πŸͺ΄ Knowledgebase

2.9 β€” International Trade and Public Policy

2 min read

Trade allows countries to specialize in goods where they have a comparative advantage, enabling them to produce at a lower opportunity cost and consume beyond their production possibilities curve (PPC).

  1. Absolute vs. Comparative Advantage:
  2. Terms of Trade:
    • Trade is beneficial when the price of traded goods falls between the opportunity costs of both parties.
    • For example, if Country A gives up 2 units of wheat for 1 unit of cars, and Country B gives up 1 unit of cars for 3 units of wheat, trade benefits both if 1 car is exchanged for 2–3 units of wheat.
  3. Gains from Trade:
    • Increases total output and consumption.
    • Allows access to goods and services not domestically available or efficiently produced.

Public Policy in Trade

  1. Trade Barriers:
    • Tariffs: Taxes on imports, raising their price. This protects domestic industries but reduces efficiency
    • Quotas: Limits on the quantity of imports. This reduces supply, raising prices and benefiting domestic producers
    • Subsidies: Government payments to domestic producers to lower costs and boost exports
  2. Arguments for Protectionism:
    • Protects infant industries
    • Safeguards jobs in domestic industries
    • Ensures national security by reducing reliance on foreign goods
  3. Criticisms of Trade Barriers:
    • Reduces overall efficiency and total surplus
    • Can provoke retaliatory measures, leading to trade wars
    • Limits consumer choices and raises prices

Graphical Representation

  1. World Price and Trade:
    • World Price Below Domestic Price: Country imports the good, benefiting consumers but reducing producer surplus.
    • World Price Above Domestic Price: Country exports the good, benefiting producers but increasing costs for consumers.
  2. Impact of Tariffs:
    • Tariffs raise prices, reducing imports and creating deadweight loss.
    • Consumer surplus decreases, while producer surplus increases.

International trade is fundamental to economic and equilibrium systems and is also largely discussed in relation to GDP within AP Macroeconomics. See 2.1 β€” Circular Flow Model and Gross Domestic Product (GDP).

Graph View