Learning Module 6
International Trade
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Describe the benefits and costs of international trade.
Compare types of trade restrictions, such as tariffs, quotas, and export subsidies, and their economic implications.
Explain motivations for and advantages of trading blocs, common markets, and economic unions.
1 · Benefits and Costs of Trade
Benefits — Gains from exchange and specialization; economies of scale; greater product variety; increased competition; more efficient allocation of resources.
Comparative Advantage — Countries specialize in producing goods where they have a relative cost advantage and trade for others.
Intra-Industry Trade — Two-way trade in similar products (e.g., cars) driven by product differentiation and economies of scale.
Costs — Adjustment costs (job losses in import-competing industries), income inequality, need for retraining. Overall welfare gains, but not everyone wins.
2 · Trade Restrictions
Tax on imports. Raises domestic price, reduces imports, generates government revenue. Creates deadweight loss (consumer surplus loss > producer surplus gain + tariff revenue).
Quantity limit on imports. Raises price, creates quota rents (captured by foreign producers unless licenses auctioned). Welfare loss larger than tariff if rents captured by foreigners.
Exporter agrees to limit exports. Quota rents captured by exporting country; greater welfare loss for importing country.
Government payment to exporters. Lowers world price, raises domestic price; costs government revenue; welfare loss.
Deadweight loss from tariffs arises from inefficiencies in production (high-cost producers) and consumption (lost mutually beneficial exchanges).
3 · Trading Blocs
Free Trade Area (FTA) — Eliminates tariffs among members, each maintains own external tariffs (e.g., USMCA).
Customs Union — FTA + common external tariffs against non-members (e.g., Southern African Customs Union).
Common Market — Customs union + free movement of factors of production (labor, capital) (e.g., MERCOSUR).
Economic Union — Common market + harmonized economic policies, common institutions (e.g., European Union).
Trade Creation — Replacing higher-cost domestic production with lower-cost imports from members (welfare gain).
Trade Diversion — Replacing lower-cost imports from non-members with higher-cost imports from members (welfare loss).