ECO101 Lecture 04

• ECO101 - Week 04 International.pdf

Gains From Free Trade

• Mercantilist Theory
• Absolute Advantage
• Comparative Advantage
• Trade between two countries is like trade between two individuals
  • Ex:
    • Mom can make 6 dinners an 12 shirts in an hour
    • Dad can make 2 dinners and 1 shirt in an hour
    • No Absolute Advantage, no trade?
    • Comparative Advantage, he's better at dinners than shirts, so he still does have an advantage.
    • So if mom makes less meals and irons more shirts and if dad makes more meals and less shirts (low opportunity cost), everyone is better off.

Imported

• $D=S$
• $12-2p=2p$
• $12=4p$
• $\frac{12}{4}=p$
• $3=p$
• $S=2(3)=6$
• $(6,3)$
• $\begin{array}{cccc}x& p=4& p_w=1& \mathrm{\Delta }\\ cs& 9& 25& +16,+ABC\\ ps& 9& 1& -8,-A\\ ts& 18& 26& +8,BC\end{array}$
• Consumers are better off because price goes down, they want a lot more, but there is no supply, so there's imports.
• Producer surplus is less because lower price and lower quantity.
• Total surplus goes up
• If inelastic, less efficiency gain
• If elastic, bigger efficiency gain

Exported

• $\begin{array}{cccc}x& p=3& p_w=5& \mathrm{\Delta }\\ cs& 9& & -A\\ ps& 9& & A\\ ts& 18& 26& 8\end{array}$

• Not all countries gain by the same amount

  • If we have an inelastic supply curve and inelastic demand curve
  • If inelastic, less efficiency gain
  • If elastic, bigger efficiency gain
    • These are the countries that win more gains from free trade
    • What are these countries?
      • Countries who respond quickly to price changes
      • So then efficiency gains are large
      • If it's an urban country, or big urban areas (toronto):
        • Easier to buy stuff
      • Mostly rural country (middle of nowhere):
        • Harder to buy stuff
      • Less developed countries:
        • Less developed financial markets
        • Supply and demand is inelastic
  • You snooze you lose

Are There Any Disadvantages From Free Trade?

Two Country Equilibrium

• America
  • $D_A=18-p$
  • $S_A=p-6$
    • $P_A=12$
• Britain
  • $D_B=12-p$
  • $S_B=p-4$
    • $P_B=8$
• $D=18-p+12-p$
• $D=30-2p$
• $D=2(-p+15)$
• $S=2(p-5)$
• Equilibrium
• $D=S$
• $-p+15=p-5$
• $15=2p-5$
• $20=2p$
• $10=p$
• $S=2(10-5)$
• $S=2(5)=10$
• $(10,10)$
• $0=2(-p+15)$
• $0=-p+15$
• $15=p$

Import Tariffs

• $D=12-2p$
• $S=2p$
• $p_w=1$
• $D=S$
• $12-2p=2p$
• $12=4p$
• $3=p$
• See that producers gain area A but consumers lose that area
• Government takes area C
• Deadweight of B and D
• World price $1$ bone
• $Q_d=10$
• $Q_s=2$
• Volume of imports is $8$
• After tariff
  • Volume of imports is down, $8\to 4$

  • Producer surplus is up

  • Consumer surplus is down
    • Higher price, smaller quantity
  • Government surplus is up
    • Revenue from tariff
• $\begin{array}{cccc}x& p_w=1& p_w+t=2& \mathrm{\Delta }\\ cs& 25& & -ABCD\\ ps& 1& & +A\\ gs& 0& 4& +C\\ ts& 26& & -BD\end{array}$
• A tariff works at the border:
  • Why does the price go up in toronto, when tariff at border
  • go shopping at buffalo
  • border security says y'all bought shit there?
  • Tariff collected at the border
  • Domestic producers who have higher surplus might be located in toronto
  • how does a $1$ dollar tariff affect the domestic producers?
    • Because the $1 tariff
• Does elasticity matter?
  • Yes, always matters.
  • Remember the start of the story. Here we're comparing elasticity at the world price, before tariff.
• The same one dollar tariff results in a much smaller decrease in imports.
• If the change in imports is smaller, the efficiency loss is very small.
• When supply and demand are inelastic, the efficiency loss will be smaller.
• Will increasing the tariff necessarily increase tariff revenues?
  • Currently $1$ per unit, if it's $1.50$ will tax revenue go up or down?
  • It depends on elasticity of supply and demand
  • Supply and Demand Inelastic
  • Supply and Demand Elastic
  • Supply Elastic and Demand Inelastic
  • Supply Inelastic and Demand Elastic
  • Trying to increase gains and decrease loss
  • When supply and demand are both inelastic, increasing the tariff will increase tariff revenues
    • Small efficiency loss

Import Quotas

• It would have the same effect as tariffs, however area BCD is deadweight.
• Area a is gained by producers and lost by consumers
• Demand or Supply can shift left or right
• Does elasticity matter?
  • When demand shifts, focus on elasticity of supply
  • When supply shifts, focus on elasticity of demand
• After shifting demand:
  • Import Quotas, Output Quota
  • Price Ceiling
  • Price Floor
  • $\begin{array}{cccc}x& p_w=1& q=2& \mathrm{\Delta }\\ cs& 25& & -ABCD\\ ps& 1& & +A\\ ls& 0& 3& +C\\ ts& 26& & -BD\end{array}$
  • LS = Licensee Surplus
    • The licensed importer of this good
    • They're allowed to buy a good for cheap, and sell it for the new price.
  • $\overline{Q}=2$ means demand can only exceed supply by $2$ units.
  • Demand $-$ supply $=2$
  • $(12-2p)-(2p)=2$
  • $p=2.50$
  • Why is an import quota bad for consumers?:
    • More price, less quantity
  • Why is an import quota bad for producers?
    • More price, more quantity
  • Figure 20-2
    • Efficiency loss is area BCD if the licensed importers are not Canadian. Then the licensee surplus goes somewhere else. If the licensed imported lives here and are part of the candian economy, that isn't lost efficiency.
  • Elasticity
    • If supply and demand are inelastic, then achieving a $\overline{Q}=2$ means a much higher price. The efficiency loss is also higher.
    • Explain why inelastic supply and demand for a quota, but a small efficiency loss for a tariff
      • A quota restricts quantity, allows price to adjust
        • A steep supply and demand, gives a tall efficiency loss triangle
      • A tariff affects price (height), but allows the quantity to adjust.
        • Inelastic supply and demand results in small efficiency loss, because the quantity change is smaller.

Labour Mobility

• Law of One Price:
  • L.O.O.P
  • Says that internationally traded goods, will trade at the same price all over the world.
  • (World price)
  • Example:
    • Oil: International
      • $80usd a barrel anywhere in the world (what about BRICS)?
    • Houses: Not international
      • You can't import a mexican house easily to toronto?
    • Haircut: Not international
      • How can you import a haircut?
    • Labour Mobility:
      • Vancouver sushi chef moves to toronto.
      • The price of sushi goes down here because of the supply of sushi chefs in vancouver and toronto.
• $S_c=w-60$
• $D_c=180-w$
• $S_m=w-40$
• $D_m=120-w$
• Canadian:
  • Q-int
    • $S_c=0$
    • $0=w-60⟹w=60$
    • $D_c=0$
    • $0=180-w⟹w=180$
  • W-int
    • $S_c=-60$
    • $D_c=180$
  • Equilibrium
    • $S_c=D_c$
    • $w-60=180-w$
    • $-60=180-2w$
    • $-240=-2w$
    • $240=2w$
    • $120=w$
    • $S_c=(120)-60$
    • $S_c=60$
    • $(60,120)$
• Mexico:
  • Q-int
    • $S_m=0$
    • $w=40$
    • $D_m=0$
    • $w=120$
  • W-int
    • $S_m=-40$
    • $D_m=120$
  • Equilibrium
    • $S_m=D_m$
    • $w-40=120-w$
    • $-40=120-2w$
    • $-160=-2w$
    • $160=2w$
    • $80=w$
    • $(80)-40=40$
    • $(40,80)$
• Total:
  • $D=D_m+D_c$
    • $D=120-w+180-w$
    • $D=300-2w$
  • $S=S_m+S_c$
    • $S=w-40+w-60$
    • $S=2w-100$
  • Demand is 0
    • $0=300-2w$
    • $2w=300$
    • $w=150$
    • $0=2w-100$
    • $100=2w$
    • $50=w$
  • Wage is 0
    • $300$
    • $-100$
  • Equilibrium
    • $D=S$
    • $300-2w=2w-100$
    • $400-2w=2w$
    • $400=4w$
    • $100=w$
    • $(2(100)-100)=100$
    • $(100,100)$
• Capital Mobility:
  • Suppliers of capital are households
  • Demand of capital are firms
  • Canada has a shortage of savings
    • So businesses can't borrow enough for their needs
  • If one country has an excess supply of savings, and one has a shortage.
    • Example: China to Canada
    • Chinese investors put money into Canada because Canada has the savings shortage.