Ch 9: Application: International TradeSunday, October 19, 201410:32 PMConsumer SurplusDomesticSupplyThe Determinants of Trade-The Equilibrium without TradeoWhen an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. oThe sum of the consumer and producer surplus measures the total benefits that buyers and sellers receive from participating in the textile marketEquilibrium Price Producer SurplusDomesticDemandEquilibrium Quantity-The World Price & Comparative AdvantageoWorld Price: the price of a good that prevails in the world market for that goodoComparing the world price and domestic price before trade indicates if there is a comparative advantage oThe domestic price reflects the opportunity cost.o If the domestic price is low, the cost of producing the product is low, suggesting that that country has a comparative advantage in producing that product relative to the rest of the world. The Winners and Losers from Trade-Assume that "Isoland" is a small economy compared to the rest of the world. -The Gains and Losses of an Exporting Country Once trade is allowed, the domestic price rises to equal the world price. Exports equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. The area D shows the increase in total surplus and represents the gains from trade.Price AfterTrade: Exports Domestic Supply AWorldPrice!Price BeforetradeB D Before Trade After Trade ChangeConsumer Surplus A+B A -BProducer Surplus C B+C+D +(B+D)Total Surplus A+B+C A+B+C+D +DC ExportsDomestic Demand Domestic Quantity demanded Domestic Quantity suppliedoWhen a country allows trade and becomes an exporter of a good, domestic producers of the good are better off, and domestic consumers of the good are worse off. oTrade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers -Domestic producers can now sell the product at a higher price (winners)-Domestic consumers of the product have to buy it at a higher price (losers) Once trade is allowed, the domestic price falls to equal the world price. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. The area D shows the increase in total surplus and represents the gains from trade. -The Gains and Losses of an Importing Country -When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are worse off. -Trade raises the economic well-being of a nation in the sense that the gains of the winners (consumers) exceed the losses of the losers (producers)DomesticSupply A B DPrice beforeTradePrice afterTradeWorld Price C Imports Domestic Demand Before Trade After Trade ChangeConsumer Surplus A A+B+D +(B+D)Producer Surplus B+C C -BTotal Surplus A+B+C A+B+C+D +DDomesticQ Supplied Domestic Q Demanded -The Effects of a TariffoTariff: a tax on goods produced abroad and sold domesticallyoA tariff raises the price of imported goods above the world price by the amount of the tariff. Domestic suppliers of the good who compete with suppliers of the imported goods can now sell their good for the world price plus the amount of the tariff. The price of goods - both imported and domestic - rise by the amount of the tariffoThe tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade Domestic supply Before Tariff After Tariff ChangeConsumer Surplus A+B+C+D+E+F A+B -(C+D+E+F)Producer Surplus G C+G +CGov. Revenue None E +ETotal Surplus A+B+C+D+E+F+G A+B+C+E+G -(D+F)-Area D represents the deadweight loss from the overproduction of the good-Area F represents the deadweight loss from the underconsumption of the good-The area D+F shows the fall in total surplus and represents the deadweight loss of the tariffEquilibrium w/o tradeA Price w/ tariffBCD E FTariff Price w/o tariffWorld Price G Imports w/ tariffDomestic demand Q1s Q2s Q2d Q1dImports w/o tariff-The Lessons for Trade PolicyoQ: If the government allows a place to import and export goods, what will happen to the price of the good and the quantity of the good sold in the domestic market?-A: Once trade is allowed, the domestic price of the good will be driven to equal the price prevailing around the world. If the world price is higher, the domestic price will rise. The higher price will reduce the amount of goods consumed and raise the amount of goods produced in that country. Therefore, the country will become an exporter of that good because they have the comparative advantage in producing the good. -A: if the world price is lower than the domestic price, the domestic price will fall. The lower price will raise the amount of the good consumed and lower the amount that is produced. The country will become an importer of that good because the other countries have the comparative advantage. oQ: Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses?-A: If the price rises, the producers gain and the consumers lose. If the price falls, consumers gain and producers lose. In both cases, the gains are larger than the losses, thus free trade raises the total welfare of the countryoQ: Should a tariff be part of the new trade policy?-A: A tariff has an impact only if the country becomes an importer of the good. In this case, a tariff moves the economy closer to the no-trade equilibrium and like most taxes, has deadweight losses. Although the tariff improves the welfare of domestic producers and raises revenue for the government, these gains are more than offset by the losses suffered by consumers. The best policy, from the standpoint of economic efficiency, would be to allow trade without a tariff-Other Benefits of International TradeoIncreased variety of goodsoLower costs through economies of scale: some goods can be produced only if they are produced in large quantities - phenomenon called economies of scale oIncreased competition: a company shielded from foreign competitors is more likely to have market power, which gives it the ability to raise prices above competitive levels. This is a type of economic failure. Increased competition gives the invisible hand a better chance to work its magic.oEnhanced flow of ideas The Arguments for