Analyzing Trade with Supply and Demand

Let’s look at trade—and trade restrictions—using tools that you are already familiar with: demand and supply.

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Figure 9.1 shows a domestic demand curve and a domestic supply curve for semiconductors. If there were no international trade, the equilibrium would be, as usual, at PNo trade, QNo trade. Suppose, however, that this good can also be bought in the world market at the world price. To simplify, we will assume that the U.S. market is small relative to the world market, so U.S. demanders can buy as many semiconductors as they want without pushing up the world price. In terms of our diagram, the world supply curve is flat (perfectly elastic) at the world price.

International Trade Using Demand and Supply If there were no international trade, the equilibrium would be found, as usual, at the intersection of the domestic demand and domestic supply curves at PNo trade, and QNo trade. With trade, U.S. consumers can buy as many semiconductors as they want at the world price, and at this price U.S. consumers demand QdFree trade units. At the world price, the difference between domestic demand, QdFree trade, and domestic supply, QsFree trade, is made up by imports.

Given that U.S. consumers can buy as many semiconductors as they want at the world price, how many will they buy? As usual, we read the quantity demanded off the domestic demand curve so at the world price, U.S. consumers will demand semiconductors. How many semiconductors will be supplied by domestic suppliers? As usual, we read the quantity supplied off the domestic supply curve so domestic suppliers will supply units. Notice that > , so where does the difference come from? From imports. In other words, with international trade, domestic consumption is units; of these units are produced domestically and the remainder, – , are imported.

Analyzing Tariffs with Demand and Supply

Protectionism is the economic policy of restraining trade through quotas, tariffs, or other regulations that burden foreign producers but not domestic producers.

Many countries, including the United States, restrict international trade with tariffs, quotas, or other regulations that burden foreign producers but not domestic producers—this is called protectionism. A tariff is simply a tax on imports. A trade quota is a restriction on the quantity of foreign goods that can be imported: Imports greater than the quota amount are forbidden or heavily taxed.

A tariff is a tax on imports.

A trade quota is a restriction on the quantity of goods that can be imported: Imports greater than the quota amount are forbidden or heavily taxed.

Figure 9.2 shows how to analyze a tariff. The figure looks imposing but it’s really the same as Figure 9.1 except that now we analyze domestic consumption, production, and imports before and after the tariff. Before the tariff, the situation is exactly as in Figure 9.1: units are demanded, units are supplied by domestic producers, and imports are – .

International Trade Using Demand and Supply: Tariffs A tariff shifts the world supply curve up by the amount of the tariff, thus raising the world price. In response to the higher price, consumers reduce their purchases from QdFree trade to QdTariff and domestic suppliers increase their production from QdFree trade to QsTariff. Since domestic consumption decreases and domestic production increases, the quantity of imports falls from QdFree trade – QsFree trade to QdTariff – QsTariff.
The government collects revenues from the tariff equal to the tariff × the quantity of imports, which is shown as the blue area.

Analyzing Trade and the Welfare Cost of Tariffs

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The tariff is a tax on imports so—just as you learned in Chapter 3—the tariff (tax) shifts the world supply curve up by the amount of the tariff. For example, if the world price of semiconductors is $2 per unit and a new tariff of $1 per semiconductor is imposed, then the world supply curve shifts up to $3 per unit.

At the new, higher price of semiconductors, two things happen. First, there is an increase in the domestic production of semiconductors as domestic suppliers respond to the higher price by increasing production. In the diagram, domestic production increases from to . Second, there is a decrease in domestic consumption from to as domestic consumers respond to the higher price by buying fewer semiconductors. Since the quantity produced by domestic suppliers rises and the quantity demanded by domestic consumers falls, the quantity of imports falls. Specifically, imports fall from – to the smaller amount – .

Figure 9.2 illustrates one more important idea. A tariff is a tax on imports so tariffs raise tax revenue for the government. The revenue raised by a tariff is the tariff amount times the quantity of imports (the quantity taxed). Thus, in Figure 9.2 the tariff revenue is given by the blue area.