Micro CHAPTER 2.9:

CHAPTER SUMMARY

Economists usually believe that free trade between countries almost always results in the best outcomes. Many countries have free trade agreements, such as the USMCA (US-Mexico-Canada Agreement), the EEA (European Economic Area), and ASEAN (Association of South East Asian Nations).

When the government allows imports under free trade, if other countries can produce something for cheaper, then the price level in this country would be set at the "world price" (the price we can import it for - PW). In this case, local producers in our countries (domestic producers) would only produce if they can make a profit at that price, so they would only produce up to QT since the rest of the suppliers are not willing to supply at PW. That reduces our quantity supplied from domestic producers, and we import the rest (the quantity labeled 'imports'). Now, consumers buy all those imports from suppliers outside the country at a low price. As a result, the consumer surplus is equal to W + X + Z, while the producer surplus is just Y.

However, when countries do not have free trade agreements, they may use protectionist policies to try to protect the companies in their own countries from competition from other countries. These policies are also called trade barriers. A few of those protectionist policies are:

• Subsidies: paying per-unit $$ to companies within the country to help them compete with international companies.

• Quotas: putting a limit on how much of something can be imported into the country.

• Tariffs: taxes on imported goods.

We have already seen the impact of subsidies, which can increase the supply in a market.

When the government puts a quota on imports, no matter how low the price goes, there is now a limit on how much imported supply can exist, so sellers will sell the amount they are allowed to import at the highest price they can while still selling everything. This will cause the price of imported goods to rise from the blue line to the red line below. So people will buy from domestic suppliers first, up until S(Q), because they can supply it more cheaply than the imported price. After that, people will buy imported goods until the red line meets the demand curve. Area B+C+D will be deadweight loss.

When the government imposes a tariff, the price of the imported good for consumers rises from P(world) to P(tariff). You can see the resulting consumer surplus and producer surplus below in green and yellow. The government collects some tax revenue, as shown in the blue box. There is also still a deadweight loss, as shown in the red triangles, but less than when a quota is imposed. This graph is exactly the same as the quota graph, except for the tax revenue replacing deadweight loss.

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