gainsfromtrade - October 7 2005 The gains from trade These...

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October 7, 2005 The gains from trade These notes explain the simplest model for calculating the gains from trade. I use a partial equilibrium model, i.e. a model in which all prices and income are held f xed, except for the price of the particular commodity that we are interested in. In contrast, a general equilibrium model takes into account the prices of inputs, such as labor and raw materials, and the prices of complements and substitutes. First I review the meaning of consumer and producer surplus, two welfare measures that are needed to calculate the gains from trade. Then I explain the measurement of the welfare increase when a country moves from autarky (notrade)tofreetrade .NextIshowhowatraderestr ict ion ,suchasatar i f or export tax, or a quantity restriction a f ects welfare, relative to free trade. This simple analysis yields a number of important insights. These are: (i) There are gains to trade regardless of whether the country is an importer or an exporter. (ii) Any policy change, e.g. a move from autarky to free trade, or a move from free trade to restricted trade, has distributional e f ects. Some agents win and others lose. (iii) A trade restriction leads to a welfare loss: the gain to the winner is less than the loss to the loser. (iv) The welfare loss is proportional to the square of the trade restriction (e.g. the tari f ). Therefore, if the restriction is small (in the sense that it leaves the economy close to free trade), a further reduction in the restriction (a movement toward free trade) has a very small welfare e f ect. (v)The distributional e f ect of a trade restriction is large relative to the welfare e f ect. That is, the amount by which a winner gains or a loser loses is large relative to the net losses. 1 A review of Consumer, Producer and So- cial Surplus In order to evaluate the bene
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oranges.) The simplest welfare measures, and the ones that I describe here, are consumer and producer surplus. Consumer surplus : the dollar value to consumers of participating in a market. Figure 1a shows a graph of individuals’ "willingness to pay" for a commodity. In this example, the individual who values the commodity most is willing to pay $10, the second individual is willing to pay $8, and so on. If the price happens to be $6, the market demand is 5 units, because there are f vepeop lew i l l ingtopayatleast$6tobuyaun it . Eachperson who buys obtains a "surplus": the di
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gainsfromtrade - October 7 2005 The gains from trade These...

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