Midterm 2

Midterm 2
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Unformatted text preview: Chapter 9: Application:International Trade The story of the textiles industry raises important questions for economic policy: How does international trade affect economic well-being? Who gains and who loses from free trade among countries, and how do the gains compare to the losses? THE DETERMINANTS OF TRADE The steel market is well suited to examining the gains and losses from international trade. Moreover, the steel market is one in which policymakers often consider (and sometimes implement) trade restrictions to protect domestic steel producers from foreign competitors. The Equilibrium without Trade The sum of consumer and producer surplus measures the total benefits that buyers and sellers gain from trade. When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. - If the government allows Isolandians to import and export steel, what will happen to the price of steel and the quantity of steel sold in the domestic steel market? - Who will gain from free trade in steel and who will lose, and will the gains exceed the losses? - Should a tariff (a tax on steel imports) be part of the new trade policy? The World Price and Comparative Advantage To figure out whether Isoland will become a steel importer or exporter, we need to compare the current Isolandian price of steel with that of the rest of the world. If the world price of steel is higher than the domestic price, then Isoland will export steel once trade is permitted. Conversely, if the world price of steel is lower than the domestic price, then Isoland will import steel. This comparison provides an answer to whether Isoland has a comparative advantage in producing steel. The domestic price reflects the opportunity cost of steel. THE WINNERS AND LOSERS FROM TRADE To analyze the welfare effects of free trade, the Isolandian economists begin with the assumption that Isoland is a small economy compared to the rest of the world so that its actions have little effect on world markets. Isolandians are said to be price takers in the world economy. That is, they take the world price of steel as given. They can sell steel at this price and be exporters or buy steel at this price and be importers. The small-economy assumption is not necessary to analyze the gains and losses from international trade. However, it makes it easier to analyze the economic model and the and the basic conclusions do not change in a large economy. The Gains and Losses of an Exporting Country Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of steel produced domestically, and the demand curve shows the quantity consumed domestically. Once the domestic price rises to equal the world price, the domestic quantity supplied differs from the domestic quantity demanded, the difference between these two equals the exports from Isoland....
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