AGEC 340 – International Economic Development Course slides for week 13 (April 6-8) Trade Policy* If trade is so desirable, why do governments restrict.
Download ReportTranscript AGEC 340 – International Economic Development Course slides for week 13 (April 6-8) Trade Policy* If trade is so desirable, why do governments restrict.
AGEC 340 – International Economic Development Course slides for week 13 (April 6-8) Trade Policy* If trade is so desirable, why do governments restrict it? * In the textbook, this material is covered in Chapter 17. So far… we’ve explained prices and quantities in terms of market equilibrium between supply and demand Price ($/lb) 1.25 S 1.00 0.75 D 10 15 17 Quantity (thousands of tons/yr) …but usually trade is available, so our price is determined by equilibrium with trade Price ($/lb) For exported goods 1.25 S Price ($/lb) For imported goods 1.25 S 1.00 1.00 0.75 0.75 D 10 17 Exports = 7 D 10 17 Imports = 7 Our production & consumption depend on our S & D curves relative to the given world price... An export An import S S Pt Pt D Qd Qs Our exports D Q Qs Qd Our imports Q So why worry about trade? Who cares about the WTO or NAFTA? An export An import S S Pt Pt D Qd Qs Our exports D Q Qs Qd Our imports Q To see the “welfare effects” of trade, let’s start by looking at a market without trade... P ($/bu) S D Q (bu/yr) What price do we expect to observe? P ($/bu) S D Q (bu/yr) The equilibrium price is the only price where Qs = Qd P ($/bu) S Pe D Qe Q (bu/yr) … but it is also the price & quantity which maximizes economic surplus, defined as the area between the supply and demand curves P ($/bu) S=marginal cost of production D=consumers’ willingness to pay Q (bu/yr) … at low quantities, there’s a big gap, so increasing quantity is very valuable! P ($/bu) S=marginal cost of production D=consumers’ willingness to pay Q (bu/yr) a small quantity As production & consumption increase, the gain in economic surplus gets smaller... P ($/bu) S=marginal cost of production D=consumers’ willingness to pay an increased quantity Q (bu/yr) … but stays positive.. P ($/bu) S=marginal cost of production D=consumers’ willingness to pay an increased quantity Q (bu/yr) … but stays positive.. P ($/bu) S=marginal cost of production D=consumers’ willingness to pay an increased quantity Q (bu/yr) … but stays positive.. P ($/bu) S=marginal cost of production D=consumers’ willingness to pay an increased quantity Q (bu/yr) … but stays positive.. P ($/bu) S=marginal cost of production D=consumers’ willingness to pay an increased quantity Q (bu/yr) …until it hits the equilibrium quantity! P ($/bu) S=marginal cost of production D=consumers’ willingness to pay Qe Q (bu/yr) At the equilibrium quantity, consumers are willing to pay for one more unit exactly what it costs to produce. P ($/bu) S=producers’ marginal cost Pe D=consumers’ willingness to pay Qe Q (bu/yr) … so “economic surplus” is maximized. P ($/bu) S=marginal cost of production D=consumers’ willingness to pay Q (bu/yr) What would happen to economic surplus if production were higher than Qe? P ($/bu) S=marginal cost of production Pe D=consumers’ willingness to pay Qe Q (bu/yr) Above Qe, marginal costs would be higher than willingness to pay, so economic surplus would fall. P ($/bu) S=marginal cost of production Pe costs exceed benefits D=consumers’ willingness to pay Qe above Qe... Q (bu/yr) How does trade enter the picture? P ($/bu) S=producers’ marginal cost Pe D=consumers’ willingness to pay Qe Q (bu/yr) For an export, Pt exceeds Pe... P ($/bu) S=producers’ marginal cost Pt Pe D=consumers’ willingness to pay Qe Q (bu/yr) So Qs exceeds Qd by the amount of exports... P ($/bu) S=producers’ marginal cost Pt Pe D=consumers’ willingness to pay Qd Qe exports Qs Q (bu/yr) Who gains from trade? Who loses? P ($/bu) Pt S=producers’ marginal cost the price rises Pe D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises To value gains and losses, we need to distinguish between consumers’ economic surplus and producers’ economic surplus P ($/bu) Pt S=producers’ marginal cost the price rises Pe D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises the change from no-trade to exports reduces consumers’ surplus, defined as area between demand curve and price P ($/bu) CS loss: Pt loss in consumers’ surplus due to higher price S=producers’ marginal cost Pe D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises the change from no-trade to exports increases producers’ surplus, defined as area between supply curve and price P ($/bu) Pt PS gain: gain in producers’ surplus due to higher price S=producers’ marginal cost Pe D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises Which is bigger? Here, PS gain is always larger than CS loss! P ($/bu) CS loss: PS gain: Pt This triangle is a net gain in national economic surplus S=producers’ marginal cost Pe Net gain: D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises Magic! Exports offer money for nothing, requiring only that we adjust to the foreigners’ prices… P ($/bu) Pt This triangle is a net gain in national economic surplus S=producers’ marginal cost Pe D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises OK, so exports create economic gains… what about imports? P ($/bu) S=producers’ marginal cost Pe Pt D=consumers’ willingness to pay Qe Qd Qs Q (bu/yr) consumption falls production rises the change from no-trade to imports reduces producers’ surplus P ($/bu) S=producers’ marginal cost PS loss: Pe Pt Qs production falls D=consumers’ willingness to pay Qe Qd Q (bu/yr) consumption rises …but going from no-trade to imports increases consumer surplus P ($/bu) S=producers’ marginal cost PS loss: Pe CS gain: Pt Qs production falls D=consumers’ willingness to pay Qe Qd Q (bu/yr) consumption rises Again magic! Imports also offer money for nothing, requiring only that we adjust to foreign prices… P ($/bu) PS loss: This triangle is a net gain in national economic surplus S=producers’ marginal cost Pe CS gain: Net gain: Pt Qs production falls D=consumers’ willingness to pay Qe Qd Q (bu/yr) consumption rises But do governments usually allow completely free trade? Now, we need to start from free trade, and ask: Who gains and who loses what from an import tariff? Price price in domestic market Pd import tariff t Pt A B C Gains and losses from the tariff Change in: Producer surplus: +A Consumer surplus: -ABCD Govt. revenue: +C D Nat’l. econ. surplus: -BD price in trade, or “world price” Supply Demand Qs Qs’ Qd’Qd Qty. How about when government restricts an export? Who gains and who loses what from an export tax? Price price in trade, or “world price” export tax Pt t price in Pd domestic market Demand Supply AB C D Gains and losses from the tax Change in Producer surplus: -ABCD Consumer surplus: +A Gov’t. revenue: +C Nat’l. econ. surplus: -BD Qd Qd’ Qs’ Qs So is more trade better? What if government subsidizes exports? Who gains and who loses what from an export subsidy? Price price in domestic market Pd export s subsidy Pt price in trade, or “world price” Demand A Supply C D E B F Gains and losses from the subsidy Change in Producer surplus: +ABCDE Consumer surplus: -AB Gov’t. revenue: -BCDEF Nat’l. econ. surplus: -BF Qd Qd’ Qs’ Qs Conclusion: it’s not trade that creates value; it’s free trade Some preliminary conclusions… • The simple bit of economics so far tells us that… • Exports are not “better” than imports • More trade is not “better” than less trade • What’s best is free trade… • But, from the example of environmental policies in week 8, may need plenty of domestic taxes, subsidies, or regulations to offset externalities in production and consumption. Now, some more detail • So far we have taken foreign prices as given – just like in the first half of the semester, the household takes market prices as given • But where do foreign prices come from? We need to understand that market too! Start with our country’s S&D diagram... Our country ...as compared with the rest of the world: Our country The rest of the world But the quantity scales are different! Our country The rest of the world Q (tons) Q (thou. tons) If people in the two markets can trade… Int’l. Trade Our country Q (tons) The rest of the world Q (tons) Q (thou. tons) ...our country won’t trade anything at our Pe. Int’l. Trade Our country The rest of the world Pe Q (tons) Q (tons) Q (thou. tons) …but at higher prices, we’d export the “surplus” (production - consumption) Int’l. Trade Our country Q (tons) The rest of the world Q (tons) Q (thou. tons) …creating a “supply of exports” curve Int’l. Trade Our country The rest of the world Sexports Q (tons) Q (tons) Q (thou. tons) …and similarly for the rest of the world... Int’l. Trade Our country The rest of the world Sexports Q (tons) Q (tons) Q (thou. tons) …except that the scale is different! Int’l. Trade Our country The rest of the world Sexports a small gap here is a large gap here, because of different scales Q (tons) Q (tons) Q (thou. tons) …so their “demand for imports” curve is very flat Int’l. Trade Our country The rest of the world Sexports Dimports Q (tons) Q (tons) Q (thou. tons) Let’s clean up the diagram a little... Int’l. Trade Our country The rest of the world Sexports Simports Q (tons) Q (tons) Q (thou. tons) …to see the equilibrium point in world trade... Int’l. Trade Our country The rest of the world Sexports Dimports Q (tons) Q (tons) Q (thou. tons) …which shows where trade prices come from! Int’l. Trade Our country The rest of the world Sexports Pt Dimports Q (tons) Q (tons) Q (thou. tons) When we have a small share of world production, our trade prices are fixed by the rest of the world. Int’l. Trade Our country The rest of the world Sexports Pt Dimports Q (tons) Q (tons) Q (thou. tons) Our S & D curves do not affect trade prices, but only the quantities produced, consumed, and traded. Int’l. Trade Our country S The rest of the world S Sexports Pt Dimports D D Qd Qs Our exports Q Q Qs Qd Q Their imports Trade prices depend on world supply and demand. For example, if foreign supply & demand shift down... Int’l. Trade Our country The rest of the world S S Pt D S’ D D’ Q Q Q Trade prices could fall so much that our country begins to import. Int’l. Trade Our country The rest of the world S S D Sexports Pt Dimports D Qs Qd Our imports Q Q Qd Qs Q Their exports …in any case, because the rest of the world is so big, we can draw Pt as an (almost) horizontal line and look only at the “our country” diagram The rest of the world S Int’l. Trade Our country S Sexports Pt Dimports D D Qd Qs Our exports Q Q Qs Qd Q Their imports Our production & consumption depend on our S & D curves relative to that fixed world price... An export An import S S Pt Pt D Qd Qs Our exports D Q Qs Qd Our imports Q This is our pattern of comparative advantage, using the “small country assumption” that foreign prices are fixed Export this: And import this: S S Pt Pt D Qd Qs Our exports D Q Qs Qd Our imports Q Does free international trade always help a country maximize its national income? – there are many arguments against free trade, such as to keep high-paying jobs to stop foreigners from ‘dumping’ their products to help our firms grow or recover from bad times – but these are rarely valid reasons for trade restrictions most restrictions benefit favored groups, at the expense of others who have less influence – is this always true? Can trade policy help remedy market failures? what did our result depend on? The only data we used were... P ($/bu) S=producers’ marginal cost Pt How could this picture be misleading? D=consumers’ willingness to pay Q (bu/yr) Remember the possibility of “externalities” from production or consumption? If production provides external benefits to other S=producers’ people… marginal cost of production P ($/bu) “external” benefit to others from production S’=society’s net marginal cost of production Pt D=consumers’ willingness to pay Q (bu/yr) With externalities, society’s optimum is not the market outcome S (producers’ marginal costs) P ($/bu) producers’ optimal production - EB (benefits to other people) =S’ (society’s marginal cost) Pt D=consumers’ willingness to pay society’s optimal production Q (bu/yr) So if there are externalities, how could people get the outcome they want? S (producers’ marginal costs) P ($/bu) - EB (benefits to other people) =S’ (society’s marginal cost) producers’ optimal production Pt D=consumers’ willingness to pay Q Q* society’s optimal production Q (bu/yr) The government could raise production to Q* by restricting trade... S (producers’ marginal costs) P ($/bu) - EB (benefits to other people) =S’ (society’s marginal cost) Pd producers’ optimal production Pt D=consumers’ willingness to pay Q Q* society’s optimal production Q (bu/yr) … the economy would gain from capturing the external benefit from more production... S - producers’ costs P ($/bu) economic-surplus gain from increasing production to Q* external benefit S’ - society’s net costs Pd producers’ optimal production Pt D=consumers’ willingness to pay Q Q* society’s optimal production Q (bu/yr) … but the economy would also lose from higher costs paid by consumers, thus offsetting any gain; this is like pushing both accelerator and brake at once. S - producers’ costs P ($/bu) economic-surplus gain from increasing production to Q* external benefit S’ - society’s net costs economic-surplus loss from decreasing consumption Pd producers’ optimal production Pt D=consumers’ willingness to pay Q Q* Qd society’s Q (bu/yr) optimal consumption To have a net gain government would need to use a subsidy to producers only! S - producers’ costs P ($/bu) external benefit S’ - society’s net costs subsidy to producers only producers’ optimal production Pd Pt D=consumers’ willingness to pay Q Q* Qd society’s Q (bu/yr) optimal consumption Some conclusions… • To reach the highest possible national income, (almost) always governments should… – keep the economy open to international trade, – while using domestic policies to offset externalities and other “market failures” in production or consumption.