Topic 8 - International Trade and Trade Policy

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International Trade And Trade Policy

Production Possibility Curve (PPC)

Shows the max amount of one good that can be produced at every possible level of production of another good. The PPC and Consumptions Possibility Curve is illustrated in the diagram below: [1]

  • Consumption Possibilities Curve
    • If Closed Economy – the CPC is identical to the PPC,
    • If Open Economy – the CPC is greater or equal to the PPC

Refer to the Diagram

  • Point C – greatest amount of both coffee & tyres, OC of producing= OC Importing
  • Line FG – CPC, slope is the relative prices of coffee & tyres
  • Point H – opportunity cost of producing > opportunity cost of purchasing --> reduce production and increase imports
  • Point I – opportunity cost of production < than purchasing --> Increase production and reduce exports

A country maximises its C.P when it produces at the point where the CP Line is tangent to the PPC. The slope of the line is determined by the amount of a good on the vertical axis that must be traded on the international market to obtain a unit of the other good [2]

IT1.jpg


Supply And Demand Perspective on International Trade

Comparative Disadvantage

Whilst, international trade can benefit the country as a whole, there are winners and losers. Take this example of domestic producers losing out to more competitive foreign imports [3] This diagram shows the price of tyres measured relative to the price of another good

  • If Closed economy – Equilibrium = Point E (Quantity = q)
  • If Open Economy
    • Relevant price of tyres is the world price, perfectly elastic supply
      • At the world price, Qd – Qs needs to be imported
  • If the domestic price (Dp) of a good or service is greater than the world price (Wp), if the economy opens up, it’s likely that they will become a net importer and domestic producers will lose whilst the rest of the economy gains from lower prices.

IT2.jpg

Comparative Advantage

Whilst, international trade can benefit the country as a whole, there are winners and losers. Take this example of exporters gaining significant surplus [4] The diagram below shows the following:

  • If Closed Economy – Equilibrium (E)
  • If Open Economy – than Qs – Qd is exported
    • If the domestic price of a good or service is lower than the Wp, the economy will tend to be an net exporter

IT3.jpg

Winners And Losers From Trade

  • Comparative Disadvantage (fig.1 on the left below)[5]
    • Consumers Surplus Increases by the Purple + Green Areas
    • Producer Surplus Decreases by the Purple Area
      • Wages Decrease
  • Comparative Advantage (fig.2 on the right below)[6]
    • Consumer Surplus Decreases by the Purple Area
    • Producer Surplus Increases by the Purple + Green Areas
      • Wages increase reflecting the higher relative price
  • Total Economic Surplus increases in both cases (Efficiency)

IT4.jpg

Protectionist Policies: Tariffs And Quotas

[7]

Protectionism is the use of policies that are intended to protect domestic industries from foreign competition

  • Import Tariff - taxes imposed on an imported good
    • Has the effect of increasing the world price and lowers imports (see diagram)
    • Government Revenue = Yellow shaded box but consumer surplus losses > producer surplus gains
      • Deadweight loss = Green (consumer loss) + Purple (production loss – resources taken from efficient production of another good)

IT5.jpg

  • Import Quota - a legal limit on the quantity of a good or service that may be imported
    • Domestic Supply shifted right by the quota amount = domestic supply + quota
    • Raises domestic price above the world price
    • Reduces domestic demand, increases domestic production and reduces imports
    • Benefits domestic producers (high price, more volume)
    • costs consumers (higher price, less demand)
  • When Import Quota = Imports with a tariff policy the policies have the same effect except that government revenue is replaced by importer license revenue (gains by those who have the right to import).
    • Rights to import can be auctioned off by the government to receive the same taxation revenue as a tariff

IT6.jpg


Inefficiency of Protectionism

  • It blocks free trade, which has shown to be needed for maximum efficiency (because of comparative advantages caused by specialisation allows countries to produce the same goods at different prices - either more effectively or less effectively than trading partners)
    • Total economic surplus increases (but winners & losers) – bigger economic pie
  • Protectionism is inefficient (as demonstrated in the above diagrams), it lowers total economic surpluses and benefits groups (politically organised).
    • It would be better if the benefits of free trade were spread around with worker training programs to get more people in export competitive industries (e.g. resources in Australia)


References

  1. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  2. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  3. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  4. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  5. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  6. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  7. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
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