Consider a competitive home market for a good. Suppose it is in equilibrium. The equilibrium price is $4/unit and the quantity traded is 10 units.Now suppose that home opens itself to trade with the rest of the world. Since now home market buyers are not restricted to purchasing the good from the home sellers and home sellers do not have to sell their good to home buyers, then a single price will apply in the entire world market for the good. Home and foreign buyers as well as home and foreign sellers will have to agree on a single price for the good and the total quantity that buyers (at home or abroad) will buy from sellers (at home and abroad) must be equal.But to avoid from now looking at how the home economy may affect the world market for the good, influence the world price, etc., we will make at this point the simplifying assumption that the home economy is very small compared to the economy of the rest of the world. As a result, the amounts of the good that home buyers may import from the rest of the world or that home sellers may export will be negligibly small compared to the world demand for and supply of the good. Consequently, the decisions of home buyers or sellers to import or export the good will not influence the world price of the good.
Let us do the welfare analysis of the equilibrium in the home market. The consumer surplus is the area of the triangle above the equilibrium price, bounded by the equilibrium quantity. The area of the triangle is equal to the base times the height divided by 2. The height of the triangle is 12 minus 4 = 8. The basis of the triangle is the equilibrium quantity 10. 8 times 10 is 80, divided by 2 = 40. It is $40.The producer surplus is the area of the triangle below the equilibrium price, bounded by the equilibrium quantity. The height of that triangle is 4-2 = 2, and the base is 10 units again. 2 times 10 is 20, divided by 2 = $10.We now introduce trade.
Let’s say now that the price in the rest of the world is $5/unit. Since whatever home buyers or sellers may import or export will not affect the price, then the prevailing world price will be (by our assumption) $5/unit. Home buyers and sellers will just have to adjust their choices accordingly. Because that will be the price of the good in the market.To determine the amount of the good that home buyers will buy at such higher price, we use the demand equation and evaluate it to the world price of $5/unit. We find that the quantity buyers will now demand at such price is 8.75 units. At that price, however, home sellers will supply 15 units. Since home buyers will buy 8.75 units out of the 15 supplied by home sellers, the remainder will be exported to the rest of the world: 15 – 8.75 = 6.25.Let us now do the welfare analysis – that is, let us see what happens to the welfare of buyers (their consumer surplus), to the welfare of sellers (their producer surplus), and to the market as a whole (the total surplus) as a result of trade with the rest of the world.
The new consumer surplus is given by the area of the triangle above the prevailing world price of $5/unit, bounded by the quantity the buyers purchase at that price, which is 8.75 units. The height of that triangle is 12 minus 5 or 7, and the base is 8.75 units. 7 times 8.75 = 61.25, divided by 2 = $30.625.The new producer surplus is the area of the triangle below the world price, bounded by the quantity they will be selling, to domestic or foreign buyers, the quantity that they will be selling at home plus the quantity they will be exporting to the rest of the world. The height of that triangle is 5 minus 2 = 3, and the base is 15 units. 3 times 15 is 45, divided by 2 = $22.5.The total surplus is the sum of the consumer and producer surpluses: $30.625 plus $22.5 = 53.125.What happened to the welfare of buyers (CS), the welfare of sellers (PS), and the welfare of the market as a whole (TS) as a result of trade?
This table summarizes the results of trade – the impact on the well-being of buyers and sellers in that market.The consumer surplus drops by $9.37 while the producer surplus increases by $12.50. As a whole, the market is better off by $3.13.This highlights the main trade issues we will encounter in the course:On the one hand, the market as a whole seems to benefit from trade. However, the distribution of those benefits are very contentious, since there are winners and losers.We should end this presentation mentioning one big limitation of our analysis so far: We have only considered one market. This is called partial equilibrium analysis. Actual economies have many markets and the markets (and also non-market sectors) are all interrelated. What happens in one market reverberates through the other markets. So, we should try and get a sense of how what happens to one market relates to what happens in an economy as a whole. In order for us to move to general equilibrium analysis -- and that’s what the analysis is called when we try to see the repercussions of what happens in one market on the rest of the economy – we will need to develop a few additional tools to those we have used so far. That is the theme of the next presentation.
Intecon trade (one market)
InternationalEconomics –Trade in onemarketJhuato.email@example.com
GoalApply the basic market model tostudy the effects of internationaltrade on a market when: The home economy is small and cannot influence the world price The home economy is large and influences the world price
Home market equilibrium Demand: P =12 -.8Qd Supply: P = 4 +.2Qs Equilibrium: (Q = 8, P = 5.6) * *
Home market with trade Pw = $5 / unit ® 5 = 12 -.8Qd ® Qd = (12 - 5) /.8 = 8.75; 5 = 2 +.2Qs ® Qs = (5 - 2) /.2 = 15 X = Qs - Qd = 15 - 8.75 = 6.25 At the world price $5/unit, the quantity demanded by home buyers is now 8.75 units while the quantity supplied by home sellers is 15. Home buyers buy 8.75 units and the rest, 6.25 units, are exported to the rest of the world.
Trade: Welfare analysis Before trade After trade DifferenceCS $40.00 $30.63 -$9.37PS $10.00 $22.50 +$12.50TS $50.00 $53.13 +$3.13 Issues with trade: • The market as a whole gains: $3.13 • There are winners and losers: • Sellers win $12.50 • Buyers lose $9.37