Chapter 9: Application: International Trade
9.1 The Determinants of Trade
The textile market as a case study for international trade:
o Textiles are made in many countries across the world.
o Textiles comprise a large global market for trade.
o Governments have actively enacted policies to protect domestic
textile production.
Mankiw considers the case of the hypothetical “Isolandian textile
market” which is isolated from global trade. There is no import or export of
textiles in Isolandia.
“When an economy cannot trade in world markets, the price adjusts to
balance domestic supply and demand.”
Questions to ask when evaluating a trade policy:
o If free trade becomes policy, what happens to the price and
quantity of the good sold in the domestic textile market?
o Who will gain and who will lose from free trade in textiles? (And
do the benefits outweigh the costs?)
o Should a tariff (a tax on imports) be part of the trade policy?
World price: The price of a good that prevails in the world market for
that good.
o If the world price is lower than the domestic price, a nation will
import the good.
o If the world price is higher than the domestic price, a nation will
export the good.
Comparing the world price to the domestic price reveals if there is a
comparative advantage.
The domestic price reflects the opportunity cost for one unit of the good
or service.
“Trade among nations is ultimately based on comparative advantage.”
“Trade is beneficial because it allows each nation to specialize in doing
what it does best.”
9.2 The Winners and Losers from Trade
Consider the size of the economic actor in the equation: Can it influence
the overall market?
o In the example of Isolandia, a small nation, its small economy
cannot significantly impact the global economy.
o Price takers: An economic actor that must accept the prevailing
world price for imports or exports.
o Price makers: Economic actors capable of influencing the market
price and enjoying pricing power.
When a country becomes an exporter of a good:
o Domestic price will rise to equal the world price.
o Domestic producers of the good are better off.
o Domestic consumers of the good are worse off.
When a country become an importer of a good:
o Domestic price will fall to equal the world price.
o Domestic producers of the good are worse off.
o Domestic consumers of the good are better off.
In both the export/import scenarios the overall impact of trade is
increased well-being in that the gains of the winners exceeds the losses of
the losers.
The reality is that while trade expands the economic pie, not all
participants will benefit equally.
“Whenever a policy creates winners and losers, the stage is set for a
political battle.”
Tariff: A tax on goods produced abroad and sold domestically.
Effects of a tariff:
o Tariffs reduce the quantity of imports and move the domestic
market closer to its equilibrium without trade.
o Like other taxes, tariffs result in deadweight loss.
Import quotas are another method for governments to restrict trade. An
import quota places an artificial limit on the quantity of an imported good.
The key difference is that a tariff raises revenue for a government. A quota
creates a surplus for those who obtain the license to import.
Additional economic benefits of international trade:
1. Increased variety of goods (e.g. German beer is different from
American beer).
2. Lower costs through economies of scale. For example: a firm in a
small country cannot take advantage of economies of scale if it can only
operate in a small domestic market. Free trade gives firms access to
large, global markets.
3. Increased competition. Free trade fosters competition which
allows the free market to work its magic.
4. Enhanced flow of ideas. Trade is a tremendous force for
knowledge transfer and universal advancement. For instance, a poor
nation can purchase high-tech components from a more developed
nation to learn about the technology (rather than start from scratch).
9.3 The Arguments for Restricting Trade
The Jobs Argument
o Advocates say: Free trade will impact or eliminate domestic jobs.
o Counterargument: Free trade creates jobs for laborers willing to
move into domestic industries where there is a comparative advantage.
o Advocates counter: “Everything can be produced more cheaply
abroad.”
o Counterargument: Even if a country is better than another at
everything, there are still goods and services in which a country has a
comparative advantage.
The National-Security Argument
o Advocates say: Specific industries are vital to national security.
For instance, domestic steel is necessary for the production of guns and
tanks.–
o Counterargument: There may be situations where this policy is
appropriate but this line of reasoning is used as a matter of convenience
by producers at the expense of consumers at times where there is no
security threat.
o Companies and industries have a strong incentive to obtain
protection from foreign competition.
o Imports can be beneficial since, to use the guns and tanks
example, they result in lower cost to the buyer (in this case the military).
The Infant-Industry Argument
o Advocates say: Temporary trade restrictions are necessary to get
started. After a period of protection, a mature and stable industry will
then compete with foreign firms.
o Counterargument: Requires government to pick winners and
losers. Once an industry is protected from competition it is very difficult to
remove “temporary” policies.
The Unfair-Competition Argument
o Advocates say: Free trade is only desirable when all participants
(countries) play by the same rules. If a foreign government provides
subsidies to an industry another nation might want to protect its domestic
industry in response.
o Counterargument: The imports will benefit the population (and this
gain exceeds the losses of domestic producers). Moreover, the foreign
nation is subsidizing the production, a burden which impacts the
exporting nation’s taxpayers (not the importing nation).
The Protection-as-a-Bargaining-Chip Argument
o Advocates say: Use threat of a trade restriction to negotiate for
removal of other trade restrictions.
o Counterargument: Bargaining may not work. If it doesn’t, a nation
is faced with two bad choices: carry out its threat and implement the
restriction (which reduces its own welfare) or back down from the threat
(which reduces its international prestige).
Case study: Trade Agreements and The World Trade Organization
o Unilateral approach: Situation where a country removes trade
restrictions on its own.
o Multilateral approach: Bargaining with trading partners to reduce
or eliminate trade restrictions.
Examples of multilateral trade agreements:
o North American Free Trade Agreement (NAFTA)
o General Agreement on Tariffs and Trade (GATT)
o World Trade Organization (WTO): Established in 1995 and
headquartered in Geneva, Switzerland. Main function is to administer
trade agreements, act as a forum for negotiations and handle disputes
among member nations.
9.4 Conclusion
Economists and the public often disagree about free trade. Economists
overwhelmingly support free trade. The public can be ignorant and skeptical
about free trade.
Reality is that Americans would not enjoy their current high standard of
living without free trade.
