CHAPTER

9
Application:
International Trade
Economics
P RINCIP LES OF

N. Gregory Mankiw

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by Ron Cronovich
© 2009 South-Western, a part of Cengage Learning, all rights reserved

In this chapter,
look for the answers to these questions:

§ What determines how much of a good a country will

import or export?
§ Who benefits from trade? Who does trade harm?
Do the gains outweigh the losses?
§ If policymakers restrict imports, who benefits?
Who is harmed? Do the gains from restricting
imports outweigh the losses?
§ What are some common arguments for restricting
trade? Do they have merit?
1

Introduction
§ Recall from Chapter 3:
A country has a comparative advantage in a
good

Countries can gain from trade if each exports the

goods in which it has a comparative advantage.
§ Now we apply the tools of welfare economics
to see where these gains come from and
who gets them.

APPLICATION: INTERNATIONAL TRADE 2

1
 The World Price and
Comparative Advantage
§ PW =

§ PD =
§ If PD < P W,

§ If PD > P W,

APPLICATION: INTERNATIONAL TRADE 3

The Small Economy Assumption

§ A small economy

§ Not always true – especially for the U.S. – but

simplifies the analysis without changing its
lessons.
§ When a small economy engages in free trade,
PW is the only relevant price:

APPLICATION: INTERNATIONAL TRADE 4

A Country That Exports Soybeans

Without trade,
PD = $4 P Soybeans
Q = 500
S
PW = $6
Under free trade,
§ domestic $4
consumers
demand _____
D
§ domestic producers Q
supply _____ 500
§
APPLICATION: INTERNATIONAL TRADE 5

2
 A Country That Exports Soybeans
Without trade,
P Soybeans
CS =
PS = S
Total surplus = A
$6
B D
With trade, $4
CS = C
PS = D
Total surplus = Q

APPLICATION: INTERNATIONAL TRADE 6

ACTIVE LEARNING 1
Analysis of trade
Without trade, P Plasma TVs
PD = $3000, Q = 400
S
In world markets,
PW = $1500
Under free trade, $3000
how many TVs
will the country $1500
import or export? D

Identify CS, PS, and Q

200 400 600
total surplus without
trade, and with trade.
7

Summary: The Welfare Effects of Trade

PD < PW PD > PW

direction of trade

consumer surplus

producer surplus

total surplus

Whether a good is imported or exported,

trade creates winners and losers.

APPLICATION: INTERNATIONAL TRADE 10

3
Other Benefits of International Trade
§ Consumers
§ Producers

§ Competition from abroad may

§ Trade

APPLICATION: INTERNATIONAL TRADE 11

Then Why All the Opposition to Trade?

§ Recall one of the Ten Principles from Chapter 1:
Trade can make everyone better off.
§

§ Yet, such compensation rarely occurs.

§

§ Hence, the losers have more incentive to organize

and lobby for restrictions on trade.
APPLICATION: INTERNATIONAL TRADE 12

Tariff: An Example of a Trade Restriction

§
§ Example: Cotton shirts
PW = $20
Tariff: T = $10/shirt
Consumers must pay $____ for an imported shirt.
So, domestic producers can charge $___ per shirt.

§ In general, the price facing domestic buyers &

sellers equals (PW + T ).

APPLICATION: INTERNATIONAL TRADE 13

4
 Analysis of a Tariff on Cotton Shirts
P
PW = $20 Cotton shirts
Free trade:
buyers demand ____
S
sellers supply ____
imports = ____
T = $10/shirt
price rises to ____
buyers demand ____ $20
sellers supply ____ D
imports = ____ Q
25 80
APPLICATION: INTERNATIONAL TRADE 14

Analysis of a Tariff on Cotton Shirts

Free trade P deadweight
Cotton shirts
CS = loss =

PS = S
Total surplus =

A
Tariff
B
CS = $30
C D E F
PS = $20
Revenue = G
D
Total surplus = Q
25 40 70 80
APPLICATION: INTERNATIONAL TRADE 15

Import Quotas:
Another Way to Restrict Trade
§

§ Mostly has the same effects as a tariff:

§ Raises price, reduces quantity of imports.
§ Reduces buyers’ welfare.
§ Increases sellers’ welfare.
§ A tariff creates revenue for the govt. A quota

§ Or, govt could auction licenses to import to

capture this profit as revenue. Usually it does not.
APPLICATION: INTERNATIONAL TRADE 17

5
 Arguments for Restricting Trade
1. The jobs argument

Economists’ response:
Look at the data to see whether rising imports
cause rising unemployment…

APPLICATION: INTERNATIONAL TRADE 18

U.S. Imports & Unemployment,

Decade averages, 1956-2005
16%
Imports
14%
(% of GDP)
12%
10%
8%
6% Unemployment
(% of labor force)
4%
2%
0%
1956

1966

1976
-85

1986
-95

1996
-2005
-65

-75

APPLICATION: INTERNATIONAL TRADE 19

Arguments for Restricting Trade

1. The jobs argument
Trade destroys jobs in the industries that compete
against imports.
Economists’ response:
Total unemployment does not rise as imports rise,
because

Even if all goods could be produced more

cheaply abroad, the country need only have a
____________________ to have a viable export
industry and to gain from trade.
APPLICATION: INTERNATIONAL TRADE 20

6
 Arguments for Restricting Trade
2. The national security argument

Economists’ response:

APPLICATION: INTERNATIONAL TRADE 21

Arguments for Restricting Trade

3. The infant-industry argument

Economists’ response:

Besides, if a firm will be profitable in the long run,

it should be willing to incur temporary losses.
APPLICATION: INTERNATIONAL TRADE 22

Arguments for Restricting Trade

4. The unfair-competition argument

Economists’ response:
Great! Then we can import extra-cheap products
subsidized by the other country’s taxpayers.

APPLICATION: INTERNATIONAL TRADE 23

7
 Arguments for Restricting Trade
5. The protection-as-bargaining-chip argument
Example:

Economists’ response:
Suppose France refuses. Then the U.S. must
choose between two bad options:
A) Restrict imports from France,

B) Don’t restrict imports,

APPLICATION: INTERNATIONAL TRADE 24

Trade Agreements
§ A country can liberalize trade with
§ unilateral reductions in trade restrictions
§ multilateral agreements with other nations
§ Examples of trade agreements:

§ World Trade Organization (WTO), est. 1995,

APPLICATION: INTERNATIONAL TRADE 25