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Unformatted text preview: Principles of Economics I
Economics 101 Announcements Readings: Today: Chapter 8 Next week: Chapter 6 and some notes available next week on CTools Discussion Sections this week No new assignment Chance to review exam questions Copies of exams and answers available online Exam results Mean: 107 Median: 110 Standard Deviation: 19 What do these scores mean? Score of 107 (mean): B Score of 126 (mean + 1 S.D.): A Score of 88 (mean 1 S.D.): trouble 40 35 30 25 20 15 10 5 0 0 20 40 60 80 15% 17% 88 100 107 120 126 140 160 Application of the Market Model: International Trade Policy Supply and Demand model yielded a very strong result: Freely operating markets tend to allocate resources efficiently Creates tension between competing goals of policy makers Highlight the tradeoffs inherent in these policy choices by examining trade policy Application of the Market Model: International Trade Policy Adopt the Supply/Demand model to discuss trade issues Why trade with other countries? How do we measure the benefits of trade? Are there motivations to protect local industries from lowcost producers overseas? The Gains from Trade Case 1: "Low" world price
Price/unit Decrease in Producer Surplus PAutarky Increase in consumer surplus PWorld Imports QS Social Surplus Gains: from reduced prodn Domestic Supply Gains: from increased Gains from trade consn Market Supply DomesticD emand QD Quantity QAutarky A comment on the equilibrium price: Pworld < Pautarky Domestic consumers will not buy domestically at a price above Pworld As domestic producers are competing with the other producers in the world market, domestic producers cannot charge a higher price than Pworld They could import the equivalent product for a lower price Therefore Pworld is the price at which trade occurs in the domestic market The Gains from Trade Case 2: "High" world price
Price/unit PWorld Decrease in Consumer Surplus PAutarky Increase in Producer Surplus QD Social Surplus Gains: from decreased consn Domestic Supply Market Demand Gains from Trade Gains: from increased production Exports QAutarky DomesticD emand QS Quantity Domestic producers will not sell domestically at a price below Pworld A comment on the equilibrium price: Pworld > Pautarky As domestic producers are competing with each other in the domestic market, a producer selling domestically cannot charge a higher price than the producer who exports They could export their product and receive the higher price Therefore Pworld is the price at which trade occurs in the domestic market i.e domestic sales cannot occur at a price higher than Pworld Gains from Trade Domestic demand and domestic supply need not be equal Trade adjusts resource allocation on two margins
Consumption adjusts Production adjusts Can import at the world price (when world price is low) Or export at the world price (when world price is high) Free Trade and Efficiency Free trade ensures efficient allocation of resources: Any distortion will result in reduction in social surplus. Trade taxes Quotas Cosumption taxes/subsidies Production taxes/subsidies MV = MC = PWorld Social surplus is maximized Trade Taxes Trade taxes levy a duty on each unit of the good that crosses the national border
Provides disincentive to trade Should observe in equilibrium that these taxes reduce trade levels Also affects incentives to produce/consume domestically Export taxes Tariffs (i.e. import taxes) Tariffs: Producer and Consumer Prices The price paid to an importer for an imported good is always PWorld If a tariff of $t is levied, the consumer buying the import must pay (PWorld + t) for that good If domestic producers charge If the importer were offered less, she would sell somewhere else in the world There is no reason to offer her any more Less than PWorld + t: excess demand for domestically produced goods More than PWorld + t: excess supply of domestically produced goods Exactly PWorld + t: consumers are indifferent between domestically produced goods and imports The Tariff
Price/unit Domestic Supply Lost surplus from increasing production PWorld+t PWorld Lost surplus from reducing consumption DWL t Imports QS QS' QD' QD Market Supply DomesticD emand Quantity Effects of the Tariff Tariff is a tax on imports Adjust on two margins: both constitute distortions from the efficient allocation of resources
Consume too little Produce too much Disincentive to import Imports fall Who wins and who loses? The price that sellers receive rises The price that consumers pay rises Increase in producer surplus Tariff revenue is collected Decrease in consumer surplus DWL tells us that the consumer surplus loss exceeds the producer surplus loss plus the tariff revenue raised Revenue= Tariff * Imports Revenue available to be distributed to the benefit of members of society The Welfare Effects of the Tariff
Price/unit Domestic Supply Loss in consumer surplus PWorld+t PWorld Increase in producer surplus DWL Tax Revenue Market Supply DomesticD emand QD Quantity Imports QS QS' QD' Why Impose Trade Taxes? By taxing imports, domestic producers face more accommodating market conditions Tariffs and other policies designed to deter trade "protect" domestic producers Producer Surplus increases Accomplished at the expense of domestic consumers DWL reflects the fact that consumer surplus losses exceed producer surplus gains Consumers are a loose, poorly organized, poorly informed group; hard for consumers to lobby effectively Justification/Explanation of Protection Policies Secure Jobs/Save Industry Infant Industry Arguments National security/self sufficiency arguments Rent seeking motivations Manipulation of world prices Strategic Trade Policy Rent Seeking and the Sugar Quota
$/lb Increase in producer surplus $0.21 PQuota $1.16b Domestic Supply Quota Rent DWL =$1.29b $2.91b $0.46b Quota 1.0 QS Market Supply Lost consumer surplus $0.08 PWorld Imports 20.3 QD' QS' 16.8 DomesticD emand QD Lbs (billions) 24.3 Welfare effects of the sugar quota Producer surplus rises Consumer surplus falls Rents accrue to the holders of import licenses Under the US sugar quota producer surplus AND quota rents are largely captured by the same people Buy imports at the world price Sell imports at the domestic, quota price Domestic Trade Policy and the World Price Imposing tariff reduces imports Effectively reduces demand on the world market If domestic import demand is "small" relative to the world market, we expect no effect on the world price This is the assumption implicit in our analysis to now But what if domestic import demand is a significant element of world demand? The World Market
P World Supply PW0 PW1 World Demand Q1 Q0 Q The Export Tax Exported goods sell on the world market for PWorld If an export tax of $t must be paid, then the exporting producer only receives (PWorld t) As there remains competition to serve domestic consumers, the price that the domestic consumer pays will also fall to (PWorld t) Export Tax
Price/unit PWorld PWorld t Decrease in Increase in Producer Consumer Tax Revenue Surplus Surplus DWL t Domestic Supply Market Demand Exports QD DomesticD emand QS' QS Quantity QD' Export tax and the world price The export tax is a tax on trade Reduces trade in equilibrium Specifically, reduces supply of goods to the world market If domestic producers represent a significant portion of world supply, this will shift the world supply curve left Word prices tend to rise Price/unit PW1 Increase in PW consumer surplus PW1 t
0 Export Tax
Gain in Social Tax revenue Surplus Domestic Supply Market Demand Market Demand DWL t Lost producer surplus DomesticD emand QS' Exports QD QD' QS Quantity ...
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