David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 28 International trade
SS
£6000
World price
plus subsidy
I
DD
. :...- Exports ---+: ---.,
I I I I
I
I
Qs
Quantity
Under free trade, consumers demand Qd, production is Q" and exports ore GE. With o subsidy on exports
alone, domestic producers will restrict supply to the home market to Q so that home consumers pay £6000,
the some os producers con earn by exporting. T otol output is Q and exports AB. K shows the socio I cost of
producing goods whose marginal cost exceeds the world price for which they are sold. H shows the social
cost of restricting consumption when marginal benefits exceed the world price of the good.
Figure 28.5 An export subsidy
Q' s
To help the computer industry, the government offers a 20 per cent export subsidy on all exported computers,
on which domestic producers now earn £6000. No firm sells at home for £5000 when it can sell abroad for
£6000. The supply to the domestic market is reduced to Q/ so that domestic consumers also pay £6000.
Total domestic output rises to Q/ and exports are AB.
Although the subsidy increases exports, it entails a social cost given by the shaded triangles H and K.
Triangle H is the social cost of reducing domestic consumption from Qd to Q/ The consumer benefits of
the extra consumption would have exceeded the world price, the social marginal cost at which the economy
can obtain computers. Triangle K is the social cost of increasing output from Qs to Q/ when the marginal
domestic cost exceeds the world price at which computers could have been imported.
Just as with a tariff, an export subsidy is usually a second-best policy. Even if a country wants to raise its
output of computers, it is cheaper to use a production subsidy, incurring the cost of the triangle K, but
avoiding the cost of the triangle H.
Summary
• World trade grew rapidly over the past 40 years, and is dominated by the developed countries. Primary
commodities are 25 per cent of world trade; the rest is trade in manufactures.
• Countries trade because they can buy goods more cheaply abroad. Differences in costs reflect differences
in technology and factor endowments. Scale economies also lead to international specialization.
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