International Trade - Theory and Policy, 2010a

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We examine the effects of optimal tariffs and retaliation more formally by using a simple game theory setup. Suppose the players in the game are the governments of two large countries, the United States and Brazil. Suppose the United States imports a set of products (A, B, C, etc.) from Brazil, while Brazil imports a different set of products (X, Y, Z, etc.) from the United States. We imagine that each country’s government must choose between two distinct trade policies, free trade and optimal tariffs. Each policy choice represents a game strategy. If the United States chooses free trade, then it imposes no tariffs on imports of goods A, B, C, and so on. If the United States chooses optimal tariffs, then it determines the optimal tariff in each import market and sets the tariff accordingly. Brazil is assumed to have the same set of policy choices available. In Figure 7.20 "A Trade Policy Game", U.S. strategies are represented by the two columns; Brazilian strategies correspond to the two rows. The numbers represent the payoffs to the countries, measured as the level of national welfare realized in each country in each of the four possible scenarios. For example, if the United States chooses a free trade policy and Brazil chooses to impose optimal tariffs, then the payoffs are shown in the lower left-hand box. The Brazilian payoff is below the diagonal, while the U.S. payoff is above the diagonal. Thus Brazil gets 120 units of welfare, while the United States gets 70 units. Note that the size of the numbers used in the example is immaterial, but how they relate to the numbers in alternate boxes is not. We will use the results from the tariff analysis section to inform us about the relationship between the numbers. To begin, let’s assume that each country receives 100 units of national welfare when both the United States and Brazil choose free trade. If Brazil decides to impose optimal tariffs on all of its imports and the Saylor URL: http://www.saylor.org/books Saylor.org 339
United States maintains its free trade position, then a partial equilibrium welfare analysis suggests the following: 1. Brazilian welfare will rise (we’ll assume from 100 to 120 units). 2. U.S. welfare will fall (we’ll assume from 100 to 70 units). 3. World welfare will fall (thus the sum of the U.S. and Brazilian welfare initially is 200 units but falls to 120 + 70 = 190 afterward). Similarly, if the United States imposes optimal tariffs on all of its imports while Brazil maintains free trade, then the countries will realize the payoffs in the upper right-hand box. The United States would get 120 units of welfare, while Brazil would get 70. To keep the example simple, we are assuming that the effects of tariffs are symmetric. In other words, the effect of U.S. optimal tariffs on the two countries is of the same magnitude as the effects of Brazilian tariffs. Finally, if both countries set optimal tariffs against each other, then we can simply sum up the total effects. Since each country’s actions raise its own welfare by 20 units and lower its trade partner’s welfare by 30 units, when both countries impose tariffs, national welfare falls to 90 units in each country. To determine which strategy the two governments would choose in this game, we need to identify the objectives of the players and the degree of cooperation. Initially, we will assume that each government is interested in maximizing its own national welfare and that the governments do not cooperate with each other. Afterward, we will consider the outcome when the governments do cooperate. The Noncooperative Solution (Nash Equilibrium) A noncooperative solution is a set of strategies such that each country maximizes its own national welfare subject to the strategy chosen by the other country. Thus, in general, if the U.S. strategy (r) maximizes U.S. welfare, when Brazil chooses its strategy (s) and if Brazil’s strategy (s) maximizes Brazil’s welfare when the United States chooses strategy (r), then the strategy set (r,s) is a noncooperative solution to the game. A noncooperative solution is also commonly known as a Nash equilibrium. How to Find a Nash Equilibrium One can determine a Nash equilibrium in a simple two-player, two-strategy game by choosing a strategy for one of the players and answering the following series of questions: 1. Given the policy choice of the first player, what is the optimal policy of the second player? 2. Given the policy choice of the second player (from step one), what is the first player’s optimal policy choice? Saylor URL: http://www.saylor.org/books Saylor.org 340
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This text was adapted by The Saylor
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Chapter 1 Introductory Trade Issues
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However, rapid growth in the value
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As of 2009, 153 countries were memb
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International trade is a field in e
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imported, the U.S. government colle
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Kenya 12.7 Ghana 13.1 Generally spe
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Average tariffs can be measured as
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When the bubble bursts, the demand
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missed deadlines are commonplace in
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a well-known “bicycle theory” a
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But at the same time that many deve
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Recent opposition to trade liberali
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ought back to the United States and
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conference attended by the main all
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One of the key principles of the GA
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arriers. [1] The trade remedy laws
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ound tariff rate the country reache
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instead, they are put into place ov
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5. The WTO principle to treat an im
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subsidies. Recall that export subsi
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As a result of Uruguay Round negoti
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Agreement, or TRIPS. The TRIPS inte
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1.7 The World Trade Organization LE
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1. Consultations. The DSB first dem
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countries from choosing more destru
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P, P+ CAFTA-DR FTA PE MA OM R SG U.
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0806.10.20 $1.13/m 3 (Feb. 15-Mar.
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Tariffs vary according to time of e
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1.9 Appendix B: Bound versus Applie
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EXERCISE 1. Jeopardy Questions. As
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2.1 The Reasons for Trade LEARNING
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For example, the Ricardian model of
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2. Learn the major historical figur
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could end up with more of both good
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The primary issue in the analysis o
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Real wages (and incomes) of individ
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he begins planting seeds in the sec
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In this way, we might raise the wel
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2.3 Ricardian Model Assumptions LEA
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Utility Maximization and Demand In
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United States L C + L W = L France
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2. Suppose that the unit labor requ
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KEY TAKEAWAYS The equation aLC QC
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comparative advantage in newspaper
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−aLCaLW⎡⎣⎢hrslbhrsgal=gallb
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KEY TAKEAWAYS Labor productivity i
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2.6 A Ricardian Numerical Example L
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With full employment of labor, prod
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At this point, we can already see a
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The answer to some of these questio
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wC=PCaLC. If production occurs in t
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Thus a good way to think about how
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Similarly, by rearranging the above
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production. But where will they fin
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The focus on real wages allows us t
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Real Wages in Autarky To calculate
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exchange. Thus the real wage of che
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2.11 The Welfare Effects of Free Tr
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Free trade will raise aggregate wel
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Chapter 3 The Pure Exchange Model o
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A Simple Example of Trade Suppose t
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3.2 Determinants of the Terms of Tr
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Persuasion The art of persuasion ca
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KEY TAKEAWAY The terms of trade is
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two individuals make a voluntary ex
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3.4 Three Traders and Redistributio
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is not motivated by profit but inst
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The changes described above assume
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3.6 The Nondiscrimination Argument
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clothing worker. The same applies i
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the page, scroll down to the “Bou
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4.1 Factor Mobility Overview LEARNI
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argument that free trade can only b
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them, but only if the prices are ve
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4.3 Time and Factor Mobility LEARNI
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factor to be moved and become produ
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KEY TAKEAWAY The immobile factor m
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wine workers and cheese workers. Th
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In autarky, the quantity demanded o
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4.7 Depicting a Free Trade Equilibr
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0 the variable does not change A th
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Thus cheese workers are most likely
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Real Wage of Wheat Workers in Terms
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wages. However, these extra profits
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French production and consumption i
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5.1 Chapter Overview LEARNING OBJEC
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less-developed countries have much
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would rise, while the wage rate wou
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Ricardian model, then factor prices
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4. This is by which industries diff
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where KC and KS are the quantities
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Let aLC[labor−hrsrack] represent
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The capital-labor ratio in an indus
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that would employ all the capital i
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The Relationship between Endowments
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Suppose the exogenous variables of
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Adding these two equations vertical
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3. Write the magnification effect f
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tariffs or other government regulat
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If the price of clothing had risen,
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Table 5.6 Numerical Values for Exog
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w∧>PC∧>PS∧>r∧. The effect i
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2. Suppose the price of cheese fall
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this requires a fair amount of adva
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workers per unit of capital in the
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of quantities CS″/CC″. Since CS
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In Figure 5.8 "Free Trade Equilibri
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5.11 National Welfare Effects of Fr
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calculating changes in real income
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who has deposits in a pension plan
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export industry in order to benefit
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Income is redistributed among indiv
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Thus it is always possible to find
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affects the capital-labor ratios in
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1. Describe the pattern of factor f
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assumed to be freely and costlessly
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expansion of output in the export s
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[1] See R. W. Jones, “A Three-Fac
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product line for a representative t
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The total amount of revenue earned
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The horizontal length of Figure 5.1
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Our prime concern, however, is the
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An alternative version of the magni
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8. The magnification effect for pri
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can be used to transport tomatoes o
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esponds to the excess supply of wor
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The effect on workers is, in genera
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Factor Rewards over Time Now let’
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Figure 5.20 Dynamic Import-Capital
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In summary, the models suggest that
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[1] See J. P. Neary, “Short-Run C
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6.2 Economies of Scale and Returns
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produced and if the costs of this e
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6.3 Gains from Trade with Economies
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United States aLC = 1 L = 100 Franc
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thirty racks of clothing, then each
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model best describes markets in whi
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2. Each firm produces a product tha
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2. The demand assumption in which e
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Keep in mind that this is the equil
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Page 386 and 387: KEY TAKEAWAYS An antisubsidy law,
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Notice that a unique set of prices
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in the import country and in the ca
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Figure 7.36 Welfare Effects of a VE
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the quota rents will benefit, but p
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A the variable change is ambiguous
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Mexico, and all wheat sold in Mexic
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7.23 Export Taxes: Large Country We
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Because there are both positive and
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− the variable decreases 0 the va
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If a domestic consumption tax is im
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Equivalency between Domestic and Tr
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An import tariff applied on an impo
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KEY TAKEAWAYS Domestic production
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a Domestic Production Subsidy", whi
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Domestic policies can affect trade
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+ the variable increases − the va
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Domestic consumption taxes are ofte
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Figure 8.3 Inducing Exports with a
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8.7 Consumption Tax Effects in a Sm
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Since the cost to consumers exceeds
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When a specific consumption tax “
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time of the founding of the nation,
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Chapter 9 Trade Policies with Marke
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Market imperfections or market dist
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firm’s welfare) by restricting su
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are neatly kept and homes are well
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Policy-Imposed Distortions Another
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In this section, we will provide an
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Welfare-Improving Policies in a Sec
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Summary of the Theory of the Second
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9.4 Unemployment and Trade Policy L
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Suppose that international market c
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9.2 "Welfare Effects of an Import T
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Begin with the same surge of import
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eliminate the same unemployment imp
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A the variable change is ambiguous
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their own production efficiency imp
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Suppose that the infant industry ar
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This means that in the second perio
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The Economic Argument against Infan
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world efficiency standards, protect
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9.6 The Case of a Foreign Monopoly
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Assuming the monopolist maximizes p
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Import tariff effects on the import
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This shows that although a tariff c
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2. Recognize that a trade policy ca
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consider a large importing country
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the subsidy is set too high, the lo
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9.8 Public Goods and National Secur
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nonexcludable because once it is th
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efficiency loss. Nevertheless, the
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5. The term describing a ìgoodî l
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the environment. On the other hand,
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Pollution Effect National Welfare
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Govt. Revenue Pollution Effect + e
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A Source of Controversy For many en
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This statement points out that many
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noneconomists, providing permits th
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[4] World Trade Organization, “Tr
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product categories. This type of tr
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The key question of interest concer
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Figure 9.10 "Harmful Trade Diversio
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Free trade area effects on Country
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We assume that A has a specific tar
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The simple way to do that is to ima
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Chapter 10 Political Economy and In
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do indeed seek to maximize national
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a representative democracy, governm
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3. This type of lobbying does not i
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much larger than the number of firm
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We can now ask whether a household
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Large groups are much less effectiv
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Because the per-producer benefit of
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clearly he or she would vote for th
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10.7 The Lobbying Problem in a Demo
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Chapter 11 Evaluating the Controver
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the results from any one model. Ins
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increase in national welfare. This
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4. The enhancement of this is what
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of the real world. The real world c
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Another way to deflect the concern
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For example, an optimal tariff or o
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Stuart Mill in hisPrinciples of Pol
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11.5 The Economic Case against Sele
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to eliminate some of the inefficien
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effects, it would then need to meas
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to avoid the use of any such policy
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Selected protection requires detail
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11.6 Free Trade as the “Pragmatic
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