Chapter 9: Application:International Trade
The story of the textiles industry raises important questions for economic policy: How does
international trade affect economic well-being? Who gains and who loses from free trade among
countries, and how do the gains compare to the losses?
THE DETERMINANTS OF TRADE
The steel market is well suited to examining the gains and losses from international trade.
Moreover, the steel market is one in which policymakers often consider (and sometimes
implement) trade restrictions to protect domestic steel producers from foreign competitors.
The Equilibrium without Trade
The sum of consumer and producer surplus measures the total benefits that buyers and sellers
gain from trade.
When an economy cannot trade in world markets, the price adjusts to balance domestic supply
- If the government allows Isolandians to import and export steel, what will
happen to the price of steel and the quantity of steel sold in the domestic steel
- Who will gain from free trade in steel and who will lose, and will the gains
exceed the losses?
- Should a tariff (a tax on steel imports) be part of the new trade policy?
The World Price and Comparative Advantage
To figure out whether Isoland will become a steel importer or exporter, we need to compare the
current Isolandian price of steel with that of the rest of the world. If the world price of steel is
higher than the domestic price, then Isoland will export steel once trade is permitted.
Conversely, if the world price of steel is lower than the domestic price, then Isoland will import
This comparison provides an answer to whether Isoland has a comparative advantage in
producing steel. The domestic price reflects the opportunity cost of steel.
THE WINNERS AND LOSERS FROM TRADE
To analyze the welfare effects of free trade, the Isolandian economists begin with
the assumption that Isoland is a small economy compared to the rest of the
world so that its actions have little effect on world markets. Isolandians are said to be
in the world economy. That is, they take the world price of steel as given. They can sell steel at
this price and be exporters or buy steel at this price and be importers.
The small-economy assumption is not necessary to analyze the gains and losses from
international trade. However, it makes it easier to analyze the economic model and the and the
basic conclusions do not change in a large economy.
The Gains and Losses of an Exporting Country
Once trade is allowed, the domestic price rises to equal the world price. The supply
curve shows the quantity of steel produced domestically, and the demand curve shows the
quantity consumed domestically. Once the domestic price rises to equal the world price, the
domestic quantity supplied differs from the domestic quantity demanded, the difference between
these two equals the exports from Isoland.
Although domestic quantity supplied and domestic quantity demanded differ, the steel market is
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