BEO6600 · Business Economics
International Trade
This session applies the consumer- and producer-surplus tools to a country trading with the world; the skill is welfare-area reasoning, not arithmetic. A small open economy is a price taker at the world price: compare it with the domestic no-trade price — if the world price is higher the country exports, if lower it imports. Comparative advantage (producing at a lower opportunity cost) is treated conceptually here through that single price comparison, so you reason about the direction of trade rather than compute opportunity costs. Either way trade raises total surplus: when a country exports, producers gain more than consumers lose; when it imports, consumers gain more than producers lose. A tariff raises the import price to world price + tariff, lifting producer surplus a little and giving government revenue, but leaving two deadweight-loss triangles (D + F), so the net welfare effect is negative. This is group-report scope (Australia and the WTO), not the closed-book exam.
What this chapter covers
- 0113.1 The world price and comparative advantage (conceptual)
- 02The trade rule: world price > domestic → export; < → import
- 0313.2 Winners and losers: an exporting country (CS down, PS up, TS up)
- 0413.3 Winners and losers: an importing country (CS up, PS down, TS up)
- 0513.4 The welfare effect of a tariff (the two DWL triangles D + F)
- 0613.5 Quotas and the terms of trade
- 0713.6 Arguments for restricting trade and the economist's rebuttals (the WTO)
Worked example: the welfare effect of a tariff
- +1(a) The higher price raises domestic quantity supplied and cuts quantity demanded, so the volume of imports shrinks.
- +1(b) Consumer surplus falls by areas C + D + E + F (higher price, less bought). Producer surplus rises by area C (domestic producers sell more at the higher price).
- +1Government revenue = area E = the tariff × the (smaller) volume of imports.
- +1(c) Areas C (to producers) and E (to government) are transfers from consumers, not new wealth. The two triangles D (production distortion: high-cost domestic output replaces cheap imports) and F (consumption distortion: buyers priced out of valued trades) are pure deadweight loss.
- +1Net effect: the change in total surplus = −(D + F), so the tariff reduces national welfare. Tariff revenue does not make a tariff 'worth it' — it is just a transfer.
Key terms
- World price
- The price at which a good trades on the international market. A small open economy is a price taker at the world price; comparing it with the domestic no-trade (autarky) price decides the direction of trade — export if the world price is higher, import if it is lower.
- Comparative advantage
- The ability to produce a good at a lower opportunity cost than others — not necessarily at greater absolute efficiency. Countries specialise in and export the goods they make at lower relative cost. In BEO6600 it is applied conceptually through the price comparison; you do not compute opportunity costs.
- Gains from trade
- The result that opening to trade raises a nation's total surplus whichever way trade flows. When a country exports, producers gain more than consumers lose; when it imports, consumers gain more than producers lose. The losses are real and concentrated, which is why protection is politically tempting.
- Tariff
- A tax on imported goods sold domestically, raising the import price to world price + tariff. It lifts producer surplus a little (area C) and gives the government revenue (area E), but consumer surplus falls more, leaving two deadweight-loss triangles, D (production distortion) and F (consumption distortion).
- Deadweight loss of a tariff (D + F)
- The net welfare cost of a tariff: the production-distortion triangle D (high-cost domestic output replacing cheap imports) plus the consumption-distortion triangle F (buyers priced out of valued trades). These are pure losses, destroyed not transferred, so the net change to total surplus is −(D + F).
International Trade FAQ
How do I tell whether a country exports or imports a good?
Compare the domestic no-trade (autarky) price with the world price. If the world price is higher than the domestic price, the country exports — the domestic price rises to the world price, raising quantity supplied and cutting quantity demanded, with the surplus exported. If the world price is lower, the country imports — the domestic price falls, raising quantity demanded and cutting quantity supplied, with the gap imported. In BEO6600 this single price comparison, not an opportunity-cost calculation, gives the direction of trade.
Do I need to compute comparative advantage in BEO6600?
No. Comparative advantage is treated conceptually: you reason about the direction of trade and the welfare areas, but you are not asked to compute opportunity costs or fill a two-country output table. The price comparison above already embodies opportunity cost. Note that a country can be the most efficient producer of a good in absolute terms and still import it, because its comparative advantage lies elsewhere — the direction of trade follows the price comparison.
Why does free trade raise total surplus even though some people lose?
Because the winners' gains exceed the losers' losses. When a country exports, the price rises: producers gain more than consumers lose. When it imports, the price falls: consumers gain more than producers lose. Either way total surplus rises — the welfare case for free trade. The losses are real and concentrated, though, which is why protection is politically tempting and why each protection argument has a standard economist's rebuttal.
Does the revenue from a tariff make it worthwhile?
No. The government collects area E and domestic producers gain area C, but those are transfers from consumers, not new wealth. The two triangles, D (production distortion — high-cost domestic output replacing cheap imports) and F (consumption distortion — buyers priced out of valued trades), are pure deadweight loss: destroyed, not transferred. The net change to national welfare is −(D + F), which is negative. A quota produces a similar picture, except the revenue may accrue to licence holders rather than government.
Exam move
Master welfare-area reasoning rather than arithmetic. Start every question by comparing the world price with the domestic price to call the direction (export if world price higher, import if lower). Then shade the CS and PS changes and state who wins and who loses — export: CS down, PS up, TS up; import: CS up, PS down, TS up. For a tariff, mark the change in CS, the small gain in PS (area C), the government revenue (area E), and the two deadweight-loss triangles D + F, then conclude the net welfare change is −(D + F). Have a judgement ready: free trade raises total surplus, but losses are concentrated, so weigh that against any restriction argument and its rebuttal. Because the WTO topic is a 30% group report, label both axes, both curves, the world-price line and every lettered area.
