CH09 ISM Mankiw Micro 7ce PDF

Preview

Summary

note...

Description

Chapter 9 Application: Interna International tional T Trrade SOLUTIONS T TO O TEXT PRO PROBLEMS BLEMS Quick Quizzes 1.

The country Autarka does not allow international trade. In Autarka, you can buy a wool suit for 100 grams of gold. Meanwhile, in neighbouring countries, you can buy the same suit for 60 grams of gold. If Autarka was to allow free trade, would it import or export suits? Since wool suits are cheaper in neighbouring countries, Autarka would import suits if it were to allow free trade.

2.

Draw the supply and demand curves for wool suits in the country of Autarka. When trade is allowed, the price of a suit falls from 100 to 60 grams of gold. In your diagram, what is the change in consumer surplus, the change in producer surplus, and the change in total surplus? How would a tariff on suit imports alter these effects? Figure 1 shows the supply and demand for wool suits in Autarka. With no trade, the price of suits is 100 grams of gold, consumer surplus is area A, producer surplus is area B + C, and total surplus is area A + B + C. When trade is allowed, the price falls to 60 grams of gold, consumer surplus rises to A + B + D (an increase of B + D), and producer surplus falls to C (a decline of B), so total surplus rises to A + B + C + D (an increase of D). A tariff on suit imports would reduce the increase in consumer surplus, reduce the decline in producer surplus, and reduce the gain in total surplus.

Figure 1

Copyright © 2017 Nelson Education Ltd.

117 • Chapter 9: Application: International Trade

3.

The textile industry of Autarka advocates a ban on the import of wool suits. Describe five arguments its lobbyists might make. Give a response to each of these arguments. Lobbyists for the textile industry might make five arguments in favour of a ban on the import of wool suits: (1) Imports of wool suits destroy domestic jobs; (2) The wool-suit industry is vital for national security; (3) The wool-suit industry is just starting and needs protection from foreign competition until it gets started; (4) Other countries are unfairly subsidizing their wool-suit industries; and (5) The ban on wool suits can be used as a bargaining chip in international negotiations. In defending free trade in wool suits, you could argue that: (1) Free trade creates jobs in some industries even as it destroys jobs in the wool-suit industry and allows Autarka to enjoy a higher standard of living; (2) The role of wool suits for the military is probably exaggerated; (3) Government protection is not needed for an industry to grow on its own; (4) It would be good for Autarka to buy wool suits at a subsidized price; and (5) Threats against free trade may backfire, leading to lower levels of trade and lower economic welfare for everyone.

Questions for R Review eview 1.

What does the domestic price that prevails without international trade tell us about a nation’s comparative advantage? If the domestic price that prevails without international trade is above the world price, the country does not have a comparative advantage in producing the good. If the domestic price is below the world price, the country has a comparative advantage in producing the good.

2.

When does a country become an exporter of a good? An importer? A country will export a good for which its domestic price is lower than the prevailing world price. Thus, if a country has a comparative advantage in producing a good, it will become an exporter when trade is allowed. A country will import a product for which its domestic price is greater than the prevailing world price. Thus, if a country does not have a comparative advantage in producing a good, it will become an importer when trade is allowed.

3.

Draw the supply-and-demand diagram for an importing country. What is consumer surplus and producer surplus before trade is allowed? What is consumer surplus and producer surplus with free trade? What is the change in total surplus? Figure 2 illustrates supply and demand for an importing country. Before trade is allowed, consumer surplus is area A and producer surplus is area B + C. After trade is allowed, consumer surplus is area A + B + D and producer surplus is area C. The change in total surplus is an increase of area D.

Copyright © 2017 Nelson Education Limited

Chapter 9: Application: International Trade • 118

Figure 2 4.

Describe what a tariff is, and describe its economic effects. A tariff is a tax on goods produced abroad and sold domestically. If a country is an importer of a good, a tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade, increasing the price of the good, reducing consumer surplus and total surplus, while raising producer surplus and government revenue.

5.

List five arguments often given to support trade restrictions. How do economists respond to these arguments? The arguments given to support trade restrictions are: (1) Trade destroys jobs; (2) Industries threatened with competition may be vital for national security; (3) New industries need trade restrictions to help them get started; (4) Some countries unfairly subsidize their firms, so competition isn’t fair; and (5) Trade restrictions can be useful bargaining chips. Economists disagree with these arguments: (1) Trade may destroy some jobs, but it creates other jobs; (2) Arguments about national security tend to be exaggerated; (3) The government cannot easily identify new industries that are worth protecting; (4) If countries subsidize their exports, doing so simply benefits consumers in importing countries; and (5) Bargaining over trade is a risky business, since it may backfire, making the country worse off without trade.

6.

What is the difference between the unilateral and multilateral approaches to achieving free trade? Give an example of each. A unilateral approach to achieving free trade occurs when a country removes trade restrictions on its own. Under a multilateral approach, a country reduces its trade restrictions while other countries do the same, based on an agreement reached through bargaining. The unilateral approach was taken by Great Britain in the 1800s and by Chile and South Korea in recent years. Examples of the multilateral approach include NAFTA in 1993 and the GATT negotiations since World War II.

Copyright © 2017 Nelson Education Ltd.

119 • Chapter 9: Application: International Trade

Quick Check Multiple Choice

1. What would be the result if a nation that does not allow international trade in steel has a domestic price of steel lower than the world price? a. The nation has a comparative advantage in producing steel and would become a steel exporter if it opened up trade. b. The nation has a comparative advantage in producing steel and would become a steel importer if it opened up trade. c. The nation does not have a comparative advantage in producing steel and would become a steel exporter if it opened up trade. d. The nation does not have a comparative advantage in producing steel and would become a steel importer if it opened up trade. 2. When the nation of Ectenia opens itself to world trade in coffee beans, the domestic price of coffee beans falls. Which of the following describes the situation? a. Domestic production of coffee rises, and Ectenia becomes a coffee importer. b. Domestic production of coffee rises, and Ectenia becomes a coffee exporter. c. Domestic production of coffee falls, and Ectenia becomes a coffee importer. d. Domestic production of coffee falls, and Ectenia becomes a coffee exporter. 3. What is the result when a nation opens itself to trade in a good and becomes an importer? a. producer surplus decreases, but consumer surplus and total surplus both increase b. producer surplus decreases, consumer surplus increases, and so the impact on total surplus is ambiguous c. producer surplus and total surplus increase, but consumer surplus decreases d. producer surplus, consumer surplus, and total surplus all increase 4. If a nation a. b. c. d.

that imports a good imposes a tariff, it will increase which of the following? the domestic quantity demanded the domestic quantity supplied the quantity imported from abroad the quantity exported abroad

5. Which of the following trade policies would benefit producers, hurt consumers, and increase the amount of trade? a. the increase of a tariff in an importing country b. the reduction of a tariff in an importing country c. starting to allow trade when the world price is greater than the domestic price d. starting to allow trade when the world price is less than the domestic price 6. The main difference between imposing a tariff and handing out licences under an import quota is that a tariff increases which of the following? a. consumer surplus b. producer surplus c. international trade d. government revenue 1. 2. 3. 4. 5. 6.

a c a b c d

Copyright © 2017 Nelson Education Limited

Chapter 9: Application: International Trade • 120

Problems and Applications 1.

When China’s clothing industry expands, the increase in world supply lowers the world price of clothing. a. Draw an appropriate diagram to analyze how this change in price affects consumer surplus, producer surplus, and total surplus in a nation that imports clothing, such as the United States. b. Now draw an appropriate diagram to show how this change in price affects consumer surplus, producer surplus, and total surplus in a nation that exports clothing, such as the Dominican Republic. c. Compare your answers to parts (a) and (b). What are the similarities and what are the differences? Which country should be concerned about the expansion of the Chinese textile industry? Which country should be applauding it? Explain. a.

For a country that imports clothing, the effects of a decline in the world price are shown in Figure 3. The initial price is Pw1 and the initial level of imports is Q d1 – Q s1. The new world price is PW2 and the new level of imports is Q d2 – Q s2. The table below shows the changes in consumer surplus, producer surplus, and total surplus. Domestic consumers are made better off, while domestic producers are made worse off. Total surplus rises by areas D + E + F.

Figure 3

Consumer surplus Producer surplus Total surplus

Copyright © 2017 Nelson Education Ltd.

Figure 4

P w1 A+B C+G A+C+G

Pw2 A+B+C+D+E+F G A+B+C+D+E+F+G

CHANGE C+D+E+F –C D+E+F

121 • Chapter 9: Application: International Trade

b. For a country that exports clothing, the effects of a decline in the world price are shown in Figure 4. The initial price is Pw1 and the initial level of exports is Q s1 – Q d1 . The new world price is Pw2 and the new level of exports is Q s2 – Q d2. The table below shows the changes in consumer surplus, producer surplus, and total surplus. Domestic consumers are made better off, while domestic producers are made worse off. Total surplus falls by area D.

Consumer surplus Producer surplus Total surplus c.

2.

P w1 A B+C+D+E+F+G+H A+B+C+D+E+F+G+H

CHANGE P w2 A+B+C B+C –B – C – D E+F+G+H A + B + C + E + F + G + H –D

Overall, importing countries benefit from the fall in the world price of clothing, while exporting countries are harmed.

The world price of wine is below the price that would prevail in Canada in the absence of trade. a. Assuming that Canadian imports of wine are a small part of total world wine production, draw a graph for the Canadian market for wine under free trade. Identify consumer surplus, producer surplus, and total surplus in an appropriate table. b. Now suppose that an unusual shift of the Gulf Stream leads to an unseasonably cold summer in Europe, destroying much of the grape harvest there. What effect does this shock have on the world price of wine? Using your graph and table from part (a), show the effect on consumer surplus, producer surplus, and total surplus in Canada. Who are the winners and losers? Is Canada as a whole better off or worse off? a.

Figure 5 illustrates the Canadian market for wine, where the world price of wine is P1. The following table illustrates the results under the heading “ P1.”

Consumer surplus Producer surplus Total surplus

P1 A+B+D+E C A+B+C+D+E

P2 A+D B+C A+B+C+D

Change –(B+E) +B –E

Figure 5

Copyright © 2017 Nelson Education Limited

Chapter 9: Application: International Trade • 122

b.

3.

The shift in the Gulf Stream destroys some of the grape harvest, raising the world price of wine to P2. The table shows the effects on consumer, producer, and total surplus under the heading “ P2,” and the change in the surplus measures under the heading “Change.” Consumers lose, producers win, and Canada as a whole is worse off.

Suppose that Parliament imposes a tariff on imported clothes to protect the Canadian clothing industry from foreign competition. Assuming that Canada is a price taker in the world clothing market, show the following on a diagram: (a) the change in the quantity of imports, (b) the loss to Canadian consumers, (c) the gain to Canadian manufacturers, (d) government revenue, and (e) the deadweight loss associated with the tariff. The loss to consumers can be decomposed into three pieces: a transfer to domestic producers, a transfer to the government, and a deadweight loss. Use your diagram to identify these three pieces. Figure 6 shows the market for clothes in Canada. a.

The change in the quantity of imports is the difference H − I.

b.

The loss to Canadian consumers is equal to C + D + E + F.

c.

The gain to Canadian manufacturers is C.

d.

Government revenue is E.

e.

The deadweight loss is D + F.

The three pieces of the loss to consumers are: C = transfer to domestic producers, E = transfer to the government, and D + F = the deadweight loss.

Figure 6

Copyright © 2017 Nelson Education Ltd.

123 • Chapter 9: Application: International Trade

4.

5.

Most Canadian dairy farmers oppose free trade, and most Canadian lumber producers support it. For simplicity, assume that Canada is a small country in the markets for both milk and lumber, and that without free trade, Canada would not trade these goods internationally. (Both of these assumptions are false, but they do not affect the qualitative responses to the following questions.) a. Based on who opposes and who supports free trade, do you think the world milk price is above or below the Canadian no-trade milk price? Do you think the world lumber price is above or below the Canadian no-trade lumber price? Now analyze the welfare consequences of free trade for both markets. b. Considering both markets together, would free trade make Canadian producers as a group better off or worse off? Would it make Canadian consumers as a group better off or worse off? Does it make Canada as a whole better off or worse off? a.

The world milk price must be below the Canadian no-trade price, because dairy farmers oppose free trade. They oppose it because they know that when trade is allowed, the Canadian price of milk will decline to the world price, and their producer surplus will fall. The world lumber price must be above the Canadian no-trade price, since lumber producers support free trade. They know that when trade is allowed, the Canadian price of lumber will rise to the world price, and their producer surplus will rise.

b.

Considering both markets together, free trade makes dairy farmers worse off and lumber producers better off, so it isn’t clear whether producers as a whole gain or lose. Similarly, consumers of milk gain (since the price of milk will decline) and consumers of lumber lose (since the price of lumber will rise), so consumers as a whole may either gain or lose. However, we know that the total gains from trade are positive, so Canada as a whole is better off.

Imagine that winemakers in British Columbia petitioned the provincial government to tax wines imported from Ontario. They argue that this tax would both raise tax revenue for the provincial government and raise employment in the BC wine industry. Do you agree with these claims? Is it a good policy? The tax on wine from Ontario is just like a tariff imposed by one country on imports from Ontario. BC producers would be better off and BC consumers would be worse off. The higher price of wine in BC means producers would produce more wine, so they would hire more workers. Tax revenue would go to the government of BC. So both claims are true, but it is a bad policy because the losses to BC consumers exceed the gains to producers.

Copyright © 2017 Nelson Education Limited

Chapter 9: Application: International Trade • 124

6.

The nation of Textilia does not allow imports of clothing. In its equilibrium without trade, a T-shirt costs $20 and the equilibrium quantity is 3 million T-shirts. One day, after reading Adam Smith’s The Wealth of Nations while on vacation, the president decides to open the Textilian market to international trade. The market price of a T-shirt falls to the world price of $16. The number of Tshirts consumed in Textilia rises to 4 million, while the number of T-shirts produced declines to 1 million. a. Illustrate in a graph the situation just described. Your graph should show all of the numbers. b. Calculate the change in consumer surplus, producer surplus, and total surplus that results from opening up trade. (Hint: Recall that the area of a triangle is ½ x base x height.) a.

Figure 7 shows the changes in consumer, producer, and total surpluses.

Price of T-shirts Domestic Supply

A $20

B

D

$16

World Price C Domestic Demand

1

3

4

Quantity of T-shirts (in Millions)

Figure 7

b.

The increase in consumer surplus (B + D) = $14 million. (An easy way to calculate the area B + D is the following: B + D = (20 − 16) × 3 + (1/2) × (20 − 16) × (4 − 3) = $14 million.) The change in producer surplus is −B = −[(20 − 16) × 3 − (1/2) × (20 − 16) × (3 − 1)] = −$8 million, and the change in total surplus, D = 14 – 8 = $6 million.

Copyright © 2017 Nelson Education Ltd.

125 • Chapter 9: Application: International Trade

7.

Consider a small country that exports steel. Suppose that a “pro-trade” government decides to subsidize the export of steel by paying a certain amount for each tonne sold abroad. How does this export subsidy affect the domestic price of steel, the quantity of steel produced, the quantity of steel consumed, and the quantity of steel exported? How does it affect consumer surplus, producer surplus, government revenue, and total surplus? (Hint: The analysis of an export subsidy is similar to the analysis of a tariff.) An export subsidy increases the price of steel exports received by producers by the amount of the subsidy, s, as shown in Figure 8. The figure shows the world price, P W, before the subsidy is put in place. At that price, domestic consumers buy quantity Q1D of steel, producers supply Q1S units, and the country exports the quantity Q 1S – Q1D. With the subsidy put in place, suppliers get a total price per unit of P W + s since they receive the world price for their exports PW, and the government pays them the subsidy of s . However, note that domestic consumers can still buy steel at the world price P W by importing it. Domestic firms don’t want to sell steel to domestic customers, since...