Chapter 9: Application: International Trade

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If you're like me, you probably don't think too much about where your favorite shirt or your coffee mug comes from, but just take a quick look at the labels around you.

A lot of them probably say made in another country.

That's right.

It's pretty common now.

And this isn't just like a small thing.

It reflects a huge shift in our economy.

Think about textiles in the U .S.

for instance, a century ago, a massive industry now.

Well, not so much foreign competition, making goods may be cheaper, maybe just different.

It's totally reshaped things.

It really has.

And it brings up these big questions about international trade, doesn't it?

How does it actually affect us?

Exactly.

And that's what we're digging into today.

This is The Deep Dive, and we're focusing on Chapter 9 of Manki's Principles of Microeconomics.

The topic,

international trade.

Our mission basically is to unpack how this global trade impacts economic well -being,

who gains, who loses, and what tools economists use to figure all this out.

You might remember back in Chapter 3, we touched on comparative advantage.

Yeah, the idea that countries benefit by specializing in what they do, relatively speaking, best.

Right.

So today, we're building on that foundation.

We'll show how those gains actually happen, how they're distributed, using tools like supply and demand, equilibrium.

And crucially, consumer surplus and producer surplus.

Those are key to seeing the effects.

And this isn't just textbook theory, is it?

It's very relevant.

Think about President Trump's 2018 tariffs on steel and aluminum.

And the retaliation that followed, yeah.

The concepts we're discussing today really help make sense of those real -world events and their impacts.

So to make this all concrete, we're going to use Manki's example.

The imaginary country of Iceland and its textile market.

Good place to start.

Okay, so first, imagine Iceland completely isolated.

No trade, no imports, no exports, and textiles.

A closed economy for textiles.

Exactly.

In that situation, the price of textiles inside Iceland just settles.

It finds a level where the amount isolating producers want to sell matches exactly what isolating consumers want to buy.

That's the domestic equilibrium, right, where supply meets demand on their own internal graph.

Precisely.

And at that equilibrium price and quantity, we can measure the benefits.

You've got consumer surplus.

Which is like the extra value consumers get because the price is lower than the maximum they'd be willing to pay.

Right.

The area below the demand curve and above the price.

And then you have producer surplus.

The flip side for sellers.

The benefit they get selling at a market price that's higher than their minimum cost or willingness to sell.

Below the price.

Above the supply curve.

And if you add those two together, consumer surplus plus producer surplus, that gives you the total benefits, the total welfare, in Iceland's textile market without trade.

Okay.

Baseline established.

But now Iceland gets a new president, and she wants to look at trade policy.

Yeah, she tasks her economist with figuring things out.

Basically, three questions.

One, if we allow free trade in textiles, what happens to the price and the amount bought and sold?

Two, who wins?

Who loses from this free trade?

And overall, are the gains bigger than the losses for Iceland as a whole?

And third,

what about tariffs?

Should Iceland put a tax on imported textiles?

Is that a good idea?

So the economists need to figure out first off if Iceland will even import or export textiles if they open up.

That's the starting point.

And it all comes down to comparing Iceland's domestic price before trade.

The price they had when they were isolated.

To the world price of textiles.

The price prevailing in the global market.

Okay, so how does that comparison tell them?

It's simple, really.

If Iceland's domestic price is lower than the world price, then Icelandian producers will want to export.

Why sell for less at home when you can get a higher price internationally?

Makes sense.

They chase the higher price.

But if Iceland's domestic price is higher than the world price, then Icelandian consumers will want to import.

They'll look at the cheaper textiles available from other countries.

So consumers would drive imports in that case.

And this comparison, it actually reveals something fundamental, doesn't it?

It reveals their comparative advantage.

A low domestic price suggests Iceland is relatively efficient at producing textiles.

Low opportunity cost.

They have a comparative advantage.

And a high domestic price means the opposite.

Exactly.

It suggests other countries can make textiles more efficiently at a lower opportunity cost.

Iceland has a comparative disadvantage in textiles and would gain by importing.

Now, the economists make a simplifying assumption here, right?

The small economy thing.

Ah, yes.

They assume Iceland is a small economy, meaning its decisions to buy or sell textiles won't really change the world price.

Iceland is a price taker.

So they just accept the world prices given.

That makes the analysis cleaner.

It does.

It simplifies things, lets us see the core logic clearly.

The basic lessons hold even for larger economies that can influence world prices.

But this makes it easier to grasp initially.

Okay, ground rule set.

Let's dive into the winners and losers.

Scenario one.

Iceland becomes an exporter.

This happens if their domestic price was below the world price.

Right.

So trade opens up.

What happens to the price inside Iceland?

It has to rise.

It'll rise right up to meet the world price.

Because sellers wouldn't accept less domestically if they can get the world price abroad.

So this higher price has two effects inside Iceland.

Producers, seeing a higher price, want to produce more textiles.

That's the law of supply.

But consumers facing that same higher price want to buy less.

Law of demand.

Precisely.

So domestic production goes up, domestic consumption goes down, and the gap between those two.

That must be the amount they export.

That's exactly it.

The surplus production is sold on the world market.

Okay.

So who's happy, who's not?

Producers are definitely better off higher price selling more overall.

Their producer surplus increases significantly.

But domestic consumers,

they're worse off.

They pay a higher price and consume less.

Their consumer surplus shrinks.

So does it balance out?

Or is the country better off overall?

This is where measuring the surplus changes is key.

The gain in producer surplus is actually larger than the loss in consumer surplus.

There's a net gain in total surplus for Iceland.

So even though consumers lose, the producers gain more than the consumers lose.

Correct.

The economic pie gets bigger.

Conclusion for an exporting country.

Producers win, consumers lose, but the overall economic well -being of the nation increases.

Fascinating.

Okay, let's flip it.

What if Iceland's domestic price was above the world price?

They become an importer.

Right.

So trade opens.

Now the domestic price has to fall to match the lower world price.

No one would pay the higher domestic price if they can just import cheaper textiles.

Okay, so lower price domestically, what does that do?

Again, two effects.

Domestic consumers, seeing the lower price, want to buy more textiles.

Happy consumers.

Definitely.

But domestic producers, facing that lower price, will choose to produce less.

Some might cut back, some might stop producing textiles altogether.

Unhappy producers.

So now domestic consumption is higher than domestic production.

And the difference?

That's filled by imports.

The quantity demanded minus the quantity supplied domestically equals the imports.

Okay, winners and losers this time.

Consumers clearly win.

Lower prices, more goods.

Their consumer surplus increases substantially.

Producers lose, they get a lower price, sell less, their producer surplus decreases.

So again, the crucial question,

what's the net effect on Iceland's total welfare?

Same logic applies.

We measure the changes in surplus.

And again, the gains this time to consumers are larger than the losses suffered by producers.

Total surplus increases.

So whether exporting or importing, the result is the same in terms of overall welfare.

In terms of the total economic pie, yes, for an importing country.

Consumers win, producers lose.

But the gains to the winners outweigh the losses to the losers.

The nation as a whole is better off.

That's a really powerful conclusion.

Trade raises overall economic well -being, but it also creates these internal shifts, winners and losers within the country.

And that's the rub, isn't it?

Economists emphasize the overall gain, the pie gets bigger.

But politics often focuses on how the pie is sliced.

The winners could compensate the losers and still be better off.

But they usually don't in reality.

Right, compensation is rare.

So some groups do end up worse off, even if the country overall benefits.

And that's why trade policy is so often debated and controversial.

It makes perfect sense why it's such a political hot potato.

OK, this leads us nicely into the third question for the Icelandian economists, tariffs.

Ah, the tariff, a tax on imported goods.

And as you said, it really only matters if Iceland is an importer, right?

Correct.

If they're exporting textiles, a tax on textile imports is irrelevant.

So let's assume Iceland is importing textiles because its domestic price was higher than the world price.

OK, so they impose a tariff.

What does that do?

It raises the price of the imported good above the world price by the amount of the tariff.

So the domestic price for textiles becomes the world price plus the tariff.

So the price inside Iceland goes up, but maybe not all the way back to the no trade price.

Exactly.

It moves the price upwards, somewhere between the world price and the original no trade price.

This higher domestic price then affects both supply and demand again.

Let me guess.

Higher price means consumers demand less and domestic producers supply more.

You got it.

Consumers cut back.

Domestic producers ramp up a bit because the price is better for them.

And both of those effects mean fewer imports, fewer imports.

The tariff reduces the quantity of imports.

It pushes the market back towards the no trade outcome, but not necessarily all the way.

OK, so analyzing the effects here, who wins, who loses now?

Domestic producers, sellers win because they get a higher price.

Domestic consumers, buyers lose because they pay a higher price.

But there's a new player here, right?

The government.

Yes.

The government collects revenue from the tariff amount multiplied by the quantity of goods that are still imported.

OK, so producers win, government wins, gets revenue, consumers lose.

How does it shake out overall?

Is total welfare higher or lower?

It's lower.

When you add up the changes, the gain to producers, the gain to government revenue and the loss to consumers, you find that the consumer losses are greater than the combined gains of producers and the government.

Total surplus falls.

And that reduction in total surplus, that's the deadweight loss again.

That's the deadweight loss of the tariff.

It represents the economic inefficiency created by the tax.

Value is lost.

Why does that loss happen?

What's the inefficiency?

There are two main reasons, two sources of the deadweight loss.

First, the tariff encourages domestic producers to make textiles that actually cost more to produce than the world price.

It's inefficient overproduction.

Society uses more resources than necessary.

Because the tariff artificially inflates the price they receive.

Right.

And second, the higher price causes consumers to cut back on buying textiles, even though some of those units they're no longer buying are valued by the more than the world price it costs to obtain them.

That's inefficient under consumption.

So it distorts both production and consumption decisions away from the most efficient outcome.

Precisely.

Yeah.

Areas DNF and Mankiw's Figure 4 visually represent these two deadweight loss triangles.

The book also mentions import quotas briefly.

How do they compare?

An import quota is just a limit on the quantity of a good that can be imported.

The effects are very similar to a tariff.

They both reduce imports, raise the domestic price, help domestic producers, hurt domestic consumers and create deadweight losses.

What's the main difference then?

The key difference is who gets the money.

With a tariff, the government gets revenue.

With a quota,

whoever holds the license or permit to import gets the profit from buying at the world price and selling at the higher domestic price.

This profit is called quota rent.

And unless the government sells those licenses, that profit goes to private importers, maybe even foreign ones instead of the public treasury.

Exactly.

Which can sometimes make quotas even less desirable than tariffs from a national welfare perspective.

OK, so summing up the economist's report to the Icelandian president, what were their final answers?

Pretty straightforward.

Answer one.

Free trade aligns the domestic price with the world price.

If the domestic price was low, it rises.

Export.

If high, it falls.

Import.

Quantities adjust accordingly.

Answer two.

Winners and losers depend on whether the price rises or falls.

Producers win if price rises.

Consumers win if price falls.

But crucially, in both cases, the winner's gains exceed the loser's losses.

Total welfare increases.

And answer three.

Tariffs only matter for importers.

They reduce welfare overall by creating deadweight losses.

While producers and the government gain something, consumers lose more.

The best policy for economic efficiency.

Free trade.

No tariffs.

That's a clear verdict based on the supply and demand model.

But you mentioned earlier the case for free trade might be even stronger.

It really is.

The standard model is powerful, but it doesn't capture everything.

There are other significant benefits of international trade.

Like what?

Well, first, increased variety of goods.

Trade gives consumers access to a much wider range of products than any single country could produce on its own.

Think German beer versus American beer, Japanese cars versus Italian cars.

More choice.

Yeah, that's definitely a plus.

What else?

Lower costs through economies of scale.

Access to larger world markets allows firms to produce on a bigger scale, which often lowers the average cost per unit.

Think about software or pharmaceuticals.

Huge upfront costs, but low cost per additional user.

Global markets help recoup those costs.

Makes sense.

Scale matters.

Third,

increased competition.

Imports provide competition for domestic firms, which can reduce their market power, push them to be more efficient and keep prices lower for consumers.

Keeps everyone on their toes.

Fourth, increased productivity.

Trade tends to allow the most productive firms in a country to expand and export while less productive firms may shrink or exit when faced with import competition.

This shifts resources towards more efficient uses, boosting the whole economy's productivity and enhanced flow of ideas.

Trade is a major channel for technology transfer.

When a country imports machinery or software, it often imports the technology and knowledge embedded in those goods.

It accelerates innovation and learning.

Wow.

So variety, scale economies, competition, productivity, ideas.

That's a powerful list on top of the basic gains from trade.

It makes the economic argument for free trade very compelling.

Yet despite all that, we constantly hear arguments against free trade, arguments for restricting it.

We do.

And it's important to understand them, even if economists often find them unpersuasive.

The most common is probably the jobs argument.

Trade destroys domestic jobs.

We hear that a lot, especially when imports compete with local industries like textiles in Iceland.

And it's true that trade can displace workers in specific industries facing import competition.

That's a real cost.

But economists argue that trade also creates jobs in other industries, the ones where the country has a comparative advantage in exports.

So it's more about transition and shifting jobs rather than a net loss of jobs overall?

Generally, yes.

The economy adapts.

While the transition can be painful for some, the overall standard of living tends to rise because the country is specializing more efficiently.

It's about comparative, not absolute advantage.

OK, what's another common argument?

The national security argument.

Industries like steel might argue they are vital for defense and we shouldn't rely on foreign suppliers, especially in wartime.

That sounds plausible in some cases.

It can be for genuinely critical defense materials.

But economists are wary because this argument is easily misused by any industry wanting protection from competition.

And ironically, the military itself benefits from cheaper imported materials, too.

Right.

Then there's the infant industry argument.

This one suggests that new developing industries need temporary protection to grow strong enough to compete internationally.

Temporary being the key word.

Often the sticking point.

Economists are skeptical.

It's hard for governments to pick winners, which industries deserve protection.

And temporary protection often becomes permanent due to political pressure.

Plus, if an industry has true long -term potential, maybe it should be willing to face initial losses without protection.

OK, how about the unfair competition argument, like other countries subsidize their industries so we should restrict their imports?

Yeah, it's not a level playing field.

Right.

The economic response is interesting.

While the foreign subsidy does hurt domestic producers in the importing country.

It helps domestic consumers.

Right.

They get cheaper goods.

Exactly.

And the gains to consumers usually outweigh the losses to producers.

Essentially, the foreign countries taxpayers are footing the bill to give your consumers cheap stuff.

The importing country actually benefits overall from the foreign subsidy, even if its own producers don't like it.

Maybe we should send them a thank you note, as Manki suggests.

OK, one more.

Protection as a bargaining chip.

The idea here is to threaten trade restrictions, to pressure other countries into removing their restrictions, aiming for freer trade overall.

A bit of trade brinkmanship.

Kind of.

The risk, economists point out, is that the threat might not work.

Then you either have to carry out the threat, which hurts your own economy, too, or back down and lose credibility.

It's a risky strategy that can backfire.

So these arguments often lead to trade negotiations and agreements.

You mentioned unilateral versus multilateral approaches.

Right.

A country can act unilaterally, like Great Britain did in the 19th century, just removing its own barriers, regardless of what others do.

Or more commonly today, countries use a multilateral approach bargaining together to reduce barriers reciprocally.

Like NAFTA or the GAT, which became the WTO.

Exactly.

The General Agreement on Tariffs and Trade, GATT,

started after WWII and led to huge reductions in tariffs worldwide.

The World Trade Organization, WTO, established in 1995 with now 164 members, administers these agreements, handles disputes, and provides a forum for ongoing negotiations.

What are the pros and cons of doing it multilaterally?

Pro.

You can achieve much broader liberalization, potentially bigger gains.

Con.

Negotiations are complex and can fail.

Politically, though, it can be easier because you can package concessions like we'll lower textile tariffs if you lower wheat tariffs, bringing together different domestic interest groups who support the overall deal.

It's clear economists generally favor these moves towards free trade.

Overwhelmingly so.

Surveys consistently show economists support free trade and believe past agreements have largely benefited economies like the U .S.

They tend to disagree strongly with the idea that tariffs improve welfare.

Which contrasts sharply with some recent policies, like the Trump administration's approach mentioned in the text.

Yes, the text notes that administrations focus on trade balances, viewing imports more negatively, and using tools like Section 232 national security claims for tariffs on steel and aluminum from allies, which many economists criticized as protectionism harmful to the broader economy and relationships.

And the book also notes that productivity gains, not just imports, are a major factor in job changes in industries like steel.

Right.

It's often a combination of factors, and automation and productivity have played a huge role in manufacturing employment over decades.

So there's this gap between economist consensus and sometimes public or political sentiment.

There often is.

Economists focus on the overall efficiency and standard of living gains, which are significant, but diffused.

The losses, while smaller overall, are often concentrated and very visible, making them politically potent.

The U .S.

itself is a good analogy, isn't it?

Free trade between states, Florida, oranges going north, Washington Apples going south.

Everyone benefits.

It's a great example of the principle working on a large scale.

Which brings us back to that wonderful Iceland parable at the end of the chapter, the inventor.

Ah, yes, the inventor who discovers a miraculous way to make textiles from wheat with almost no labor.

Hailed as a genius, living standards rise until the reporter finds out she's not inventing anything.

She's just secretly trading the wheat internationally for textiles.

She's simply discovered the gains from trade.

And when the government finds out they shut her down, call her a fraud and living standards fall back.

The punchline is perfect.

She was no inventor.

She was just an economist.

It brilliantly highlights how trade, while seeming mundane, can be as powerful as a technological breakthrough in raising welfare.

So let's quickly recap the key points.

Domestic price versus world price tells you if you export or import, revealing comparative advantage.

Trade creates winners and losers internally,

but the overall national gains always exceed the losses.

The pie gets bigger.

Tariffs shrink that pie.

They help domestic producers and government revenue, but hurt consumers more, creating deadweight losses.

And while arguments for trade restrictions exist, jobs, security, fairness, most economists believe the benefits of free trade, including variety, efficiency and innovation, are much larger.

And maybe, as that parable suggests, the biggest discoveries aren't always new technologies, but just a better understanding and application of fundamental economic principles like trade.

It makes you wonder what other simple economic truths are out there, waiting to boost our well -being if we just embrace them.

That's a great thought to end on.

Thank you for joining us for this deep dive into international trade based on Mancus Chapter 9.

On behalf of the deep dive and the last minute lecture team, we really appreciate you spending this time with us exploring these vital economic ideas.