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ECON2105
INTRODUCTION TO MACROECONOMICS

ML5.20 MODULE5 LECTURE FOR

CHAPTER 20

Dr. Aselia Urmanbetova

School of Economics
Georgia Institute of Technology
Atlanta, GA, 30332
Dr.U
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CH.20 OUTLINE

20.1: Protectionism: An Indirect Subsidy from

Consumers to Producers
20.2: International Trade and Its Effects on Jobs,
Wages, and Working Conditions
20.3: Arguments in Support of Restricting Imports
20.4: How Trade Policy Is Enacted:
Globally, Regionally, and Nationally
20.5: The Tradeoffs of Trade Policy
 20.1 Protectionism: An Indirect Subsidy 3
from Consumers to Producers

● Protectionism - when a government legislates policies to reduce

or block imports.

● Protectionist policies often seek to shield domestic producers and

domestic workers from foreign competition.

● Protectionism takes three main forms:

• Tariffs
• Import quotas
• Nontariff barriers
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Trade Barriers: Tariffs, Export Subsidies, and
Quotas

Tariff
● A tax on imports.

Quota
● A limit on the quantity of imports.

export subsidies
● Government payments made to domestic firms to encourage exports.

Dumping
● A firm’s or an industry’s sale of products on the world market at prices below its own cost of
production or fair market value.
Embargo
Sanctions
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Nontariff Barriers

● Nontariff barriers - ways a nation can draw up rules, regulations,

inspections, and paperwork to make it more costly or difficult to
import products.
• Examples: Rules requiring certain safety standards or origin
regulations.
19.4 The Benefits of Reducing Barriers to 6
International Trade

● Tariffs - taxes that governments

place on imported goods.

● Traditionally, tariffs were used

simply as a political tool to protect
certain vested economic, social,
and cultural interests.
SUPPLY, DEMAND, AND 7

INTERNATIONAL TRADE
We can use the demand and supply
model to determine:
the effects of free trade on:
domestic equilibrium price and quantity.
imports.
the effects of trade barriers on:
domestic equilibrium price and quantity.
imports.
The Sugar Trade between Brazil and the 8
United States
The Sugar Trade between Brazil and the 9
United States
Effects of Trade Barriers: U.S. Sugar 10
Supply and Demand

● When there is free trade, the equilibrium

is at point A.
● When there is no trade (due to barriers),
the equilibrium is at point E.
Free Trade of Sugar 11
CONSUMER AND PRODUCER 12

SURPLUS IN AUTARKY
Price of phones

Domestic supply

Consumer
surplus
PA A

Producer
surplus

Domestic
demand

QA Quantity of phones
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THE DOMESTIC MARKET WITH IMPORTS

Price of phones

Domestic
supply

Autarky price
A
PA

PW

World price
Domestic demand

Domestic quantity QS QA QD Domestic quantity Quantity of

supplied with demanded with phones
trade Imports trade
THE EFFECTS OF IMPORTS ON SURPLUS 14
Allowing imports increases total
surplus. Changes in surplus
Price of Gain Loss
phones
Consumer surplus X+Z
Domestic Producer surplus -X
supply
Change in total
surplus
+Z
W

PA A
X Z
PW

Y Domestic
demand

QS QA QD Quantity of phones

Imports
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THE DOMESTIC MARKET WITH EXPORTS

Price of
phones

Domestic
World price supply
PW

A
PA

Autarky price

Domestic
demand

Domestic QD QA QS Domestic Quantity of

quantity quantity phones
demanded Exports supplied
with trade with trade
THE EFFECTS OF EXPORTS ON SURPLUS 16

Allowing exports increases total Changes in surplus

Price of
surplus. Gain Loss
phones
Consumer surplus –X
Domestic Producer surplus X+ Z
supply
W Change in total
+Z
PW surplus
X Z
PA A

Domestic
demand

QD QA QS
Quantity of
phones
Exports
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THE EFFECTS OF A TARIFF

●A tariff has two effects:
1. ↑ domestic production, ↓ domestic consumption.
•The good is now produced by the higher-cost country.
2. Less is consumed → lower gains from trade.
● Measuring the losses and wasted resources
• Can we measure the value of wasted resources? Yes!
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THE EFFECT OF A TARIFF
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A TARIFF REDUCES TOTAL SURPLUS

Price of Changes in surplus
phones Gain Loss
Domestic Consumer surplus –(A + B + C + D)
supply +A
Producer surplus
Government revenue +C

Change in total
PT –( B + D)
surplus
Tariff A B C D
PW
Domestic The tariff reduces
demand
consumer surplus,
QS QST QDT QD Quantity of increases producer
Imports
after tariff
phones
surplus,
Imports before
tariff
creates new
government revenue,
and creates
deadweight loss.
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Q1: Suppose the government allows imports
of leather footwear into the United States.
What will the market price be?

A. > $24
B. $24
C. $30
D. $54
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Q2: Suppose the government allows imports
of leather footwear into the United States.
What will be the quantity demanded?

A. Q0
B. Q1
C. Q2
D. Q2 - Q0
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Q3: Suppose the government allows imports
of leather footwear into the United States.
What will be the quantity of imports?

A. Q0
B. Q1
C. Q2
D. Q2 - Q0
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Q4: Suppose the government allows imports of leather
footwear into the United States. The market price falls to
$24. What area represents consumer surplus?

A. R+S+V
B. V+W+X+Y
C. R+S+T+U
D. R+S
 20.4 How Trade Policy Is Enacted: Globally, 24
Regionally, and Nationally

● General Agreement on Tariffs and Trade (GATT) - forum in which

nations could come together to negotiate reductions in tariffs and
other barriers to trade.
• The precursor to the World Trade Organization
● Free trade agreement - economic agreement between countries to
allow free trade between members.
• Without tariffs or quotas
● Common market - economic agreement between countries to
allow free trade in goods, services, labor, and financial capital
between members while having a common external trade policy.
● Economic union - economic agreement between countries to allow
free trade between members, a common external trade policy, and
coordinated monetary and fiscal policies.
Regional Trade Agreements 25

● Many nations belong both to the World Trade Organization (150) and to
regional trading agreements.
● Examples:
• European Union
• North American Free Trade Agreement (NAFTA)
• Asia Pacific Economic Cooperation (APEC)
● General trend in the last 60 years is toward lower barriers to trade.
● The average level of tariffs on imported products charged by
industrialized countries:
• 40% in 1946
• less than 5% by 1990
Ricardian Trade (inter-industry), New Trade (intra-industry), Special
Interests
Optimal tariffs (non-retaliatory), Retaliatory regimes, Cooperative regimes
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TRADE PROTECTION IN THE UNITED
STATES

●Until recently, clothing and

textiles were strongly protected
from import competition.
●Now: the United States has very low
tariffs, which increased the benefit of
trade (or, as in the graph, reduced the
lost “welfare”).
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A TARIFF REDUCES TOTAL SURPLUS

Price of Changes in surplus
phones Gain Loss
Domestic Consumer surplus –(A + B + C + D)
supply +A
Producer surplus
Government revenue +C

Change in total
PT –( B + D)
surplus
Tariff A B C D
PW
Domestic The tariff reduces
demand
consumer surplus,
QS QST QDT QD Quantity of increases producer
Imports
after tariff
phones
surplus,
Imports before
tariff
creates new
government revenue,
and creates
deadweight loss.
 Demand and Supply Analysis of 28
Protectionism

● To the non-economist, restricting imports may appear to be nothing more than taking sales
from foreign producers and giving them to domestic producers.

● A demand and supply analysis of protectionism shows that it is not just a matter of domestic
gains and foreign losses, but a policy that imposes substantial domestic costs as well.

• Additionally: Why are the poor countries of the world poor? There are a number of reasons, but one of
them will surprise you: the trade policies of the high-income countries.
• United States, Canada, countries of the European Union, and Japan—subsidize their domestic farmers
collectively by about $360 billion per year;
• As Michael Gerson of the Washington Post describes it: “[T]he effects in the cotton-growing regions of
West Africa are dramatic . . . keep[ing] millions of Africans on the edge of malnutrition. In some of the
poorest countries on Earth, cotton farmers are some of the poorest people, earning about a dollar a day. .
. . Who benefits from the current system of subsidies? About 20,000 American cotton producers, with an
average annual income of more than $125,000.”
 Benefits of Reducing Barriers to 29
International Trade

● Low-income countries benefit more from trade than high-income countries do.

● But before dismissing the gains from trade, it is worth remembering two points:

• Even a small gain is enough money to deserve attention, since this increase is not a
one-time event; it would persist each year into the future.

• Estimates of gains may be on the low side because some of the gains from trade are
not measured well in economic statistics.

• It is difficult to measure the advantages to consumers of having a variety of

products available and a greater degree of competition among producers.

• Trade between countries often involves a transfer of knowledge that can involve
skills in production, technology, management, finance, and law.
20.2 International Trade and Its Effects 30
on Jobs, Wages, and Working Conditions

● In theory, imports might injure workers in several different ways:

• fewer jobs
• lower wages
• poor working conditions

● Protectionism can save jobs in a specific industry that’s being protected, but it
costs jobs in other unprotected industries.
• If consumers are paying higher prices to a protected industry, they have
less money to spend on goods from other industries - so jobs are lost in
those other industries.
• If a firm sells a protected product to other firms, so that other firms must
now pay a higher price for a key input, then those firms will lose sales to
foreign producers. Lost sales = lost jobs.
 20.2 International Trade and Its Effects 31
on Jobs, Wages, and Working Conditions

● The U.S. International Trade

Commission, in its study of
barriers to trade, predicts that
reducing trade barriers would
not lead to an overall loss of
jobs.

● Protectionism reshuffles jobs

from unprotected industries to
protected industries, but
doesn’t create new jobs.
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Q5: Free trade refers to trade between
countries

A. that is without shipping costs.

B. of products which are free to low-income
consumers.
C. that is licensed by both governments.
D. that is without restrictions.
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ARGUMENTS FOR TRADE PROTECTION

● Trade and domestic employment

• Globalization will force some firms to lay off
workers.
• Even so, increased trade usually increases jobs in
other industries (exporters).
• But: for workers who lose their jobs, switching
industries can be difficult and time-consuming.
 20.3 Arguments in Support of Restricting 34
Imports
● Arguments that are in support of restricting
imports:
• Infant Industry Argument
• Anti-dumping Argument
• Environmental Protection Argument
• Unsafe Consumer Products Argument
• National Interest Argument

● The Infant Industry Argument - block imports for a

limited time, to give an infant industry time to
mature, before it starts competing on equal terms
in the global economy.
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ARGUMENTS FOR TRADE PROTECTION

●National Security
●In
times of national crisis or war the United States
must be able to rely on key domestic industries:
•Oil
•Steel
•Defense
•Food

●Protection is required even during peacetime

to ensure their availability.
 The National Interest Argument 36

● National interest argument - the argument that there are compelling national interests against
depending on key imports from other nations. Examples:
• oil
• special materials or technologies that might have national security applications
● This argument for protectionism proves weak.
● Examples of more reasonable strategies for the U.S. to protect from a cutoff of foreign oil:
• Import 100% of petroleum supply now, and save domestic oil resources for when/if foreign
supply cut off.
• Discourage use through raising taxes on oil, and start a high-powered program to seek out
alternatives to oil.
● Economists often treat the national interest argument skeptically because lobbyists and
politicians can tout almost any product as vital to national security.
 The Anti-Dumping Argument 37

● Dumping - selling goods below their cost of production.

● Anti-dumping laws - block imports that are sold below the cost of
production by imposing tariffs that increase the price of these
imports to reflect their cost of production.
● Dumping is not allowed under WTO rules.
● Why would foreign firms export a product at less than its cost of
production - presumably taking a loss?
• Innocent explanation: demand and supply set market prices,
not the cost of production.
• Sinister explanation: dumping is part of a long-term strategy to
drive out the domestic competition, then raise prices.
• This is called predatory pricing.
The Unsafe Consumer Products Argument 38

● Another argument for shutting out certain imported products is that

they are unsafe for consumers.
● For imported products, WTO says:
• Countries can set their own safety standards.
• Regulations must be based on science.
• They should not arbitrarily or unjustifiably discriminate between
countries where identical or similar conditions prevail.
● Examples of recalls:
• 2007 - Mattel recalled nearly two million toys imported from
China due to concerns about high levels of lead in the paint, as
well as some loose parts.
• 2013 - Japan blocked imports of U.S. wheat because of
concerns that genetically modified (GMO) wheat might be
included in the shipments.
 The Environmental Protection Argument 39

● Race to the bottom - when production locates in countries with the lowest
environmental (or other) standards, putting pressure on all countries to reduce
their environmental standards.

• Does not appear to describe reality: generally, other factors that determine
location are much more important to companies than trying to skimp on
environmental protection costs.

● Alternatively, the threat of blocking international trade can pressure low-income

countries for higher environmental standards.
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Labor Standards and Working Conditions

● Workers in many low-income countries around the world:

• labor under conditions that would be illegal for workers in the U.S.
• are often paid less than the U.S. minimum wage.
• have working conditions that may be extremely unpleasant or unsafe.
● What are acceptable and enforceable minimum labor standards and protections to have the
world over?
● In thinking about labor standards in other countries, it is important to draw some distinctions
between what is truly unacceptable and what is painful to think about.
● The United States is not a world leader in government laws to protect employees.
• One of 41 countries that does not provide mandated paid leave for new parents.
20.5 The Tradeoffs of Trade Policy 41

● Over time the “average” person gains from international trade.

● The “average” person is hypothetical - representing a mix of those who have
done very well, those who have done all right, and those who have not been
lucky at all.
● Common belief among economists - it is better to embrace the gains from
trade, than it is to cut off trade.
• Deal with the costs and tradeoffs with other policy tools.

● Disruptive market change - innovative new product or production technology

which disrupts the status quo in a market.
• The innovators earn more income and profits.
• The other firms lose income and profits, unless they can come up with
their own innovations.
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How does the United States really feel about
expanding trade? In summer 2007, the Pew Foundation surveyed 45,000 people in 47 countries.
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An Economic Consensus

● According to the theory of comparative advantage, all countries benefit from specialization
and trade: Free international trade raises real incomes and improves the standard of living.

● Although protectionists argue for the protection of workers from foreign competition, it is
unlikely to cause net job loss in an economy as workers are absorbed into expanding sectors
over time.

● Foreign trade and full employment can be pursued simultaneously.

● Although economists disagree about many things, the vast majority of them favor free trade.
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International Trade

https://www.ft.com/video/542a1a89-9603-485c-8ac2-8513e3f5dfab
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Q6: International trade

A. helps consumers but hurts firms that are

less efficient than their foreign competitors.
B. helps consumers and firms that compete
with their foreign competitors.
C. helps consumers but harms exporting
firms and their workers.
D. harms consumers but helps exporting
firms.
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Q7: Which of the following is the best
example of a tariff?

A. a $150 fee imposed on all imported

residential air conditioners
B. a tax placed on all residential air
conditioners sold in the domestic market to
help offset the impact of emissions on the
environment
C. a limit on the quantity of residential air
conditioners that can be imported from a
foreign country
D. a subsidy from the U.S. government to
domestic manufacturers of residential air
conditioners to enable them to compete
more effectively with foreign producers
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Till Next Time!