22.

INTERNATIONAL TRADE (THE GLOBAL ECONOMY

I)

GAINS FROM TRADE: Countries trade with one another to enjoy the benefits of lower
prices, more choice, greater access to resources, ability to earn foreign currency to facilitate
more production and trade, exposure to new markets, economies of scale, more knowledge
and ideas, more efficiency in production and more innovation through greater competition.

1. Suppose two countries have the following prices for things (in ounces of silver)

Salt (NaCl) Pepper Amber

Rome 10 20 40

Indies 10 10 60

A merchant seeking to make a profit would carry pepper from the Indies to Rome, and return
with amber.
2. A commodity might be produced more cheaply in one area for any of the following
reasons except:
A. The climate is more favourable in that area
B. Labour is in high demand in that area
C. Key natural resources are available in that area
D. Technical knowledge is available in that area
Explain B high demand for labour often leads to higher wage/ higher cost of
production, discouraging production

3h . State the meaning of “absolute advantage (AA)”.

The ability to produce a product using fewer resources

4h . Country A has a comparative advantage (CA) over Country B, in producing some good,
if the opportunity cost of producing the good is lower in Country A.

5h. Each of the arrays below shows the amount of output that can be produced by a unit
of labour in two areas which trade with each other. Assume in each case that they are the
only countries, and that the goods shown are the only goods. Tell, for each array, which
country has the absolute advantage (AA) in each good and which has the comparative
advantage (CA) in each. Label which PPC diagram goes for which country, and label
quantities on the intercepts of the PPCs.
 Eggs Apples AA CA

France 8 12 Eggs Italy Italy

Italy 16 6 Apples France France

Noodle
s Burgers AA CA

US 20 30 Noodles Japan USA

Burger
Japan 24 50 Japan Japan
s

Yogurt Beer AA CA

Bohemia 12 8 Yogurt Bohemia Bohemia

Moravia 8 8 Beer Neither Moravia

 Sugar Salt AA CA

India 40 60 Sugar India India

Thailan
24 40 Salt India Thailand
d

Step-
ladders Ladders AA CA

Step- Peru
Mexico 48 36 Peru
ladders

Peru 60 30 Ladders Mexico Mexico

6 h. If the opportunity cost of producing 100 kilograms (kg) of figs per year is 2 bicycles,
and the nation can import 100 kg of figs for the price of 1.5 bicycles, the implication is:

A. bicycles produced are worth 66.6 kg figs, though 50 kg figs would be given
up to make them
B. it should produce more figs because they are worth more bicycles than on the
world market
C. it is cheaper to produce figs than to import them
D. it has a comparative advantage in fig production
Explain A A domestic “opportunity cost” exchange rate: 1bicycle = 50kg figs
International exchange rate: 1 bicycle = 66.7kg
7 h. On the PPC’s below, calculate the opportunity cost of Kayaks using the intercepts.

1K = 0.6D 1K = 2S 1K = 0.9C
8 h. In order for any 2 countries to benefit from trade with each other, the exchange rate has
to be appropriate. Explain what is an appropriate exchange rate. Any exchange rate which lies
between the 2 domestic opportunity costs.

Protectionism.

9. Suppose in a small country imported cherries which are cheaper than domestic
cherries.

a) On the diagram below, show the changes in price, Qd and Qs (domestically) due to
allowing the imports.

b) Indicate the change in producer and consumer surplus above. B lost for domestic
producers. B+C is gained by consumers.

c) Use the answer to (b) above to show that the country is better off trading. Gain B + C
(consumers) larger than loss B (producers.)

10. Using the diagram below for Q10, Q11 and Q12, show the domestic effect (in its
market) of applying a tariff on imports of melons:
a) Which areas show consumer surplus before the tariff, and which show it after?

before; a +b + c + d + e + f after: a + b only

b) Which areas show producer surplus before the tariff, and which show it after?

before: g only after: g + c

c) Which area shows the revenue from the tariff, going to the government? area
e

d) Compare the areas showing net gains and losses to each of the groups. Is the country
better or worse off overall? Interpret this result. losses to CS are larger than gains to
PS and G combined. Difference is Deadweight loss d + f

11. Why are imports less with a tariff? (Explain both of the changes which cause this
reduction).

higher P leads to less Qd and more Qs domestically the difference Qd – Qs is imported

12. What areas show the loss of sales revenue to the foreign producers of the imports?
area j + area l

13. True T or False F

a) The gain in producer surplus from adding a tariff is always greater than the gain in
revenue going to the government. T / F

b) The loss in consumer surplus from a tariff is always greater than the gains to producers
and government combined. T / F

c) If a tariff increase causes government revenue to decrease, it will also cause producer
surplus to decrease. T / F
d) For tariffs getting higher and higher, once they have eliminated imports of a product,
there is no effect of a further increase in the tariff. T / F

14. What is the difference between a tariff and a quota?

a tariff is a tax on imports, a quota limits the volume of imports.

15. How is the effect of a quota different from the effect of a tariff? Illustrate the effect of
a quota on a diagram below showing the domestic market with a quota imposed on imports.
If the price changed by the same amount as for a tariff, how would the effects on consumer
surplus, producer surplus, and government revenue be different from the case of the tariff?

all remains the same except that there is no revenue from a quota, (some countries auction the
quota licenses for about the same amount of income)
16. Suppose the government increased the amount of imports allowed under a quota.

a) Show the effect on a diagram.

b) What happens to the price of the good inside the importing country?

the price falls due to greater effective supply

17. On a diagram for the market for an imported good, show the result of the government
subsidising domestic producers.

a) What happens to price? nothing: the country is small (Sworld is

horizontal)

b) What happens to the amount consumed? nothing

c) What happens to the amount imported? imports fall since Sdom increased

d) Show the welfare loss (deadweight loss)? area B

e) Why is there no welfare loss under the demand curve?

There is no distortion to consumption decisions – only production

f) Compare the cost of the subsidy to the total of all benefits within the country.

subsidy cost is PS gained (A) plus deadweight loss (B): always greater than the rise in PS

18. What is “dumping,” and why might it be a good justification for protectionism,
allowing the responding country to be better off as a result?

selling abroad below cost if domestic producers are driven out of business, the foreign
producer can raise price and make excess profits at consumers’ expense, so anti-dumping
tariff is justified

19. What is the infant industry argument for protectionism? What assumption about
future production is necessary for it to justify current losses in welfare?

the extra cost to consumers is only justified if costs will fall with scale and experience,
enough for the country to have a comparative advantage

20. List five arguments against the use of protectionism.

- inefficiency as measured by welfare loss;

- harm to consumers in higher price and loss of variety;

- may lead to lower quality;

- higher price of inputs may harm competitiveness;

- may lead to retaliation and reduce motivation for peace;

- may encourage corruption as producers give bribes to be protected

EVALUATION QUESTIONS (International Trade)

21. Evaluate the effect of a tariff, counting only domestic costs and benefits, using the
comparison structure provided by “winners and losers”. On what basis can you come to a
conclusion?

Use diagram and loss of CS, compared to gain of PS and tariff revenue. Consumer losses are
always larger. Downstream industries may be hurt also if intermediate inputs are protected.
Unless one of the motivations for protectionism is substantial, such as dumping, on the industry is
an infant industry, (just starting out against experienced foreign producers, the country is better off
without the tariff.)

22. Evaluate the use of protectionism as policy for a less developed country and a more
developed country. LDC much more likely to need infant industry protection.
23. Evaluate the use of a subsidy to address the infant industry problem, by contrast with
the use of a tariff. (For the same benefit to the infant industry, which creates more welfare
loss in this market? Why? What other issues should be addressed?)

Two diagrams, with the same increase in domestic supply and PS.

The subsidy diagram has a cost to government/taxpayers, while the tariff case has tax revenue
coming to

the government.

The welfare loss on the diagram is larger for the case of the tariff, but if we knew how much it
distorted the economy to pay for the subsidy, the subsidy case might be the more costly to economic
efficiency.

Subsidies are explicit budget items and thus much easier to get rid of politically, so if the infant
industry never seems ready to be competitive, subsidy approach will probably be cut off first.