Extremely Competitive MarketsPart 2: Open Economies

Closed Economy: Equilibrium Without Trade

Price of Steel

EquilibriumPrice

0 Quantity of SteelEquilibrium Quantity

Domestic Supply

Domestic Demand

Priceof Steel

0 Quantityof Steel

DomesticDemand

Open Economy: If world price > domestic price, country becomes an exporter

DomesticSupply

WorldPrice

Price after trade

Exports

Domesticdemand

Domestic supply

Price before trade

Exporting Country:Who are the winners and who are the losers?

Domestic producers

Domestic consumers

Foreign producers

Foreign consumers

Domestic and foreign governments

Priceof Steel

0 Quantityof Steel

WorldPrice

Domestic demand

Who are the Winners and Who are the Losers?

DomesticSupply

Price after trade

Price before trade

Consumer surplusafter trade

C

Producer surplusafter trade

D

Exports

B

If world price < domestic price: country becomes an importer

Priceof Steel

0 Quantityof Steel

Domestic Supply

Domestic demand

World Price

Price after trade

DomesticquantitySupplied

DomesticquantityDemanded

Price before trade

Imports

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?

Priceof Steel

0 Quantityof Steel

Domestic supply

World Price

Domestic demand

Price after trade

Price before trade

A

Consumer surplusafter trade

B D

CProducer surplus

after trade

Imports

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

Price with tariff

World price

Price w/o tariff

Effect of an Import Tariff on Price, Quantity of Imports and Gov Revenue

Priceof Steel

0 Quantityof Steel

Domestic supply

Domestic demand

Tariff

Q1S Q1

D

Imports without tariff

Imports with tariff

Q2DQ2

S

Gov tariff rev

Price with quota

World price

Price without quota

The Effects of an Import Quotaon Price and Quantity of Imports

Priceof Steel

0 Quantityof Steel

Domestic supply

Domestic demand

Q1S Q2

S Q2D

Imports without quota

Importswith quota

Domestic supply +Import Supply

Quota

Q1D

World price

The Effects of an Production Subsidy on Price and Quantity of Imports

Priceof Steel

0 Quantityof Steel

Domestic supply

Domestic demand

Imports

Production subsidy

Price (to producers) with subsidy

Qs Qd

Effect of Large Domestic Subsidies on World Market Price

Q/t0

P/Q

D

S

S’

Q2

P2

P1

Q1

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 ConsiderationsEnvironmental/Health/Cultural Human Rights Considerations

International Trade Liberalization AgreementsInternational Trade Liberalization AgreementsBilateral 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 appropriate2. Approves retaliatory actions with regard to “illegal”

trade barriers.

WTO Rulings Retaliatory Tariffs

$2 billion $300 million €200 million

EU/US Steel Brazil/US Cotton US/EU Bananas