1. The document discusses various topics related to international trade including comparative advantage, tariffs, quotas, export subsidies, trade blocs, and trade embargoes. 2. It provides examples and diagrams to illustrate how each of these trade policies and agreements impact production, consumption, prices, and welfare in countries. 3. The key effects discussed are how policies like tariffs and quotas can reduce global welfare while benefiting domestic producers, and how export subsidies typically reduce welfare for the subsidizing country.

1. 8. International Trade
Ryan Herzog, Ph.D.

2. International Trade: Tables & Figures

3. Increasing Global Trade

4. Global Trade
0%
10%
20%
30%
40%
50%
60%
Percent of
Global GDP
Year

5. Tables & Figures

6. International Trade Policy
• Welfare Effects of Free Trade
• Global Trade Governance
• Tariffs
• Non-Tariff Barriers
– Import Quotas
– Export Subsidies
• Trade Blocks
• Trade Embargos

7. Key Questions About
International Trade
• Why do countries trade? What does each
country trade? (Import, Export)
• For each country, what are the overall gains (or
losses) from trade?
• What are the effects of trade on each country’s
economic structure? (Production, Consumption)
• What are the effects of trade on the distribution
of income within each country? (Winners,
Losers)

8. S&D of Motorbikes – Autarky
• Autarky = no trade

9. S&D of Motorbikes – Autarky

10. Terms and Definitions
• Consumer Surplus – increase in the economic well-being of
consumers who are able to buy a product at a market price
lower than the highest price they would be willing to pay.
• Producer Surplus – increase in the economic well-being of
producers who are able to sell a product at a market price
higher than the lowest price that would have drawn out their
supply.
• Arbitrage – buying something in one market and reselling the
same thing in another market to profit from a price
difference.

11. The Effects of Trade on Production,
Consumption & Price

12. Welfare Effects of Free Trade

13. Welfare Effects of Free Trade

14. Key Questions About International
Trade
1. Why do countries trade? What does each country
trade? (Import, Export)
Arbitrage, to earn profits from the price
difference between previously separated
markets.
A product will be exported from countries
where its price was lower without trade to
countries where its price was higher.

15. Key Questions About International
Trade
1. Why do countries trade? What does each country
trade? (Import, Export)
2. For each country, what are the overall gains (or
losses) from trade?
Both countries have net gains from trade (i.e.,
total welfare increases).

16. Key Questions About International
Trade
1. Why do countries trade? What does each country
trade? (Import, Export)
2. For each country, what are the overall gains (or losses)
from trade?
3. What are the effects of trade on each country’s
economic structure? (Production, Consumption)
Price changes from pre-trade price to the world price
which results in a change in quantities consumed and
produced in each country. Importing country will see
an increase in quantity consumed and decrease in
quantity produced.

17. Key Questions About International
Trade
1. Why do countries trade? What does each country
trade? (Import, Export)
2. For each country, what are the overall gains (or losses)
from trade?
3. What are the effects of trade on each country’s
economic structure? (Production, Consumption)
4. What are the effects of trade on the distribution of
income within each country? (Winners, Losers)
The winners are the producers of exports and the
consumers of imports. The losers are the producers of
import-competing products and export consumers

18. Adam Smith’s “Absolute
Advantage”
• What about countries without an absolute
advantage? Can trade benefit them?

19. David Ricardo’s Theory of
Trade
• Comparative Advantage
– A country will export products that it can produce
at a low opportunity cost (in terms of other goods
that could be produced within the country).
– A country will import products that it would
otherwise produce at a high opportunity cost.

20. Comparative Advantage
• U.S. has no absolute advantages in production
but it does have a comparative advantage.
• In order to find comparative advantage we
calculate opportunity costs of production.

21. Comparative Advantage

22. Comparative Advantage
• Price differential Arbitrage
– (assuming transportation costs are less than the price
difference)
– 2.0 W/C ≥ World Price of Cloth ≥ 0.67 W/C
• (or 0.5 C/W ≤ World Price of Wheat ≤ 1.5 C/W)

23. Comparative Advantage
• Suppose World Price of cloth is 1 W/C
– Both countries gain from trade because 2.0 ≥ 1 ≥ 0.67
• The U.S. gains because:
– It produces a unit of wheat by giving up only 0.5 unit of
cloth.
– It can export this wheat unit and receive 1 unit of cloth.
• The Rest of the World gains because:
– It produces a unit of cloth by giving up only 0.67 unit of
wheat.
– It can export this cloth unit and receive 1 unit of wheat.

24. Comparative Advantage
Assume 100 billion hours of labor available during the year (for each country).

25. Global Trade Governance
• GATT – General Agreement on Tariffs and Trade
– Was the key institution governing international trade
issues from 1947 through the early 1990’s.
• WTO – World Trade Organization
– Created in January 1995, is the organization that
oversees the global rules of government policies
toward international trade
– Provides the forum for negotiating global agreements
to improve these rules

26. Analysis of a Tariff
• A tariff is a tax on importing a good or service
into a country, usually collected by customs
officials at the place of entry.
– A specific tariff is stipulated as a money amount
per unit of import (e.g., $30/motorbike).
– An ad valorem tariff (on the value) is a percentage
of the estimated market value of the goods when
they reach the importing country.

27. Tariffs – An Overview
• We’ll show that:
– A tariff almost always lowers world well-being.
– A tariff usually lowers the well-being of each
nation, including the nations imposing the tariff.
– A tariff absolutely helps those groups tied closely
to the production of import substitutes, even
when the tariff is bad for the nation as a whole.

28. The Effect of a Tariff on Domestic
Producers
• Free Trade Situation (consider producer surplus):

29. The Effect of a Tariff on
Domestic Producers
• Now consider producer surplus after a 10% (or $30) tariff:

30. The Effect of a Tariff on Domestic
Consumers
• Free Trade Situation (consider consumer surplus):

31. The Effect of a Tariff on Domestic
Consumers
• Now consider consumer surplus after a 10% (or $30) tariff:

32. Government Revenue from
Tariffs
• If the tariff isn’t prohibitive (set so high that it
prohibits imports completely), the government
will earn revenue from the tariff.
– Revenue = tariff * volume of imports
– Revenue = $30 * 0.6 million = $ 18 million
• Tariff revenue can be spent any way the
government sees fit, however it’s “counted” as
part of a country’s total surplus (welfare).
– Total surplus = producer surplus + consumer surplus +
government revenue

33. The Effect of Tariffs on Total
Surplus
• Domestic producer’s gain from tariff = $21 million (area a)
• Domestic consumer’s loss from tariff = $45 million (area a
+ b + c + d)
• Government revenue from tariff = $18 million (area c)
• Net loss to total surplus of (b + d) = $ 6 million
– -$ 6 million = $ 21 million - $45 million + $18 million

34. The Effect of Tariffs on Total Surplus

35. The Effect of Tariffs on Total
Surplus
• What is the intuition for the economic loss to
total surplus?
– Consumption Effect – the loss to the consumers in the
importing nation based on the reduction in their total
consumption of bicycles (area d).
– Production Effect – the extra cost of shifting to more
expensive home production. The domestic resource
cost of producing these bicycles is more than the $300
price at which the bicycles are available from foreign
suppliers (area b).

36. Nontariff Barriers to Imports
• Nontariff Barrier (NTB) to imports is any policy
used by the government to reduce imports,
other than a simple tariff on imports.
– Quotas
– Discriminatory product standards
– Buy-at-home rules for government purchases
– Administrative red tape to harass importers of
foreign products

37. Import Quotas
• A quota is a limit on the total quantity of imports
of a product allowed into the country during a
period of time.
• The government gives out a limited number of
licenses to import the quota quantity legally and
prohibits importing without a license.
• A quota will impact the market if the quota
quantity is less than the quantity that people
would want to import without the quota.

38. Import Quotas
• Benefits (to protectionists/government officials)
of quotas over tariffs:
– A quota ensures that the quantity of imports is strictly
limited; a tariff would allow the import quantity to
increase if foreign producers cut their prices or if
domestic demand increases.
– A quota gives government officials greater power.
Officials can decide who gets import licenses under a
quota system and they can use this power to their
advantage (bribes).

39. Import Quotas – Small
Country

40. Import Quotas – Small
Country
• Compared to free trade model:
– The quota results in a higher price and larger production
quantity, so domestic producers gain surplus equal to area
a.
– With the higher price and smaller consumption quantity,
domestic consumers lose surplus equal to area a + b + c +
d.
– Areas b & d are the production and consumption effects,
respectively (like with tariffs) and are deadweight losses.
• These results are equivalent to a 10% (or $30) tariff.
– One exception – area c: government revenue under tariff

41. Quota Licenses to Import
• Quota license to import is a license to buy the
product from foreign suppliers at the world
price of $300 and resell these units at the
domestic price of $330.
– Price mark-up (“economic rent”) of $30/unit –
area c
– Who keeps this rent depends on how the licenses
are allocated.

42. Quota Licenses to Import
• Import License Allocation Methods
– The government allocations the licenses for free to
importers using a rule or process that involves
(almost) no resource costs (“fixed favoritism”).
– The government auctions off the licenses to the
highest bidders (“import license auction”).
– The government allocations the licenses to importers
through application and selection procedures that
require the use of substantial resources (“resource –
using application procedures”).

43. Export Subsidies
• Export subsidies are usually bad from for the
world as a whole.
• Often export subsidies are bad for the
countries that use them and benefit the
countries that complain about them.

44. Export Subsidies
• Governments subsidize exports in many ways,
often in deliberately subtle ways to escape
detection.
– Sometimes they use low-interest loans to exporters
(or their foreign customers).
– Or governments will charge low prices on imports
such as raw materials or transport services that go
into production of exported goods.
– Income tax rules might give special tax relief based on
the value of goods or services each firm exports.

45. Export Subsidies
• In a competitive industry:
– An export subsidy expands exports and production of
the subsidized product.
– Can switch the product from being imported to being exported
– An export subsidy lowers the price paid by foreign
buyers, relative to the price that local consumers pay
for the product.
– For the export subsidy to work as intended, something must
prevent local buyers from importing the product at the lower
foreign price.
– The export subsidy reduces the net national well-
being of the exporting country.

46. Export Subsidies—Who
Benefits?
• Boeing has been helped by with export
subsidies through low interest credit.
• Subsidies on production of agriculture,
particularly in developed countries.

47. Exportable Product, Small
Exporting Country
• Without subsidy firm
exports 90 million pipes
• After subsidy of $20
firm exports 140 million
and sells 50 million
domestically.
– This is only possible if
domestic buyers cannot
buy foreign pipes at the
world price.

48. Exportable Product, Small
Exporting Country
• Who are the winners/ losers
in the exporting country?
• Producer surplus:
– Gain e + f + g
• Consumer surplus:
– Lose e + f
• Cost of subsidy (to gov’t):
– f + g + h
– $20 * 140 million
• Net loss to country = f + h
– f is consumption effect
– h is production effect

49. Switching an Importable
Product into an Exportable
Product (Small Country)

50. WTO Rules on Export
Subsidies
• Subsidies linked directly to exporting are prohibited,
except export subsidies used by the lowest-income
developing countries.
– An ad valorem or specific subsidy per unit exported.
– A firm receives a tax break based on the amount it exports.
• Subsidies that are not linked directly to exporting but
still have an impact on exports are actionable.
– Example: low priced electricity is provided to assist
production by local firms in an industry, and some of this
production is exported.

51. WTO Rules on Export
Subsidies
• Prohibited and actionable subsidies are
punishable under WTO rule if an importing
countries can prove the subsidy harms
domestic production.
– If WTO agrees, importing country is permitted to
impose a countervailing duty, a tariff used to
offset the price or cost advantage created by the
subsidy to foreign exports.

52. Trade Blocs & Embargoes
• Previously we’ve been studying “equal-
opportunity” import barriers—ones that tax or
restrict all imports regardless of country of origin.
• Some import barriers are meant to discriminate;
they tax goods/services from some countries
more than those from other countries.

53. Trade Blocs & Embargoes
• Trade Blocs
– Each member country can import from other member countries
freely, or at least cheaply, while imposing barriers against
imports from outside countries (e.g., NAFTA, the European
Union).
• Trade Embargoes
– Some countries discriminate against certain other countries,
usually because of a policy dispute.
– They deny the outflow of goods, services, or assets to a
particular country while allowing exports to other countries, or
discriminate against imports from the targeted country, or block
both exports to and import from the target (e.g., U.S. embargo
against Cuba).

54. Trade Blocs
• Free Trade Area
– Member countries remove trade barriers among themselves but
keep their separate national barriers against trade with the
outside world.
– Most trade blocs operating today are free trade areas.
– North American Free Trade Area (NAFTA)
• Customs Union
– Member countries remove barriers to trade among themselves
and also adopt a common set of external barriers
– European Economic Community (EEC, 1957-1992) and the
Southern Common Market (MERCOSUR) formed between
Argentina, Brazil, Paraguay, and Uruguay in 1991 are customs
unions.

55. Trade Blocs
• Common Market
– Members allow full freedom of factor flows (migration of
labor and capital) among themselves in addition to having
a customs union.
– The E.U. became a common market at the end of 1992.
• Full Economic Union
– Member countries unify all their economic policies,
including monetary, fiscal and welfare policies as well as
policies toward trade and factor migration.
– Most nations are economic unions; Belgium and
Luxembourg have had such a union since 1921.

56. Trade Blocs

57. Trade Embargoes
• A trade embargo is an economic sanction
which refers to discriminatory restrictions or
bans on economic exchange.
• Currently the US has embargoes in place
against Burma, Cuba, Iran, North Korea, Sudan
and Syria.

58. Political Failure of an Embargo
• Example: Saddam Hussein’s refusal to retreat
from Kuwait (or, after Iraq was driven from
Kuwait, to step down from power).
• Hussein didn’t care that the sanction cost his
country upwards of $15 billion per year (nearly
half Iraq’s national income).
• A counter-example would be UN sanctions on
South Africa which succeeded in hastening the
end of apartheid and the minority-rule police
state.

59. Economic Failure of
Embargoes
• The embargo inflicts little damage on the
target country but possibly even great damage
on the imposing country.