1. WACE Economics: Unit 3
Video 2.2
THE GAINS FROM TRADE
Consumer and Producer Surplus
2. (c) Andrew Tibbitt 2017 2
Countries receive static and dynamic gains from international
trade
• Static gains are created because trade allows countries use
resources more efficiently
• Dynamic gains are created because trade leads to changes in
production and markets
Models to showing the static gains
from trade
3. (c) Andrew Tibbitt 2017 3
Countries receive static and dynamic gains from international
trade
• Static gains are created because trade allows countries use
resources more efficiently
• Dynamic gains are created because trade leads to changes in
production and markets
The level of static gains can be shown in a number of models:
1. Consumer and producer surplus diagrams
2. Production Possibility Frontier diagrams
3. Theory of Comparative Advantage calculations
Models to showing the static gains
from trade
4. International competitiveness
Specific products can be made more efficiently in some countries
than others because of quantitative and qualitative differences
in each country’s resources, including:
• Natural resources (e.g. minerals, energy)
• Human capital (skills, education, training)
• Physical capital (machinery, buildings, infrastructure)
• Technology (access to, embodiment)
• Enterprise (incentives)
• Governance (legal system, stability, corruption)
(c) Andrew Tibbitt 2017 4
5. Absolute and Comparative Advantage
(c) Andrew Tibbitt 2017 5
• A country has an absolute advantage in making a product if it
can make the product at a lower cost or more efficiently than
other countries.
• The term refers to two countries ability to make the same
product.
6. Absolute and Comparative Advantage
• A country has a comparative advantage in making a product if
the opportunity cost of making the product is lower than the
opportunity cost of making another product.
• Opportunity cost is value of other products sacrificed or
foregone in making a product.
• Hence it refers to differences in opportunity cost and two
countries ability to make two different products.
(c) Andrew Tibbitt 2017 6
• A country has an absolute advantage in making a product if it
can make the product at a lower cost or more efficiently than
other countries.
• The term refers to two countries ability to make the same
product.
7. Review of consumer and producer surplus
Domestic supply
Domestic demand
Price
Quantity
$20
(Equilibriu
m Price)
1000 cases
(Equilibriu
m Quantity)
Australian Market for red wine
Demand Curve =
Willingness to pay curve =
Marginal benefits curve
Supply curve =
Willingness to supply curve =
Marginal cost curve
Price everybody pays
Consumer surplus
Willingness to pay > price
(c) Andrew Tibbitt 2017 7
8. Domestic supply
Domestic demand
Price
Quantity
$20
(Equilibriu
m Price)
1000 cases
(Equilibriu
m Quantity)
Australian Market for Red Wine
Demand Curve =
Willingness to pay curve =
Marginal benefits curve
Supply curve =
Willingness to supply curve =
Marginal cost curve
Price everybody pays
Producer surplus
Willingness to supply < price
(c) Andrew Tibbitt 2017 8
Review of consumer and producer surplus
9. Domestic supply
Domestic demand
Price
Quantity
$20
(Equilibriu
m Price)
1000 cases
(Equilibriu
m Quantity)
Price everybody pays
Total welfare =
Community surplus =
Consumer surplus + Producer surplus
Quantity purchased
(c) Andrew Tibbitt 2017 9
Australian Market for Red Wine
Review of consumer and producer surplus
10. Exporters gain access to foreign markets
Domestic supply
Domestic demand
Price
Quantity
Access to export markets
increases demand.
Demand from exports
increases price until price
reaches ‘world’ price level.
Domestic price
Australia can export wine because the domestic price is initially lower
than ‘world’ price. Australia is a relatively competitive wine producer.
‘World’ price
Domestic +
export demand
(c) Andrew Tibbitt 2017 10
11. Domestic supply
Domestic demand
Price
Quantity
World price
Gain in producer surplus
outweighs loss in
consumer surplus
There is a loss in consumer surplus. Wine has
become more expensive in domestic market
Result? Australian consumers pay more for wine (and drink less of it). Consumer surplus
falls. But Australian wine producers sell more at higher prices and make more producer
surplus. Overall there is a rise in community surplus (triangle).(c) Andrew Tibbitt 2017 11
Exporters gain access to foreign markets
12. Domestic supply
Domestic demand
Price
Quantity
Consumers can buy to cheap imports
Australia will import toys because the domestic price is initially higher than
‘world’ price. Australia is a relatively uncompetitive toy producer.
(c) Andrew Tibbitt 2017 12
Toy market
World price
Price of imports
13. Domestic
supply
Domestic demand
Price
Quantity
Price in Oz
without trade
Toy Market
Australia imports toys because the price of Australian toys (the domestic price) is
initially higher than ‘world’ price. Australia is a relatively uncompetitive toy producer.
(c) Andrew Tibbitt 2017 13
Domestic
supply +
imports
Consumers can buy to cheap imports
World price
14. Domestic supply
Domestic demand
Price
Quantity
World price
The gain in consumer surplus from buying more, cheaper toys more than offsets loss in
producer surplus. There is an overall rise in community surplus (area of triangle).
There is a gain in consumer surplus
Toys have become more cheaper in domestic market
(c) Andrew Tibbitt 2017 14
Domestic
supply +
imports
Loss of producer surplus by
Australian toy producers
Consumers can buy to cheap imports
Price in Oz
without trade
World price
15. Summary: Gains from trade
(c) Andrew Tibbitt 2017 15
Price
Quantity
Oz
demand
S
Electrical goods in Australia
No trade
Wine in Australia
No trade
Oz
Price
Consumer
surplus
World
Price
Producer
surplus
Price
Quantity
Oz
demand
S
Oz
Price
World
Price
Consumer
surplus
Producer
surplus
16. Summary: Gains from trade
(c) Andrew Tibbitt 2017 16
Price
Quantity
Oz
demand
S
Electrical goods in Australia
With imports
Oz
Price
World
Price
S +
imports
Consumers
gain
Wine in Australia
With exports
Price
Quantity
Oz
demand
S
Oz
Price
World
Price
Producer
gain
Oz demand
+ exports
17. Summary: Gains from trade
(c) Andrew Tibbitt 2017 17
Price
Quantity
Oz
demand
S
Oz
Price
World
Price
S +
imports
Consumers
gain
Producers
loss
Electrical goods in Australia
With imports
Wine in Australia
With exports
Price
Quantity
Oz
demand
S
Oz
Price
World
Price
Consumer
loss
Producer
gain
Oz demand
+ exports
18. Summary: Gains from trade
(c) Andrew Tibbitt 2017 18
Price
Quantity
Oz
demand
S
Oz
Price
World
Price
S +
imports
Consumers
gain
Producers
loss
Electrical goods in Australia
With imports
Wine in Australia
With exports
Price
Quantity
Oz
demand
S
Oz
Price
World
Price
Consumer
loss
Producer
gain
Overall
gain
Overall
gain