International Trade

CHAPTER 37

International Trade
A. Short-Answer, Essays, and Problems
1. Describe the quantity of exports for the United States. How do exports compare with
other nations?
2. What are the major imports and exports of the United States?
3. Who are the major players in international trade?
4. Cite three important reasons why nations trade.
5. The international flow of goods helps compensate for the international immobility of
resources. Analyze and explain.
New 6. Suppose that by devoting all of its resources to the production of A, the nation of Econia
can produce 50 A. By devoting all of its resources to the production of B, Econia can
produce 25 B. The comparable figures for the nation of Optima are 5 A and 5 B.
According to the principle of comparative advantage, which nation will specialize in
which product? What are the limits to the terms of trade?
New 7. Suppose that by devoting all of its resources to the production of rice (R), Japan can
produce 40 units. By devoting all of its resources to corn (C), it can produce 20 units.
Comparable figures for Mexico are 15 units of rice (R) and 15 units of corn (C).
Explain why each nation will specialize in which product. What are the limits to the
terms of trade?
8. Answer the next three questions on the basis of the following production possibilities
data for Francia and Galacia. All data are in tons.
Francia production possibilities:
A
B
C
Soup 60
45
30
Nuts
0
15
30

D
15
45

E
0
60

Galacia production possibilities:

A
B
C
Soup 20
15
10
Nuts
0
15
30

D
5
45

E
0
60

(a) If trade occurs between Francia and Galacia, which nation should export what
product? Why?
(b) What are the limits of the terms of trade between Francia and Galacia?

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(c) Assume that prior to specialization and trade, Francia and Galacia chose production
possibility C. Now each specializes according to comparative advantage. What will
be the resulting gains from trade? Explain your answer.
9. Answer the next three questions on the basis of the following production possibilities
data for Narnia and Somosa. All data are in 1,000s.
Narnia production possibilities:
A
B
Computer chips 80
60
Fuel injectors
0
20

C
40
40

D
20
60

E
0
80

Somosa production possibilities:

A
B
Computer chips 40
30
Fuel injectors
0
20

C
20
40

D
10
60

E
0
80

(a) If trade occurs between Narnia and Somosa, which nation should export what
product? Why?
(b) What are the limits of the terms of trade between Narnia and Somosa?
(c) Assume that prior to specialization and trade, Narnia and Somosa chose production
possibility C. Now each specializes according to comparative advantage. What will
be the resulting gains from trade? Explain your answer.
10. Given the data in the graph below, which nation should specialize in steel production
and which nation in wheat production? Why?

11. Use the extreme points from a production possibilities schedule below to draw two
straight line production possibilities curves for two nations, A and B using the below
graphs. Assume constant costs.
Nation
A
B

Food
4
2

Clothing
4
8

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(a) What is the cost ratio for the two products?

(b) If each nation specializes according to comparative advantage, who should produce
and trade each product? Why?
(c) What will be the range for the terms of trade? If the terms are set at 1 food = 2
clothing, show how the trading possibilities lines will change in the graph. Explain.
12. State at least one economic benefit to increased international trade.
13. How can supply and demand analysis be used to explain the equilibrium price and
quantity of exports and imports for aluminum when there is trade between two nations
(e.g., the United States and Canada)?
14. Define the four basic types of trade barriers.
15. Which is more effective in blocking imports, a tariff or a quota?
16. Who gains and who loses from a protective tariff? Explain.
17. What are the similarities and differences in the economic effects of tariffs and quotas?
18. Unless a tariff is prohibitive, it does not inhibit competition as much as a quota.
Evaluate.
19. Do protectionist policies benefit producers, consumers, workers, or the government?
Explain.

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20. The next three questions refer to the information in the following table.
Quantity demanded
domestically
700
800
900
1,000
1,100
1,200

Quantity supplied
domestically
1,100
1,000
900
800
700
600

Price
$6
5
4
3
2
1

(a) What would price and quantity be if the market were closed to international trade?
What would the domestic and foreign quantity supplied be if it were open to
international trade and the world price was $2?
(b) If the world price was $2 and a tariff of $1 were placed on the product, what would
be the total revenues going to domestic producers, foreign producers (after-tax), and the
government? Explain.
(c) Given a world price of $2, what would be the difference in the total revenue received
by foreign producers with a $1 per unit tariff compared with a quota of 200 units?
21. The next three questions refer to the information in the following table.
Quantity demanded
domestically (in 1,000s)
60
70
80
90

Price
$10
8
6
4

Quantity supplied
domestically (in 1,000s)
80
70
60
50

(a) What would price and quantity be if the market were closed to international trade?
What would the domestic and foreign quantity supplied be if it were open to
international trade and the world price was $6?
(b) If the world price was $4 and a tariff of $2 were placed on the product, what would
be the total revenues going to domestic producers, foreign producers (after-tax), and the
government? Explain.
(c) Given a world price of $4, what would be the difference in the total revenue received
by foreign producers with a $2 per unit tariff compared with a quota of 20,000 units?
22. The next three questions refer to the below graph, where Sd and Dd are the domestic
supply and demand for a product. The world price of the product is $6.

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International Trade
(a) How much total revenue would go to domestic producers if the market were closed
to international trade compared to a market open to international trade? Explain.
(b) If the economy is open to trade, but a $2 per unit tariff were applied, what would be
the total revenue going to domestic producers, foreign producers (after-tax revenue), and
to the government? Explain.
(c) What would be the difference in revenue with a tariff of $2 per unit versus a quota of
80 units?
23. The next three questions refer to the below graph, where Sd and Dd are the domestic
supply and demand for a product. The world price of the product is $12.

(a) How much total revenue would go to domestic producers if the market were closed
to international trade compared to a market open to international trade? Explain.
(b) If the economy is open to trade, but a $3 per unit tariff were applied, what would be
the total revenue going to domestic producers, foreign producers (after-tax revenue), and
to the government? Explain.
(c) What would be the difference in revenue with a tariff of $3 per unit versus a quota of
20 units?
24. What are the net costs of tariffs and quotas on consumption and income distribution?
25. Explain and evaluate the validity of the military self-sufficiency argument for trade
protection.
26. Explain four problems with the argument that trade protection is needed to protect
American jobs.
27. Evaluate the argument: Restricting imports from other nations will save U.S. jobs.
28. Why might trade barriers be a highly ineffective technique for increasing domestic
employment?
New 29. (Consider This) Why is a trade war like shooting yourself in the foot?
30. What are the limitations to the diversification for stability argument for trade protection?

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31. Evaluate the validity of the argument that a new industry in a nation needs protection
from foreign competition if it is to prosper.
32. What is the problem with protecting industries in the United States from the dumping of
foreign products on the domestic market?
33. Evaluate the statement: Tariffs and quotas are needed to protect American products
from dumping.
34. How can the United States compete successfully with relatively low-wage nations such
as India and China?
35. Evaluate this argument for a trade barrier: The U.S. needs protection from cheap
foreign labor.
36. What does the historical evidence indicate about the value of free trade compared with
trade protection? Cite evidence to support your case.
New 37. What five trade liberations is the World Trade Organization seeking to get adopted?
New 38. (Last Word) Evaluate the controversies surrounding the policies of the World Trade
Organization from the perspective of trade liberalization.

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B. Answers to Short-Answer, Essays, and Problems

1. Describe the quantity of exports for the United States. How do exports compare with
other nations?
About 12% of the GDP of the United States is accounted for by exports of goods and
services. The percentage of exports is much higher (30 to 56%) in other industrially
advanced nations (e.g., Germany, Netherlands). [text: E p. 690; MA p. 356; MI p. 446]
2. What are the major imports and exports of the United States?
The principal exports of the United States are computers, semiconductors, chemicals,
consumer durables, and generating equipment, while its major imports are automobiles,
petroleum, computers, and clothing. [text: E p. 691; MA p. 357; MI p. 447]
3. Who are the major players in international trade?
The major participants in international trade are the United States, Japan, and the nations
of western Europe. Newer participants include Hong Kong, Singapore, South Korea,
Taiwan, and China. The collapse of the former Soviet Union changed trade patterns for
Russia and the nations of eastern Europe. Mainland China has also increased its trade.
[text: E p. 691; MA p. 357; MI p. 447]
4. Cite three important reasons why nations trade.
First, specialization and trade among nations is advantageous because the worlds
resources are not evenly distributed. To obtain resources or products that a nation does
not have but that are desired by society requires trade with other nations. Second, the
efficient production of different commodities necessitates different methods and
combinations of resources. These different methods and combinations can be obtained
through trade. Third, products vary in quality and in other ways. People prefer this
variety, which often can only be obtained through imports. [text: E pp. 691-692; MA
pp. 357-358; MI pp. 447-448]
5. The international flow of goods helps compensate for the international immobility of
resources. Analyze and explain.
If resources were as mobile as goods, they would flow across borders until cost
conditions were equalized throughout the world and there would be no need for
specialization and trade. However, it is clear that this is impossible. Even human
resources are somewhat immobile and natural resources are not equally endowed in each
nation. Therefore, cost conditions differ from nation to nation, and some nations can
produce some things relatively more cheaply than others. This leads to specialization
and exchange according to the principle of comparative advantage. It is the goods that
are bought and sold across borders rather than the resources, and this enables countries
to be compensated for the differences in the cost of production. [text: E pp. 691-692;
MA pp. 357-358; MI pp. 447-448]
New 6. Suppose that by devoting all of its resources to the production of A, the nation of Econia
can produce 50 A. By devoting all of its resources to the production of B, Econia can
produce 25 B. The comparable figures for the nation of Optima are 5 A and 5 B.
According to the principle of comparative advantage, which nation will specialize in
which product? What are the limits to the terms of trade?
In Econia, the cost of producing 1 B is 2 A (25 B = 50 A) given the stated cost
conditions. In Optima, the cost of producing 1 B is only 1 A. Thus, in terms of

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opportunity costs of the amount of A that must be given up to get each B, Optima can
produce units of B more cheaply. Therefore, Optima should product Bs and Econia
should produce units of A. Optima should trade away some of its B to Econia for some
of the units of A produced in Econia.
The limits to the terms of trade are set by the cost ratio in each country. In other words,
it is to Econias advantage to trade away units of A for as many units of B as it can get
above the lower limit of 0.5 B, which is what each A costs in Econia. However, Optima
will not be willing to trade more than one B for each A since any more than that could
be gotten more cheaply by producing them at home. Therefore the limits to the terms of
trade will be between 0.5 B and 1 B for each A. And Optima will be able to get between
1 A and 2 A for each B. [text: E pp. 733-734; MA pp. 377-378; MI pp. 475-476]
New 7. Suppose that by devoting all of its resources to the production of rice (R), Japan can
produce 40 units. By devoting all of its resources to corn (C), it can produce 20 units.
Comparable figures for Mexico are 15 units of rice (R) and 15 units of corn (C).
Explain why each nation will specialize in which product. What are the limits to the
terms of trade?
In Japan, the cost of producing 1 C is 2 R (20 C = 40 R) given the stated cost conditions.
In Mexico, the cost of producing 1 C is only 1 R. Thus, in terms of opportunity costs or
the amount of R that must be given up to get each C, Mexico can produce units of C
more cheaply. Therefore, Mexico should produce Cs and Japan should produce units of
R, and Mexico should trade away some of its C to Japan for some of the units of R
produced in Japan.
The limits to the terms of trade are set by the cost ratio in each country. In other words,
it is to Japans advantage to trade away units of R for as many units of C as it can get
above the lower limit of 0.5 C, which is what each R costs in Japan. However, Mexico
will not be willing to trade more than one C for each R since any more than that could
be gotten more cheaply by producing them at home. Therefore the limits to the terms of
trade will be between 0.5 C and 1 C for each R. And Mexico will be able to get between
1 R and 2 R for each C. [text: E pp. 733-734; MA pp. 377-378; MI pp. 475-476]
8. Answer the next three questions on the basis of the following production possibilities
data for Francia and Galacia. All data are in tons.
Francia production possibilities:
A
B
C
Soup 60
45
30
Nuts
0
15
30

D
15
45

E
0
60

Galacia production possibilities:

A
B
C
Soup 20
15
10
Nuts
0
15
30

D
5
45

E
0
60

(a) If trade occurs between Francia and Galacia, which nation should export what
product? Why?
(b) What are the limits of the terms of trade between Francia and Galacia?
(c) Assume that prior to specialization and trade, Francia and Galacia chose production
possibility C. Now each specializes according to comparative advantage. What will
be the resulting gains from trade? Explain your answer.

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International Trade
(a) Francia should export soup and Galacia should export nuts. Francia is the low cost
producer of soup. The opportunity cost of 1 unit of soup is 1 unit of nuts. For Galacia
the opportunity cost of 1 unit of soup is 3 units of nuts.
Galacia is the low cost producer of nuts. The opportunity cost for Galacia to produce
nuts is 1/3 unit of soup. The opportunity cost of nuts for Francia is 1 unit of nuts for 1
unit of soup.
(b) From 1 unit of soup for 1 unit of nuts up to 1 unit of soup for 3 units of nuts.
(c) Before specialization, Francia produced 30 units and Galacia 10 units of soup for a
total of 40 units. After specialization and trade, 60 units of soup are produced by
Francia for a gain of 20 units of output.
Before specialization, Francia produced 30 units and Galacia 30 units of nuts. After
specialization and trade, Galacia will produce 60 units. Output did not change with this
product. [text: E pp. 692-693; MA pp. 358-359; MI pp. 448-449]
9. Answer the next three questions on the basis of the following production possibilities
data for Narnia and Somosa. All data are in 1,000s.
Narnia production possibilities:
A
B
Computer chips 80
60
Fuel injectors
0
20

C
40
40

D
20
60

E
0
80

Somosa production possibilities:

A
B
Computer chips 40
30
Fuel injectors
0
20

C
20
40

D
10
60

E
0
80

(a) If trade occurs between Narnia and Somosa, which nation should export what
product? Why?
(b) What are the limits of the terms of trade between Narnia and Somosa?
(c) Assume that prior to specialization and trade, Narnia and Somosa chose production
possibility C. Now each specializes according to comparative advantage. What will
be the resulting gains from trade? Explain your answer.
(a) Narnia should export computer chips and Somosa should export fuel injectors.
Narnia is the low-cost producer of computer chips. The opportunity cost of 1 unit of
computer chips is 1 unit of fuel injectors. For Somosa the opportunity cost of 1 unit of
computer chips is 2 units of fuel injectors.
Somosa is the low-cost producer of fuel injectors. The opportunity cost for Somosa
to produce fuel injectors is 1/2 unit of computer chips. The opportunity cost of fuel
injectors for Narnia is 1 unit of fuel injectors for 1 unit of computer chips.
(b) From 1 unit of computer chips for 1 unit of fuel injectors up to 1 unit of computer
chips for 2 units of fuel injectors.
(c) Before specialization, Narnia produced 40 units of computer chips and Somosa 20
units for a total of 60 units. After specialization and trade, 80 units of computer chips
are produced by Narnia for a gain of 20 units of output.
Before specialization, Narnia produced 40 units of fuel injectors and Somosa 40.
After specialization and trade, Somosa will produce 80 units. Output did not change
with this product. [text: E pp. 693-696; MA pp. 359-362; MI pp. 449-452]

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10. Given the data in the graph below, which nation should specialize in steel production
and which nation in wheat production? Why?

The opportunity cost for 1 unit of wheat is 1 unit of steel in nation Y. The opportunity
cost of 1 unit of wheat is 1/2 unit of steel in nation X. Nation X is the lower cost
producer of wheat.
Nation Y should specialize in the production of steel where it has the comparative cost
advantage. For nation Y, 1 steel = 1 wheat. For nation X 1 steel = 2 wheat. [text: E pp.
692-693; MA pp. 358-359; MI pp. 448-449]
11. Use the extreme points from a production possibilities schedule below to draw two
straight line production possibilities curves for two nations, A and B using the below
graphs. Assume constant costs.
Nation
A
B

Food
4
2

Clothing
4
8

(a) What is the cost ratio for the two products?

(b) If each nation specializes according to comparative advantage, who should produce
and trade each product? Why?
(c) What will be the range for the terms of trade? If the terms are set at 1 food = 2
clothing, show how the trading possibilities lines will change in the graph. Explain.

(a) The cost of 1 unit of food for nation A is 1 unit of clothing but the cost of food for
nation B is 4 units of clothing. The cost of 1 unit of clothing for nation A is 1 unit of
food. The cost of 1 unit of clothing for nation B is 1/4 unit of food.
(b) Nation A should trade food for clothing with nation B. Nation A is the low cost
producer of clothing and nation B is the low cost producer of food.
(c) The terms of trade will be set between 1 food = 1 clothing (nation As cost condition)
and 1 food = 4 clothing (nation Bs cost condition). If the terms are set at 1 food = 2
clothing, then nations A and B can shift their trading possibilities lines outward as
shown in the graph. The end points for nation As graph will now be 4 food and 8
clothing. The end points for nation Bs graph will be 4 food and 8 clothing. [text: E pp.
693-695; MA pp. 359-361; MI pp. 449-451]

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International Trade
12. State at least one economic benefit to increased international trade.
Benefits include increased specialization and efficiency, increased competition that also
should increase efficiency, provision of jobs in exporting industries, improved quality,
and lower prices for consumers where imports compete with domestic products. [text: E
pp. 696-697; MA pp. 362-363; MI pp. 452-453]
13. How can supply and demand analysis be used to explain the equilibrium price and
quantity of exports and imports for aluminum when there is trade between two nations
(e.g., the United States and Canada)?
For the United States, there will be domestic supply and demand and export supply and
import demand for aluminum. The price and quantity of aluminum are determined by
the intersection of the domestic demand and supply curves in a world without trade. In a
world with trade, the export supply curve for the United States shows the amount of
aluminum that American producers will export at each world price above the domestic
equilibrium price. American exports will increase when the world price rises relative to
the domestic price. The import demand curve for the United States shows the amount of
aluminum that Americans will import at each world price below the domestic
equilibrium price. American imports will increase when world prices fall relative to the
domestic price.
For Canada, there will be domestic supply and demand and export supply and import
demand for aluminum. The description of these supply and demand curves is similar for
those of the United States. The price and quantity of aluminum are determined by the
intersection of the domestic demand and supply curves in a world without trade. In a
world with trade, the export supply curve for Canada shows the amount of aluminum
that the Canadian producers will export at each world price above the domestic
equilibrium price. Canadian exports will increase when the world price rises relative to
the domestic price. The import demand curve for Canada shows the amount of
aluminum that Canadians will import at each world price below the domestic
equilibrium price. Canadian imports will increase when world prices fall relative to the
domestic price.
The equilibrium world price and equilibrium world levels of exports and imports of
aluminum can be determined with further supply and demand analysis. The export
supply curves of the United States and Canada can be plotted on one graph. The import
demand curves of both nations can be plotted on the same graph. In this two-nation
model, equilibrium will be achieved when the United States import demand curve for
aluminum intersects the Canadian export supply curve. [text: E pp. 697-700; MA pp.
363-366; MI pp. 453-456]
14. Define the four basic types of trade barriers.
First, tariffs are excise taxes on imports. They may be used to collect revenue or
government for they may be protective tariffs that are supposed to protect domestic
producers from foreign competition. Second, import quotas specify the maximum
amounts of imports allowed into a nation over a period of time. Third, nontariff barriers
refer to licensing requirements, unreasonable standards, or bureaucratic red tape in
customs procedures. Fourth, there can be voluntary export restrictions, which are
agreements by foreign firms to voluntarily limit their exports to another nation. [text:
E pp. 700-701; MA pp. 366-367; MI pp. 456-457]
15. Which is more effective in blocking imports, a tariff or a quota?

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Generally, an import quota, especially if it is set low, is more effective in blocking the
entry imports into a nation. The reason is that once the import quota has been met, no
more goods can be imported into the nation. With a tariff, it is still possible to import
goods into a nation, so long as people are willing to pay the tariff on the imported good.
Of course the precise answer depends on how low the quota is and how high the tariff is
on the product. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]
16. Who gains and who loses from a protective tariff? Explain.
A tariff increases the price of the imported product. First, consumers are hurt. Some
consumers will not be able to purchase the product at the higher price and the consumers
who do purchase the good will pay the higher price. Second, a tariff helps domestic
producers because they receive more revenue than they would without the tariff. Third,
workers in the tariff-protected industry may benefit because it may protect jobs and
maintain higher wages than would be the case without the tariff. Fourth, business and
workers in industries that import or service the import product are hurt. Fifth, foreign
producers of the imported product receive less revenue than would be the case with free
trade. Sixth, the federal government gains from a tariff because it receives the amount
of the tariff times the number of the products that are imported. Overall, the nation loses
because the gains for the industry protected by a tariff and workers in that industry are
significantly offset by the losses to consumers and economic inefficiency that comes
from an industry that cannot compete on world markets. [text: E pp. 700-701; MA pp.
366-367; MI pp. 456-457]
17. What are the similarities and differences in the economic effects of tariffs and quotas?
Tariffs and quotas have essentially the same economic effects. They both cause a
decline in consumption because of the higher price that results. They both increase
domestic production. They both reduce the quantity of imports. They also both have
the same indirect effects of promoting the expansion of inefficient industries that do not
have a comparative advantage. The major difference between a tariff and a quota is that
a tariff raises revenue for the government while a quota transfers revenue to foreign
producers. [text: E pp. 701-702; MA pp. 367-368; MI pp. 457-458]
18. Unless a tariff is prohibitive, it does not inhibit competition as much as a quota.
Evaluate.
A tariff raises the price of an import, but it does not limit the quantity imported. It is
also possible that the price of the import will not rise by the full extent of the tariff
imposed. The foreign manufacturer can absorb part or all of the tariff amount, or may
be motivated to find lower-cost production methods to reduce the price. Clearly, when
this happens the competition remains. Even where the price of the product is raised by
the entire amount of the tariff, competition remains and domestic producers are limited
in their own pricing decisions by the foreign competition.
A quota, however, limits the amount of the imported product to a specific amount. This
may encourage the foreign producer to raise prices to cover the loss in revenue that
resulted from the limited quantity. It will also cause a leftward shift in the total supply
(domestic plus foreign) curve to consumers, allowing domestic producers to also charge
a higher price. The end result of a quota is certain higher prices and lower quantities,
and no resulting tariff revenue for the Federal government. The end result of a tariff is
uncertain with regard to price, the quantity purchased may not decline, and the
government receives some tariff revenues. [text: E pp. 701-702; MA pp. 367-368; MI
pp. 457-458]

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International Trade
19. Do protectionist policies benefit producers, consumers, workers, or the government?
Explain.
Protectionism in the form of tariffs or quotas reduces the total supply (domestic plus
foreign) of the good. As a consequence, the price will rise. This change has a number
of profound effects on all groups. Some consumers will not be able to purchase the
product at the higher price. Those consumers that still purchase the good will pay a
higher price. So consumers are hurt by protectionist legislation. Domestic producers
will receive more revenue and workers in those industries may benefit from the
improved revenue for business because it may mean fewer layoffs or higher wages.
Thus, domestic producers and workers in those industries benefit, which explains why
their organizations often lobby hard for the protectionist legislation. Businesses and
workers in industries that import or service foreign products are hurt by tariffs and
quotas. Foreign producers receive less revenue than would be the case with free trade.
The government will benefit from a tariff, but will receive no revenue from a quota.
Overall, the gains for protected industries and workers come at the expense of the whole
economy. [text: E pp. 700-702; MA pp. 366-368; MI pp. 456-458]
20. The next three questions refer to the information in the following table.
Quantity demanded
domestically
700
800
900
1,000
1,100
1,200

Quantity supplied
domestically
1,100
1,000
900
800
700
600

Price
$6
5
4
3
2
1

(a) What would price and quantity be if the market were closed to international trade?
What would the domestic and foreign quantity supplied be if it were open to
international trade and the world price was $2?
(b) If the world price was $2 and a tariff of $1 were placed on the product, what would
be the total revenues going to domestic producers, foreign producers (after-tax), and the
government? Explain.
(c) Given a world price of $2, what would be the difference in the total revenue received
by foreign producers with a $1 per unit tariff compared with a quota of 200 units?
(a) The price would be $4 and 900 units would be produced in a closed economy. In an
open economy with a $2 world price, the market price would be $2 and 1,100 units
would be demanded. There would be 1,100 units supplied. (700 domestic and 400
foreign.)
(b) Domestic producers would receive $2,400 ($3 x 800). Foreign producers would
receive $400 [($3 x 200) ($1 x 200)]. The government would receive $200 ($1 x 200).
(c) Foreign producers would receive $200 more in revenue with a quota than a tariff
because there would be no payment to government. [text: E pp. 700-702; MA pp. 366368; MI pp. 456-458]
21. The next three questions refer to the information in the following table.
Quantity demanded
domestically (in 1,000s)
60
70
80
90

Price
$10
8
6
4

Quantity supplied
domestically (in 1,000s)
80
70
60
50

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Chapter 37
(a) What would price and quantity be if the market were closed to international trade?
What would the domestic and foreign quantity supplied be if it were open to
international trade and the world price was $6?
(b) If the world price was $4 and a tariff of $2 were placed on the product, what would
be the total revenues going to domestic producers, foreign producers (after-tax), and the
government? Explain.
(c) Given a world price of $4, what would be the difference in the total revenue received
by foreign producers with a $2 per unit tariff compared with a quota of 20,000 units?
(a) The price would be $8 and 70,000 units would be produced in a closed economy. In
an open economy with a $6 world price, the market price would be $6 and 80,000 units
would be demanded. There would be 80,000 units supplied. (60,000 domestic and
20,000 foreign)
(b) Domestic producers would receive $360,000 ($6 x 60,000). Foreign producers
would receive $80,000 [($6 x 20,000) ($2 x 20,000)]. The government would receive
$40,000 ($2 x 20,000).
(c) Foreign producers would receive $40,000 more in revenue with a quota than a tariff
because there would be no payment to government. [text: E pp. 700-702; MA pp. 366368; MI pp. 456-458]
22. The next three questions refer to the below graph, where Sd and Dd are the domestic
supply and demand for a product. The world price of the product is $6.

(a) How much total revenue would go to domestic producers if the market were closed
to international trade compared to a market open to international trade? Explain.
(b) If the economy is open to trade, but a $2 per unit tariff were applied, what would be
the total revenue going to domestic producers, foreign producers (after-tax revenue), and
to the government? Explain.
(c) What would be the difference in revenue with a tariff of $2 per unit versus a quota of
80 units?
(a) In a closed market, $1,200 in total revenue would go to domestic producers ($12 x
100). In a market open to world trade, only $240 in total revenue would go to domestic
producers ($6 x 40).
(b) The $2 per unit tariff would make the market price $8 ($6 world price + $2 tariff).
At $8, there were 140 units sold, so total revenue is $1,120. Of this amount domestic
producers would get $480 ($8 x 60), foreign producers would get $480 [($8 x 80) ($2
x 80)], and the government would collect $160 ($2 x 80).
(c) A tariff produces $160 in revenue for government, but with a quota that revenue goes
to foreign producers who now earn $640 instead of $480. [text: E pp. 700-702; MA pp.
366-368; MI pp. 456-458]

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23. The next three questions refer to the below graph, where Sd and Dd are the domestic
supply and demand for a product. The world price of the product is $12.

(a) How much total revenue would go to domestic producers if the market were closed
to international trade compared to a market open to international trade? Explain.
(b) If the economy is open to trade, but a $3 per unit tariff were applied, what would be
the total revenue going to domestic producers, foreign producers (after-tax revenue), and
to the government? Explain.
(c) What would be the difference in revenue with a tariff of $3 per unit versus a quota of
20 units?
(a) In a closed market, $900 in total revenue would go to domestic producers ($18 x 50).
In a market open to world trade, only $360 in total revenue would go to domestic
producers ($12 x 30).
(b) The $3 per unit tariff would make the market price $15 ($12 world price + $3 tariff).
At $15, there were 60 units sold, so total revenue is $900. Of this amount domestic
producers would get $600 ($15 x 40), foreign producers would get $240 [($15 x 20)
($3 x 20)], and the government would collect $60 ($3 x 20).
(c) A tariff produces $60 in revenue for government, but with a quota that revenue goes
to foreign producers who now earn $300 instead of $240. [text: E pp. 700-702; MA pp.
366-368; MI pp. 456-458]
24. What are the net costs of tariffs and quotas on consumption and income distribution?
The cost to society is that protectionism raises product prices by raising the imported
price of the product. Higher priced imports cause some consumers to switch to higher
priced domestic products, thus increasing the price of domestic products. Any benefits
for government, businesses, and workers from tariffs and quotas are outweighed by the
costs to American society. Efforts to obtain trade protection are also a form of rent
seeking that causes a misallocation of resources for society. There is also an effect on
the distribution of incomes because import restrictions are more costly for low-income
families than high-income families. [text: E p. 702; MA p. 368; MI p. 458]
25. Explain and evaluate the validity of the military self-sufficiency argument for trade
protection.
The basic argument is that domestic industries that are vital to national defense should
be protected against foreign competition because otherwise the industries will not be
able to compete or be economically viable. Nations do not want to be dependent on
other nations for national defense. The argument is generally one of the need for
military self-sufficiency as opposed to economic efficiency.
The problem with the argument is that nearly every industry is critical in one way or
another to national defense. It is difficult to select defense industries to protect.

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Every industry can claim that it is directly or indirectly vital to national defense. Also,
imposing tariffs imposes costs only on those consumers who purchase an industrys
products because the prices of those products will be above competitive levels. Thus,
only the people who buy the protected products bear the burden of protecting the
domestic industries considered vital to national defense. It would be more economical
and more equitable for government to subsidize those industries that are deemed vital to
national defense. [text: E p. 703; MA p. 369; MI p. 459]
26. Explain four problems with the argument that trade protection is needed to protect
American jobs.
There are several problems with using trade protection to save American jobs. First,
imports may eliminate some jobs, but they create others in those industries that import
products. Second, there is a fallacy of composition. The imports of one nation are the
exports of another nation. Using trade policy to protect domestic jobs in the United
States will weaken the trading partners of the United States. The reason for this
weakness is that the trading partners will export less and thus have less income with
which to buy imports from the United States. Third, there is the possibility of retaliation
from trading partners that make all nations worse off. This problem occurred in the
1930s when high tariffs were imposed by the U.S. Smoot-Hawley Tariff Act of 1930.
Fourth, there are long-run feedback effects from an excess of exports over imports. This
policy leads to less income abroad that nations have to buy our goods. Workers in those
export industries in the United States are thus hurt and resources are reallocated to
protected industries at a great cost to the nation. [text: E p. 703; MA p. 369; MI p. 459]
27. Evaluate the argument: Restricting imports from other nations will save U.S. jobs.
The argument is a flawed one for several reasons. First, imports may eliminate some
U.S. jobs, but they create others in those sectors that import products. Import
restrictions change the composition of employment, but they have little effect on the
total amount of employment. Second, there is a fallacy of composition with the
argument. Restricting imports may help the U.S., but they make other nations that trade
with the U.S. poorer and thus the actions will eventually hurt U.S. exports. Third, other
nations can retaliate by imposing restrictions on imports from the U.S., thus causing a
trade war that hurts all nations. Fourth, in the long run a nation must import to export.
Domestic dollars spent on imports become income for foreign nations that they in turn
can spend on U.S. exports. [text: E p. 704; MA p. 370; MI p. 460]
28. Why might trade barriers be a highly ineffective technique for increasing domestic
employment?
First, trade barriers lower living standards by making consumer goods more expensive.
This means that consumers have less to spend on everything including domestic goods.
Second, trade barriers invite retaliation that can hurt our exports and those employed in
export industries. Even without retaliation, in the long run exports are hurt as foreigners
have fewer dollars to spend on American goods since their imports to the U.S. have
declined. Third, barriers limit the advantages to be gained by specializing in production
where costs are relatively lower and prevent attaining the lower costs which
specialization allows.
If the world has a more efficient allocation of resources and a higher level of material
well-being as a result of free trade, it follows that in the long run barriers would reduce
output and incomes throughout the world. A nation can have full employment with or
without free trade, but without free trade workers will be employed less productively
and their incomes will be lower. [text: E p. 704; MA p. 370; MI p. 460]

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New 29. (Consider This) Why is a trade war like shooting yourself in the foot?
A trade war between Nation X and Nation Y is destructive to the economies of both
nations. If Nation X boycotts or slaps protective tariffs on the imports from Nation Y,
then Nation Y will not be able to export as many goods and services. The economy of
Nation Y will suffer and there will be less income. As a consequence, Nation Y will not
be able to import as many goods and services from Nation X, so the economy of Nation
X will suffer. So trade wars hurt both nations by reducing imports and exports of each
nation. A trade war has no winners and only losers. It is like shooting yourself in the
foot. [text: E p. 704; MA p. 370; MI p. 460]
30. What are the limitations to the diversification for stability argument for trade protection?
There may be a legitimate reason for a nation to protect certain industries until they
become viable. The best case would be in nations that have one basic resource or export
and are seeking to diversify their economies. For example, the Saudi Arabian economy
is based on oil, but it may seek to limit imports if it is to develop other industries so that
it is not dependent on the price of one commodity. The argument may also be valid for
other less developed nations with only one or two major industries.
Nevertheless, there are problems with this line of reasoning. First, it does not apply to
the economy of the United States or other industrially advanced nations with diversified
economies. Second, the economic costs of diversification may be great even for nations
dependent on basically one industry. These nations may not have a comparative
advantage in other industries and will never become economically efficient in these
industries. [text: E pp. 704-705; MA pp. 370-371; MI pp. 460-461]
31. Evaluate the validity of the argument that a new industry in a nation needs protection
from foreign competition if it is to prosper.
The infant-industry argument is based on the idea that new industries need time to
become mature and sufficiently strong and large to compete with more mature industries
from other nations. These new industries allegedly may need temporary protection to
gain productive efficiencyto become low-cost producers of a product. A modern
variant of this argument is a strategic trade policy that seeks protection for domestic
industries involved in advanced technology.
The problems with this argument are several. First, it is difficult to determine which
industries are the best to protect. Second, protection may persist after maturity is
achieved in the industry. Third, direct subsidies for new industries are better than tariffs.
Tariffs penalize consumers of those products, firms that import those products, and
workers in those import industries. They also misallocate resources. A better method of
support would be subsidies to the emerging industries because they make the amount of
the support explicit. [text: E pp. 704-705; MA pp. 370-371; MI pp. 460-461]
32. What is the problem with protecting industries in the United States from the dumping of
foreign products on the domestic market?
Trade protection is sought in this case because it is thought that another nation is
dumping (selling) its excess production at below cost. When this product is sold in the
United States, it undercuts the domestic market. Economists see two plausible reasons
for this type of economic behavior. First, foreign firms may in fact be trying to drive out
U.S. competition. Second, dumping can be a form of price discrimination.
The problem is that it is difficult to determine if a nation is dumping its product on
another nations market at below the cost of production. This practice is prohibited

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under U.S. trade law, but there are few valid cases of it each year. The existence of
dumping does not justify the imposition of strong trade protection. The evidence for
dumping needs to be evaluated on a case-by-case basis. [text: E p. 705; MA p. 371; MI
p. 461]
33. Evaluate the statement: Tariffs and quotas are needed to protect American products
from dumping.
Dumping is a form of price discrimination that might be practiced by foreign producers
who sell their product at a high price in the domestic market and at a lower price in the
export market. Also, a foreign company with large financial resources may sell a
product below cost for an extended period to gain market share in another nation and to
drive out domestic competitors in that nation. Dumping can be beneficial for consumers
in that export market because they pay a lower price for the product.
The dumping charge has been used to justify tariffs or quotas, but there is little need for
such permanent and across-the-board measures to address this problem. Dumping is
prohibited by trade law in the United States. If it is found to be practiced by a foreign
firm, then it requires investigation and damages can be assessed. Dumping, however, is
relatively rare and it is difficult to determine whether a company is selling below cost or
is just a more efficient producer. [text: E pp. 705-706; MA pp. 371-372; MI pp. 461462]
34. How can the United States compete successfully with relatively low-wage nations such
as India and China?
If those low wages are a reflection of a low level of productivity, the per-unit cost of
Indian and Chinese products will not be any greater than the unit costs in the U.S. It is
not the level of wages alone that determines the cost of a product, but rather the wage
relative to the level of output per hour. Wages in the U.S. are high, but so is the level of
productivity, often keeping unit costs as low as or lower than those in low-wage nations.
[text: E pp. 705-706; MA pp. 371-372; MI pp. 461-462]
35. Evaluate this argument for a trade barrier: The U.S. needs protection from cheap
foreign labor.
The argument is flawed on several grounds. First, U.S. consumers benefit from being
able to purchase a product at a lower price than they would have if they had to buy a
domestically produced product. Second, U.S. workers earn a high wage because they
are productive. Gains from trade are based on comparative advantage, not absolute
advantage. Although the U.S. labor can produce many goods and services, according to
comparative advantage, it should produce those products for which the domestic
opportunity cost is the least. If it does so it will earn more income and the nation will
have a higher standard of living. Whether foreign labor is cheap is not important. What
is important for the nations standard of living is to use labor resources most
productively and efficiently. [text: E p. 706; MA p. 372; MI p. 462]
36. What does the historical evidence indicate about the value of free trade compared with
trade protection? Cite evidence to support your case.
The historical evidence shows that free trade has positive effects and trade protection
hurts economies. Consider this evidence: (a) The U.S. Constitution prevents trade
protection across states making the U.S. a large, free-market area. This condition has
contributed to U.S. economic growth. (b) The European Common Market created a
free-trade zone in Europe that has continued under the European Union. (c) The world
economy has grown after World War II because of the move to tariff reduction that

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began in the mid-1930s. (d) The Smoot-Hawley tariff of 1930 lead to retaliatory tariffs
that worsened the economic conditions of the Great Depression; and (e) Nations with
high protectionist policies have slower growth than those without. [text: E p. 706; MA
p. 372; MI p. 462]
New 37. What five trade liberations is the World Trade Organization seeking to get adopted?
After the 1994 Uruguay round of trade agreements, the World Trade Organization was
formed by 120 nations to oversee the agreements and get them implemented by 2005.
The major provisions of the agreements included: (1) widespread reduction in tariffs
worldwide; (2) new rules to promote the growing trade in services; (3) plans to cut
subsidies in agriculture; (4) the inclusion of protection for intellectual property rights
patents, trademarks, copyrightsin trade rules; and (5) phased reduction in quotas on
textiles and apparel. [text: E pp. 707-708; MA pp. 373-374; MI pp. 463-464]
New 38. (Last Word) Evaluate the controversies surrounding the policies of the World Trade
Organization from the perspective of trade liberalization.
The purpose of the World Trade Organization is to liberalize trade and thus encourage
more economic growth worldwide. It is estimated that if the trade liberalization it seeks
to get adopted by 2005 are put into place, the worlds GDP for 2005 will be $6 billion
greater. The critics of the WTO are often drawn from labor unions in developed nations
and environmental groups. These groups seek special changes as a condition of getting
the new trading rules adopted. The labor unions seek to have more stringent labor
standards applied to other nations, which would adversely affect less developed nations.
The environmentalists want tough environmental rules applied to all nations, which
would also adversely affect developing nations. The problem is that the purpose of the
WTO is to advance trade liberalization, and not worldwide labor standards or
environmental laws. The critics need to find other organizations to advance those
issues. It is not part of the job of the WTO. [text: E pp. 707-708; MA pp. 373-374; MI
pp. 463-464]

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