Review Questions
Following the formation of NAFTA, what was expected to happen to wages of unskilled labor
relative to wages of skilled labor in Mexico and in the United States as U.S. outsourcing
occurred? Both should fall
The table gives U.S. and Indian labor requirements (hours per unit of output) needed in each of
four activities to produce the final product. If trade costs are zero, which operations will the
United States outsource to India? assembly operations, component production, and office
services
The table gives U.S. and Indian labor requirements (hours per unit of output) needed in each of
four activities to produce the final product. Suppose that “trade costs” represent 25% of wage
costs in India. Now which operations will the United States outsource to India? assembly
operations only
What is the root of the apparent contradiction in Paul Samuelson's statements regarding the
benefits of trade and the results of the theories discussed in the book? Answer in this lecture.
Lecture09Spring09 Page 1
Wednesday, April 15, 2009
15:13
Lecture09Spring09 Page 2
Gains from outsourcing
Focus on two of the n steps: Research&Development and Components Manufacturing.
No outsourcing
With Outsourcing
Price of final good?   P * Y  (Total Cost)
Who gains?
Skilled workers:
Unskilled workers:
Can continued outsourcing be bad? (Samuelson 2004)
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Samuelson didn't compare trade to non‐trade… Samuelson compared two different trade equilibria.
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Chapter 8: Import tariffs under perfect competition
Previously:
Gains/Losses from Trade: Why tax imports (good economic reasons)?
The WTO:
Established as General Agreement on Tariffs and Trade (GATT) in 1947.
Provisions:
1. A nation must extend the same tariffs to all trading partners that are WTO members (Most favored nation clause)
2. Tariffs may be imposed in response to dumping
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3. Countries should not limit the quantity of goods and services that they import
4. Countries should declare export subsidies: benefits for firms that product goods specifically for export
5. Countries can temporarily raise tariffs for certain products.
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Trade and Surplus: perfect competition
Autarky Equilibrium
P
PA
PW
QS
QA
QD
Q
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What if trade opens up and PW < PA?
P
PW
PA
PA
PW
QS
QA
QD
Q
QD-QS
Qimports
What if trade opens up and PW > PA?
PW
P
PW
PA
PA
QD
QA
QS Q
If PW < PA, consumers will demand more than sellers are willing to Lecture09Spring09 Page 8
QS-QD
Qexports
supply, which creates an import demand
If If PW > PA, Sellers will supply more than consumers demand, which creates an export supply.
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Import Tariffs and Surplus: small countries
Small Country assumption: PW is not affected by a tariff by the home country.
Why? There are plenty of other importing countries
Result: Perfectly elastic foreign Export supply curve:
PW
PA
QD-QS
Qimports
Price consumer pays = import price + tariff
P
P=PW+t
PW
Q
S
P
P
P=PW+t
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S
P
P
P=PW+t
PW
X
D
M
Q
Conclusion: Import tariffs will lower surplus in a small country Lecture09Spring09 Page 11
M,X
Import tariffs for big countries
Small country assumption: If importing country does not buy the goods at world market prices, foreign sellers will just supply elsewhere:
Result: Perfectly elastic export supply curve.
Big country: Importing country's actions do affect world market conditions.
Result: upward sloping export supply curve.
S
P
P
X
PW
D
M
Q
Gains and losses from Tariffs
Conclusion:
Small importing countries pay all the incidence of an import tax: Lower surplus due to deadweight loss
Big importing countries make foreign suppliers pay part of the tax: terms of trade gains offset deadweight loss
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M,X
Optimal Tariff
Tariffs are always bad for small countries: optimal tariff is zero
Tariffs are sometimes good for big countries: what is the optimal tariff?
X+t
Effects of a small increase in tariff:
X
M
M,X
Lecture09Spring09 Page 13
X+t+dt
Gain in Government revenue due to tariff increase:
X+t
X
dP
t
Loss in non‐Govt Surplus
dP*
M
dM
Total change in welfare due to small tariff increase:
M
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M,X
The optimal tariff, expressed as a percent of the foreign export price, is = 1/elasticity of the foreign export supply curve.
Example: Tariffs for steel products:
Product
Actual Tariff Elasticity of export supply
Alloy steel flat rolled products 0.30
0.27
Iron and steel bars
0.15‐0.30
0.80
Ferrous waste
0
17
Iron and steel tubes
0.13‐0.15
90
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Test of this theory?
Multifibre Arrangement: Lecture09Spring09 Page 16
2004
Import Quotas: Quantity restriction on imports S
P
P
PA
PW
X
D
M
Q
Welfare Effects of a Quota resulting in import price of P2 versus a tariff that results in an import price of P2
Consumer surplus:
Producer Surplus:
Government revenue
Splitting up the Quota Rents
Quota License: Permits to import the quantity allowed under the quota system
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M,X
Quota auction: Auction off the quotas
Voluntary export restraint (VER)
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Review Questions
Suppose that the free-trade price of a ton of steel is €500. Finland, a small country, imposes a
€60-per-ton specific tariff on imported steel. With the tariff, Finland produces 300,000 tons of
steel and consumes 600,000 tons of steel.
What is the purpose of this €60-per-ton tariff?
Who will gain and who will lose as a result Finland's €60 tariff on imported steel?
Suppose that the €60 tariff caused Finnish production of steel to increase by 100,000 tons and
Finnish consumption of steel to fall by 100,000 tons. What is the value of Finland's welfare loss
due to the tariff?
Suppose that the €60 tariff caused Finnish production of steel to increase by 100,000 tons and
Finnish consumption of steel to fall by 100,000 tons. What is the value of Finland's welfare loss
due to the tariff?
What will happen to the Finnish price of steel if Finnish demand increases and the tariff remains
at €60?
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