International Business and Trade


International Business and Trade

International Business and Trade - The main determinant of whether a country imports or exports a product is price. The world price is the price prevailing in world markets and is the price at which we can sell or buy goods. The domestic price is the price in our country without trade. Ignoring transportation costs, if the world price is greater than the domestic price before the trade, then we will export the good. If the world price is less than the domestic price before the trade, then we will import the goods.

Trade allows us to buy goods more cheaply from international businesses and sell them at a higher price than if we were restricted to the domestic market.

Winners and Losers from Trade

To analyze the welfare effects of trade, we begin by assuming we are dealing with a small country, and that its actions have a very small effect on world markets. In general, the economy benefits from trade because we can import goods more cheaply than we can produce them, and can sell our exports for more than people would pay. However, some groups will be hurt.

1.    Consider if we export a good such as wheat

o    domestic price will rise to the world price since less of the product will be available for domestic consumption

o    domestic producers benefit from higher prices

o    domestic consumers are worse off because of higher prices

2.    For goods that we import, domestic prices fall and consumers benefit while producers are hurt.

Importing Goods

Lowering the price reduces producer surplus, which is transferred to consumers while consumer surplus is extended. Thus with imports, domestic consumers are made better off while domestic producers are hurt, but the overall surplus is increased. Since the gains of the “winners” are larger than the losses of the “losers”, this would allow the winners to compensate the losers and still be better off. In practice, this compensation may not happen but can be a justification for government intervention to help those groups hurt, by taxing those groups who benefit.

Tariffs and Quotas

Tariffs are taxes levied on businesses for imported goods. Tariffs raise the domestic price above the world price by the amount of the tariff. The increase in the domestic price will lead to a decrease in domestic quantity demanded, and an increase in domestic quantity supplied. Before the tariff, the domestic price is the same as the world price. After the tariff, the domestic price rises.

Quotas are restrictions on the maximum amount that may be imported and have a similar effect as do tariffs. They restrict the amount available to domestic consumers and push up the price, resulting in a deadweight loss similar to that of a tariff. The main difference is the distribution of the surplus. A tariff raises revenue for the government, whereas an import quota creates a surplus for license holders. The government could capture surplus from import quotas by charging a fee for the licenses. If license fee equals the difference in prices, then import quota works the same as tariffs.

How is the quota distributed?

1.    It can be auctioned off to the highest bidder - In this case, the revenue goes to the government and the result is exactly like that of an equivalent tariff.

2.    It can distribute quota without payments - The extra surplus goes to those who get the quota, and may lead to large expenses for lobbying the government for the quotas. In this case, the deadweight loss is usually larger than a tariff due to the cost of lobbying.

Arguments for Restricting Trade

1.    The Jobs Argument

o    jobs are created as well as eliminated

o    not possible that a country can be out-competed in all products owing to comparative advantage

2.    National Security Argument

o    products such as weapons and military equipment should be produced domestically

3.    Infant-Industry Argument

o    temporary protection while firms have a chance to learn to compete

o    economists are skeptical that govt can pick “winners” and argue that industry with real promise does not need protection

4.    Unfair-Competition Argument

o    if firms sell at below cost, they are subsidizing our consumption

5.    Protection as a Bargaining Chip Argument

o    restricting trade can be used for leverage in other foreign affairs


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