Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 3 Markets and Welfare

Chapter 9 of 36 Application: International Trade

Section 9 of 19

…

The team of Isoland economists write a report for the new president:

Dear Madame President

After study and consideration, we have answers to your three questions about opening up free international trade in textiles.

Question 1:

If the government allows free trade in textiles, how will the price of textiles and the quantity of textiles sold in the domestic textile market be affected?

Answer:

After trade is allowed, the Isoland price of textiles will settle at the price prevailing around the world.

If the world price is higher than the current domestic Isoland price

· our domestic price will rise to the world price

· the higher price will decrease the amount of textiles Isolandians consume

· the higher price will increase the amount of textiles Isolandians produce   

Because of the higher world price Isoland would have a comparative advantage in producing textiles, and would become a textiles exporter

…

Conversely, if the world price is lower than the current domestic Isoland price

· our domestic price will fall to the world price

· the lower price will increase the amount of textiles Isolandians consume

· the lower price will decrease the amount of textiles Isolandians produce  

Because of the lower world price Isoland would have a comparative disadvantage in producing textiles, and would become a textiles importer

…

Question 2:

Who in Isoland will gain from free trade in textiles, who will lose, and will the gains exceed the losses?

Answer:

If the price rises to a higher world price, our producers of textiles will gain, and our consumers of textiles will lose.

If the price falls to a lower world price, our producers of textiles will lose, and our consumers of textiles will gain.

In whichever case, the gains from trade are larger than the losses.

Therefore, free international trade in textiles raises the total welfare of Isolandians, regardless of world price of textiles in relation to Isoland price.

…

Question 3:

Should Isoland charge a tariff on textiles?

Answer:

A tariff would be applicable only if Isoland becomes a textile importer.

With a tariff on imports

· the Isoland economy moves closer to the equilibrium price without trade

· as a tax, a tariff will cause deadweight losses

· the welfare of domestic producers is increased, welfare of domestic consumers decreased

· revenue is raised for the government

· these gains for producers and government are more than offset by the larger losses incurred by consumers, because of deadweight loss

…

The best policy, creating maximum economic efficiency and total surplus, would be to allow trade without a tariff.

We hope these answers will help with your trade policy decision.

Your Isoland economics team.

… …

trade policy decision

bōeki seisaku kettei

貿易政策決定


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