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Topic 7

International Economics - NSU ECO328 - JVHN

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25 views15 pages

Topic 7

International Economics - NSU ECO328 - JVHN

Uploaded by

ABU MASROOR AHMED
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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The Instruments of Trade

Policy
Topic 7
This lecture is covered from KOM (Chapter 9)
Supply, Demand and Trade in a Single Industry
• Two countries: Home and Foreign
• Producing a single commodity: Wheat
• Costless transportation
• Supply and demand are functions of price.
• Price in both countries are in terms of Home currency.
• Trade will arise if prices are different in absence of trade.
• Let 𝑃! > 𝑃" : move wheat from Foreign to Home.
• Export of wheat raises the price in Foreign (as the demand for wheat goes
up) and lower its price in Home until the difference in price has been
eliminated.
Supply, Demand and Trade in a Single Industry
(continued)
• Home import demand: excess of what Home consumers demand over
what Home producers supply
• Foreign export supply: excess of what Foreign producers supply over what
Foreign consumers demand
• Price of good increases →Home consumers demand less and Home
producers supply more → the demand for import declines
• Price of good increases →Foreign consumers demand less and Home
producers supply more → the supply for export declines
• Home demand –Home supply = Foreign supply –Foreign demand
• Home demand + Foreign demand = Home supply +Foreign supply
• World demand = World Supply
Effects of Tariff
• Suppose a specific tariff 𝑡 is imposed on per unit of wheat.
• In absence of tariff, the equilibrium price in both countries will be 𝑃!
• Shippers will NOT move wheat from Foreign to Home unless 𝑃" −
𝑃# ≥ 𝑡
• If no wheat is shipped: Excess demand in Home and excess supply in
Foreign
• A tariff will raise the price in Home while the Foreign price will go
down until the difference is 𝑡.
• Imposition of tariff raises the Home price to 𝑃$ while the Foreign
price drops to 𝑃 $ ∗ = 𝑃$ − 𝑡
Effects of Tariff (continued)
• Home: Producers supply more and consumers demand less, and
hence fewer imports are demanded.
• Foreign: lower price leads to reduced supply and increased demand,
and thus a smaller export supply.
• Fall in quantity (from free trade volume to volume with a tariff)
• 𝑃$ − 𝑃! < 𝑡: imposition of tariff reflected in a decline in Foreign
export’s price and is passed to Home consumers.
• Imposition of tariff causes a fall in the import of the tariff imposing
country.
Consumer Surplus
• The amount a consumer gains from purchase by computing the
difference between the price he actually pays and the price he would
have been willing to pay.
• It can be derived from the market demand curve.
• Let 𝑃 is the equilibrium price while the equilibrium quantity is 𝑄.
• Consumer surplus = Area under the demand curve upto 𝑄- 𝑃𝑄
Producer Surplus
• Analogous concept.
• Derived from the market supply curve.
• Producer surplus is equal to the area above the supply curve and
below the equilibrium price.
Costs and Benefits of Tariff
• Price without tariff: 𝑃#
• After tariff, Home price raises to 𝑃$ while Foreign export price falls to 𝑃 $ ∗ .
• Domestic production rises from 𝑆% to 𝑆& and consumption falls from 𝐷% to
𝐷& .
• Five regions: a, b, c, d and e
• Gain to domestic producers: They receive a higher price with higher
producer surplus
• Before tariff, the PS was area below 𝑃"
• After the tariff, the PS is area below 𝑃#
• Producer’s gain from the trade: area a
Costs and Benefits of Tariff (continued)
• How about domestic consumers?
• Facing a higher price which makes them worse off.
• Before tariff, the CS was area above 𝑃!
• After the tariff, the CS is area above 𝑃"
• Consumer’s loss from the trade: a+b+c+d
• Role of Government?
• Government gains by collecting tariff.
• Government collection = tariff rate * volume of import = 𝑡 × 𝐷# − 𝑆# =
(𝑃" − 𝑃 "∗ ) × 𝐷# − 𝑆#
• Government’s gain: c+e
Costs and Benefits of Tariff (continued)
• Net effect of tariff:
• 𝑁𝑒𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑡𝑎𝑟𝑖𝑓𝑓 = 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑙𝑜𝑠𝑠 − 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑔𝑎𝑖𝑛
−𝑔𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
= 𝑎+𝑏+𝑐+𝑑 −𝑎− 𝑐+𝑒
=𝑏+𝑑−𝑒
• Efficiency loss: shown by the two triangles: b and d. It is effeiciency
loss because the tariff distorts incentives to consume and produce.
• Terms of trade gain: area e. It arises because a tariff lowers foreign
export prices.
Consumer Surplus
• The amount a consumer gains from purchase by computing the
difference between the price he actually pays and the price he would
have been willing to pay.
• It can be derived from the market demand curve.
• Let 𝑃 is the equilibrium price while the equilibrium quantity is 𝑄.
• Consumer surplus = Area under the demand curve upto 𝑄- 𝑃𝑄
Producer Surplus
• Analogous concept.
• Derived from the market supply curve.
• Producer surplus is equal to the area above the supply curve and
below the equilibrium price.
Costs and Benefits of Tariff
• Price without tariff: 𝑃#
• After tariff, Home price raises to 𝑃$ while Foreign export price falls to 𝑃 $ ∗ .
• Domestic production rises from 𝑆% to 𝑆& and consumption falls from 𝐷% to
𝐷& .
• Five regions: a, b, c, d and e
• Gain to domestic producers: They receive a higher price with higher
producer surplus
• Before tariff, the PS was area below 𝑃"
• After the tariff, the PS is area below 𝑃#
• Producer’s gain from the trade: area a
Costs and Benefits of Tariff (continued)
• How about domestic consumers?
• Facing a higher price which makes them worse off.
• Before tariff, the CS was area above 𝑃!
• After the tariff, the CS is area above 𝑃"
• Consumer’s loss from the trade: a+b+c+d
• Role of Government?
• Government gains by collecting tariff.
• Government collection = tariff rate * volume of import = 𝑡 × 𝐷# − 𝑆# =
(𝑃" − 𝑃 "∗ ) × 𝐷# − 𝑆#
• Government’s gain: c+e
Costs and Benefits of Tariff (continued)
• Net effect of tariff:
• 𝑁𝑒𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑡𝑎𝑟𝑖𝑓𝑓 = 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑙𝑜𝑠𝑠 − 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑔𝑎𝑖𝑛
−𝑔𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
= 𝑎+𝑏+𝑐+𝑑 −𝑎− 𝑐+𝑒
=𝑏+𝑑−𝑒
• Efficiency loss: shown by the two triangles: b and d. It is effeiciency
loss because the tariff distorts incentives to consume and produce.
• Terms of trade gain: area e. It arises because a tariff lowers foreign
export prices.

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