Okay, today we're gonna show how to analyze international trade using supply
and demand,
and then we're gonna use the same tools to show the welfare cost of tariffs.
Okay, let's get right into it.
Here is the domestic supply curve.
This is the supply curve of the home country firms.
If you're thinking about the US, this is the supply curve from US firms.
Here is the demand curve, domestic demand.
This is demand from US consumers.
If we had no international trade, then as usual, we would find the equilibrium
where the quantity demand is equal to the quantity supplied.
That will give us the price with no international trade, and
the quantity both produced and consumed with no international trade down here.
Now, let us suppose that the consumers in this country can go out into the world,
and they can buy as much of these semiconductors as they want
at the world price.
So in that case, if we had complete free trade, consumers would be able to buy as
much as they want at the world price, or as given by this word supply curve.
The free trade equilibrium then would involve greater consumption.
That is at the high price with no international trade,
the quantity demanded is here.
With international trade, consumers get to buy at the lower world price, so
their quantity demanded increases.
In terms of the diagram, the quantity demanded will increase to QD3 trade.
So domestic consumption is equal to this distance, or
domestic consumption is equal to the quantity demanded with free trade.
Now, what about production?
Well, the domestic producers can only charge as much as the world produces.
They can't charge a higher price.
So when the world price falls,
when domestic consumers are able to buy at the world price, domestic producers,
they can only sell at the world price, and they're going to be less willing to sell.
So, the domestic production will fall.
Domestic production will fall to this lower amount right here.
At a lower price, the domestic suppliers are only willing to produce a less amount,
or a lower amount, as given by QS free trade.
Now, notice that domestic consumption is QD free trade,
domestic production is QS free trade, and
demanders are demanding more than the domestic suppliers are willing to supply.
The difference, of course, is made up by imports.
So with trade, domestic consumption will be at QD free trade.
Some of that will come from imports, and
some of that will come from domestic suppliers.
Okay, that's it.
That's our analysis of international trade using supply and demand.
Now, make sure you understand each step in this diagram,
because in the next slide, we're gonna add tariffs.
It's gonna make the diagram more complicated.
Each step is actually pretty simple, each step is actually no different than
the ones we've already done, but the diagram will look a little bit messier.
So if you need to go through this slide again to make sure you understand
each step along the way.
Okay, now let's do the same diagram, but now we're gonna do it with a tax or
a tariff.
Let's remember that here is the quantity demanded with free trade.
Here is the quantity supplied with free trade.
The difference between the quantity demanded and
the quantity supplied domestically is, of course, imports.
So this is imports with free trade, this distance right here.
Now, a tariff is simply a tax on imports.
So what the tariff does is it raises the world price
by the amount of the tariff or the tax.
So the world supply curve, or
the world price shifts up until we get to the new equilibrium.
Of course, what this means is that at a higher price,
domestic consumers are gonna demand a lower quantity.
So domestic consumption falls from Q free
trade to Q quantity demanded with a tariff.
Domestic production falls by this amount, or let's just add that to the diagram.
Domestic consumption falls from here to here.
Okay, what about domestic production?
Well, with the higher price, domestic suppliers are now willing to supply more.
Here was the price of the world price, here's the world price.
With a higher world price,
domestic suppliers are willing to supply more up until this point.
So let's add that to the diagram.
So domestic production is gonna increase from the quantity supplied with free trade
to the quantity supplied with a tariff.
Or again, just putting that into the diagram,
it's gonna increase from here to here along the domestic supply curve.
Well, what about imports?
Well, imports, remember,
are the difference between the quantity demanded and the quantity supplied.
The quantity demand with the tariff is here, the quantity supplied is here, so
imports are the difference, which is this distance right here.
So notice that imports have fallen.
Final thing to add, a tariff is just a tax on imports.
This is the quantity of imports.
This is the amount of the tax or the tariff.
So the tariff will also generate some revenues.
This is the revenue from the tariff, which is gonna go to the government.
It's the tax or the tariff amount times the quantity
of import with a tariff, so this is revenue which flows to the government.
Okay, that's it.
That's the analysis of tariffs.
Now, what I wanna do is say, well, what are the welfare consequences of this?
And the welfare consequences are gonna depend upon this factor to domestic
consumption falling, and this factor, the domestic production increasing.
Let's take a closer look.
Okay, let's take a look at the welfare cost.
And here, I'm gonna look at the net cost.
What I mean by that is we can actually find the cost in two different ways.
We could look at the costs and the benefits to the consumers, the costs and
benefits to the producers, cost and benefits to the government.
We could sum all those up, that would give us the net cost.
I wanna jump straight to the net welfare cost of protectionism, and
I'm gonna do that by focusing on the real factors, the real factors which change.
And these are two.
First, domestic consumption, as I said, falls.
Second, domestic production increases.
Notice, I haven't said here anything about the revenue from the tariff.
That's because that's a cost to consumers.
They've got to pay more, but it's a benefit to the government.
They have this revenue that nets out, so it's not going to affect the net welfare.
Instead, the net welfare is gonna depend upon these two real changes.
And what I'm gonna show is that both of these effects, somewhat surprisingly,
reduce welfare.
Why is this?
Well, domestic consumption falls.
The reason that reduces welfare is because there are lost gains from trade.
And I'll say more about that in a minute.
Second, domestic production increases.
You might think that's a good thing except,
however, we're gonna have wasted resources
because the domestic producers have higher costs than the world producers.
So, on a net level,
there's gonna be more resources going to production than are necessary.
There's gonna be wasted resources.
Can we measure the value of these losses?
In fact, we can, and I'll show that in the next slide in a little bit more detail.
In order to focus on the welfare cost, I'm gonna make two simplifying assumptions.
First, I'm going to assume that the world price is so low that
if there were complete free trade, there would be no domestic supply whatsoever.
So think about a good like sugar.
If we had complete free trade in sugar,
we in the United States would probably import all of our sugar.
It's simply much more expensive to produce sugar in Florida
than it is to produce sugar in a country such as Brazil.
The problem is that in Florida, the opportunity cost of land is very high, and
the climate in Florida is not ideal for growing sugar.
So you have to invest more real resources
to produce sugar in Florida than you do to produce sugar in Brazil.
So if we had complete free trade, there would be no domestic supply.
I'm also going to assume that with the tariff or
the tax, that it raises the cost of imports so
much that there are no imports, that it's simply too expensive to import the good.
Again, this is actually quite accurate, or it's quite similar to what we have for
the case of sugar.
So with this very high tariff,
the entire domestic consumption is produced by domestic suppliers.
So our tariff equilibrium is given by this point, and
notice that domestic consumption is lower.
Okay, so what are the cost of the tariff?
Well, there are two.
First of all, the lost gains from trade.
So, the demand curve can be read as the willingness to pay.
This is the willingness to pay for sugar by domestic consumers.
The world supply curve can be read as the cost of producing sugar.
This is the price at which domestic world suppliers are willing to supply the sugar.
So there's lots of gains from trade here.
Consumers are willing to pay more than these suppliers,
than the world suppliers require in order to produce the good.
So by getting together the consumers in the world,
suppliers can earn these gains from trade.
With the tariff however, that's not possible.
With the tariff, we have reduced consumption.
And with that reduced consumption is lost gains from trade
given by this purple area.
What else?
Well, the US supply curve can be read as US cost.
So what happens with the tariff
is that instead of producing the sugar in Brazil where it's cheap to produce sugar,
reproduce the sugar in Florida where it's expensive to produce sugar,
where we have to invest more real resources in producing sugar.
We've got to invest more in irrigation, more in valuable land, more in fertilizer.
So these are wasted resources.
When the domestic industry expands because of the tariff,
we invest more resources in producing sugar than are necessary.
It would be cheaper.
We would be able to import sugar using fewer resources.
We were able to produce that sugar internationally,
using fewer resources than we can produce it in the United States.
So what the tariff does is it switches production from
the low cost world producers to the high cost domestic producers,
and that generates wasted resources.
Now, in fact, with these numbers, we can calculate the sizes or
the amount of these wasted resources.
And what economists do quite often is they make assumptions about these
supply curves and these demand curves, and they can make some of these calculations.
Let's take a quick look.
So with these numbers we can calculate these areas.
This triangle, for example, is half base times height.
So the base is 20, this is a base of 20.
The height is 20 minus 9.
There's the 20, there's the 9.
So the area of the triangle is half base times height, or 1.1 billion.
What about the deadweight loss triangle?
You do the same calculation, it's .22 billion.
So with these kind of numbers,
we could find out that the cost of the sugar tariff are 1.32 billion.
And economists do these kinds of calculations all the time.
Okay, let's hit summarize and point out some further reading.
First, tariffs increase prices to consumers.
So domestic consumption falls, and that creates a deadweight loss.
Second, tariffs divert production from low cost world producers
to high cost domestic producers, and that wastes resources.
Now, I haven't said much here about the distribution of the losses and gains.
Exactly who benefits and who loses?
Let me give you just a short story.
Tarrifs are bad for consumers, they will have to pay more.
They're good for domestic producers who gets to expand production.
They're bad, overall,
precisely because of these two reasons which I've just described.
If you wanna look in more detail, I focused on the bad overall.
If you want more detail on dividing it between consumers and producers and
the political economy of this, take a look at lots of different text books.
But the one, of course,
I would recommend, Cowen and Tabarrok, Modern Principles of Economics.
That will go into more details on the distribution, thanks.