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Extremely Competitive MarketsPart 2: Open Economies
Closed Economy: Equilibrium Without Trade
Price of Steel
EquilibriumPrice
0 Quantity of SteelEquilibrium Quantity
Domestic Supply
Domestic Demand
Priceof Steel
0 Quantityof Steel
DomesticDemand
Open Economy: If world price > domestic price, country becomes an exporter
DomesticSupply
WorldPrice
Price after trade
Exports
Domesticdemand
Domestic supply
Price before trade
Exporting Country:Who are the winners and who are the losers?
Domestic producers
Domestic consumers
Foreign producers
Foreign consumers
Domestic and foreign governments
Priceof Steel
0 Quantityof Steel
WorldPrice
Domestic demand
Who are the Winners and Who are the Losers?
DomesticSupply
Price after trade
Price before trade
Consumer surplusafter trade
C
Producer surplusafter trade
D
Exports
B
If world price < domestic price: country becomes an importer
Priceof Steel
0 Quantityof Steel
Domestic Supply
Domestic demand
World Price
Price after trade
DomesticquantitySupplied
DomesticquantityDemanded
Price before trade
Imports
Importing Country:Who are the winners and who are the losers?
Domestic producers
Domestic consumers
Foreign producers
Foreign consumers
Domestic and foreign governments
Who are the Winners and Who are the Losers?
Priceof Steel
0 Quantityof Steel
Domestic supply
World Price
Domestic demand
Price after trade
Price before trade
A
Consumer surplusafter trade
B D
CProducer surplus
after trade
Imports
Gains and Losses from Free International Trade:
1. In each country, gains to winners exceed losses to losers
2. Therefore overall economic welfare increases
3. Also, can lead to:
Increased variety of goods and service
Lower costs through economies of scale
Increased competition and efficiency
Enhanced flow of ideas
4. But, losing producers have a strong incentive to oppose free trade through:
Tariffs
Quotas
Subsidies
Price with tariff
World price
Price w/o tariff
Effect of an Import Tariff on Price, Quantity of Imports and Gov Revenue
Priceof Steel
0 Quantityof Steel
Domestic supply
Domestic demand
Tariff
Q1S Q1
D
Imports without tariff
Imports with tariff
Q2DQ2
S
Gov tariff rev
Price with quota
World price
Price without quota
The Effects of an Import Quotaon Price and Quantity of Imports
Priceof Steel
0 Quantityof Steel
Domestic supply
Domestic demand
Q1S Q2
S Q2D
Imports without quota
Importswith quota
Domestic supply +Import Supply
Quota
Q1D
World price
The Effects of an Production Subsidy on Price and Quantity of Imports
Priceof Steel
0 Quantityof Steel
Domestic supply
Domestic demand
Imports
Production subsidy
Price (to producers) with subsidy
Qs Qd
Effect of Large Domestic Subsidies on World Market Price
Q/t0
P/Q
D
S
S’
Q2
P2
P1
Q1
So, what are the arguments for restricting trade?
Protect Domestic Production & Jobs
Protect National Security
Infant Industry Protection
Protection as a Bargaining Chip
Protection/Retaliation Against “Unfair” Competition
Resulting From:
Tariffs
Subsidies
Quotas
Dumping
“Manipulation of” exchange rates
Macroeconomic Stability
Environmental/Health/Cultural Human Rights ConsiderationsEnvironmental/Health/Cultural Human Rights Considerations
International Trade Liberalization AgreementsInternational Trade Liberalization AgreementsBilateral Agreements:North American Free Trade Agreement(1993)
US China WTO Agreement (1999)
General Agreement on Tariffs and Trade (GATT): Reduced average tariff among member countries from 40% after WWII to < 5% today.
World Trade Organization (WTO)1. Promotes trade liberalization, where appropriate2. Approves retaliatory actions with regard to “illegal”
trade barriers.
WTO Rulings Retaliatory Tariffs
$2 billion $300 million €200 million
EU/US Steel Brazil/US Cotton US/EU Bananas
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