Open Economy: If world price > domestic price, country becomes an exporter Price of Steel Domestic Supply Price after trade World Price before trade Exports 0 Domestic demand Domestic Demand Domestic supply Quantity of Steel

Exporting Country: Who are the winners and who are the losers? Domestic producers Domestic consumers Foreign producers Foreign consumers Domestic and foreign governments

Who are the Winners and Who are the Losers? Price of Steel Consumer surplus after trade Domestic Supply Exports Price after trade B Price before trade D World Price C Producer surplus after trade 0 Domestic demand Quantity of Steel

If world price < domestic price: country becomes an importer Price of Steel Domestic Supply Price before trade World Price after trade Imports 0 Domestic quantity Supplied Domestic quantity Demanded Domestic demand Quantity of Steel

Importing Country: Who are the winners and who are the losers? Domestic producers Domestic consumers Foreign producers Foreign consumers Domestic and foreign governments

Who are the Winners and Who are the Losers? Price of Steel Domestic supply A Consumer surplus after trade Price before trade B Price after trade C D Imports Producer surplus after trade 0 World Price Domestic demand Quantity of Steel

Gains and Losses from Free International Trade: 1. In each country, gains to winners exceed losses to losers 2. Therefore overall economic welfare increases 3. Also, can lead to: Increased variety of goods and service Lower costs through economies of scale Increased competition and efficiency Enhanced flow of ideas 4. But, losing producers have a strong incentive to oppose free trade through: Tariffs Quotas Subsidies

Effect of an Import Tariff on Price, Quantity of Imports and Gov Revenue Price of Steel Domestic supply Price with tariff Tariff Gov tariff rev Price w/o tariff Imports with tariff 0 Q 1 S Q 2 S Domestic demand Q 2 D Q 1 D Imports without tariff World price Quantity of Steel

The Effects of an Import Quota on Price and Quantity of Imports Price of Steel Domestic supply +Import Supply Quota Price with quota Price without quota Imports with quota 0 Q 1 S Q 2 S Domestic demand Q 2 D Q 1 D Imports without quota World price Quantity of Steel

The Effects of an Production Subsidy on Price and Quantity of Imports Price of Steel Domestic supply Price (to producers) with subsidy Production subsidy Domestic demand 0 Qs Imports Qd World price Quantity of Steel

Effect of Large Domestic Subsidies on World Market Price P/Q S S’ P 1 P 2 D 0 Q 1 Q 2 Q/t

So, what are the arguments for restricting trade?

Protect Domestic Production & Jobs

Protect National Security

Infant Industry Protection

Protection as a Bargaining Chip

Protection/Retaliation Against “Unfair” Competition Resulting From: Tariffs Subsidies Quotas Dumping “Manipulation of” exchange rates

Macroeconomic Stability

Environmental/Health/Cultural Human Rights Considerations

International Trade Liberalization Agreements Bilateral Agreements: North American Free Trade Agreement(1993) US China WTO Agreement (1999) General Agreement on Tariffs and Trade (GATT): Reduced average tariff among member countries from 40% after WWII to < 5% today. World Trade Organization (WTO) 1. Promotes trade liberalization, where appropriate 2. Approves retaliatory actions with regard to “illegal” trade barriers.

WTO Rulings Retaliatory Tariffs EU/US Steel $2 billion Brazil/US Cotton $300 million US/EU Bananas € 200 million