International Trade Dynamics

Determinants of Trade

• International trade is beneficial to both trading parties.
• Welfare analysis and the small country model can be used to study the winners and losers of international trade.

World Price

• World Price: The price of a good that prevails in the world market for that good
• When a country opens up to world trade, the equilibrium price under autarky (no trade) is compared to the world price.
• If the world price is higher, the country is an exporter.
• If the world price is lower, the country is an importer.
• If the price under autarky is lower than the world price, the country has a comparative advantage.

Welfare Analysis of Exporter

• When a country opens up to trade, the domestic price rises to the world price.
• Domestic producers gain from the higher price and increased sales.
• Domestic consumers lose from the higher price and reduced consumption.
• The gain in producer surplus outweighs the loss in consumer surplus, resulting in a net gain in welfare.

Welfare Analysis of Importer

• When a country opens up to trade, the domestic price falls to the world price.
• Domestic consumers gain from the lower price and increased consumption.
• Domestic producers lose from the lower price and reduced sales.
• The gain in consumer surplus outweighs the loss in producer surplus, resulting in a net gain in welfare.

Welfare Analysis under Tariff

• A tariff is a tax on imported goods
• Tariffs raise the price of imported goods, leading to:
  • Increased domestic production
  • Decreased domestic consumption
  • Revenue for the government
• Tariffs create deadweight loss because they reduce the overall welfare of the country.

Welfare Analysis under Quota

• A quota is a limit on the quantity of goods that can be imported.
• Quotas raise the price of imported goods, leading to:
  • Increased domestic production
  • Decreased domestic consumption
• Quotas create deadweight loss because they reduce the overall welfare of the country.

How to Solve Quota Problems

• Find the initial equilibrium under the world price, taking free trade into consideration.
• Find the new supply curve: For each price level, increase the quantity supplied by the amount of the quota.
• Find the new equilibrium: The intersection of the new supply curve and the demand curve determines the equilibrium.
• Find the difference in surplus/loss.
• Ownership Matters!: If a domestic producer/consumer/government owns the quota rent, then the rent is part of the domestic economic surplus. Otherwise, it is a deadweight loss.

How to Solve Tariff Problems

• Find the initial equilibrium under the world price, taking free trade into consideration.
• Find the new price level: The new price is t dollars higher than the world price.
• Find the new equilibrium, taking free trade into consideration: The intersection of the new price level curve and the demand curve pins down the equilibrium.
• Find the difference in surplus/loss.

Equivalence of Quota and Tariff

• Given a tariff t and the world price Pw, imposing the following quota has the same effect as the tariff: Quota(t, Pw ) = Quantity Demanded(Pw +t)−Quantity Supplied(Pw +t).
• Given a quota γ and the world price Pw, imposing the following tariff has the same effect as the quota: γ = Quantity Demanded(Pw + t) − Quantity Supplied(Pw + t).