Ch2_Demand&Supply

Ch2_Demand&Supply - TRADE ANALYSIS WITH DEMAND AND...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: TRADE ANALYSIS WITH DEMAND AND SUPPLY 1 Overview Questions About International Trade 1. Why do countries trade? What is the basis for trade, especially the product (commodity) composition? 2. What are the overall gains (or losses) from trade for each country? 3. What are the effects of trade on each country’s economic structure? Production, Consumption? 4. What are the effects of trade on the distribution of income within each country? Winners, Losers? 3 Surpluses • Producer surplus: The amount a producer gains from a “market” sale: The difference between the amount he actually receives and The minimum amount he would have been willing to receive A consequence of arms-length market transactions and competition We are pretty familiar with this. We call it “Economic Profit” 10 •1 Producer Surplus • Producer’s decision: max {pq - c(q)} • the cost function c(q) depends on factor prices and techniques of production (# of factors required to produce one unit output) supply function: qs=qs(p,…) p q 11 Producer Surplus (cnt) cnt) • In the diagram, the producer surplus of selling 10 units of apple is a p 12 a b 10 q 12 Producer Surplus (cnt) cnt) • Why? The producer receives $12 * 10 = $120 But the minimum amount the producer would be willing to receive is the area under the supply curve The supply curve shown is q = p - 2 Consider: he would accept $3 for the 1st unit $4 for the 2nd unit, etc. If you add it all up you get $75 If you calculate the area: 12*10 - ½ ((12-2)*10) = $70 Surplus is $50 13 •2 On Triangles • The area of a triangle is: ½ (Height * Base) Base Height But the “base” can be any side of the triangle, so any triangle can be rotated to look like this 14 Surpluses • Consumer surplus: The amount a consumer gains from a “market” purchase: The difference between the amount she actually pays and The maximum amount she would have been willing to pay A consequence of arms-length competition Note the parallel to producer surplus market transactions and 15 Consumer Surplus • Consumer decision: max U(q1,q2) • Budget constraint: I = q1 p1 + q2 p2 Demand function: qi=qi(p1, p2, I) p q 16 •3 Consumer Surplus (cnt) cnt) • In the diagram, the consumer surplus of consuming 10 units of apple is given by a p 12 a b 10 q 17 Consumer Surplus (cnt)) cnt • Why? The consumer pays $12 * 10 = $120 But the maximum amount the consumer would pay is the area under the demand curve The demand curve shown is q = 22 – p Consider: she would pay $21 for the 1st unit $20 for the 2nd unit, etc. If you add it all up you get $165 If you calculate the area: 12*10 + ½ ((22-12)*10) = $170 Surplus = $170 - $120 = $50 18 Industry Equilibrium Closed Economy Supply Consumer surplus PAutarky Demand Producer surplus QAutarky 19 •4 Industry Equilibrium with Free Trade (Small Open Economy) SCanada Gains from free trade ` PAutarky `` PWorld ` DCanada QDomestic Production QTotal QAutarky Imports 20 What if the World Price is Above the Autarky Price? • What happens if the autarky price is higher than the world price? Does opening to world trade still make the country better off? 26 Deriving the Demand for Imports SCanada PWorld DCanada Production QDomestic Imports QTotal 27 •5 Deriving the Demand for Imports (Lower World Price) SCanada PWorld DCanada QDomestic Production QTotal Imports 28 International Market (Small Economy) Gains from free trade Supply Rest of the world PWorld Demand for imports Imports 29 Why Are the Two Areas the Same? • From the international market, the gain is: Imports*ΔP/2 ΔP is the price difference between autarky and free trade • From the domestic market, the net gain is: (QD – QS )*ΔP/2 But QD – QS is exactly imports 30 •6 Demand and Supply of Imports (Large Economy) Domestic market Rest of the World Imports demand Imports supply World market Excess supply 31 Demand and Supply of Imports (Large Economy) Domestic market Rest of the World Imports demand Imports supply World market No excess supply 32 International Market (Large Open Economy) Gains Domestic Country Supply Rest of the World PWorld Gains Rest of the World Demand for Imports Imports 33 •7 Adding Up Supplies & Demands • Clearly the “world” price is determined by the “world” demand and the “world” supply Suppose the domestic demand is: qd = 220 – 10p, and the rest-of-the-world demand is: qW = 5,600 – 210p What is the new world demand? qnewW = 5,820 – 230 p; just add up the expressions for the qs 34 A Numerical Example • • • Consider the market for bicycles in a small open economy like Sweden The demand in Sweden is: QD = 250 – 0.50 P The supply in Sweden is: QS = -150 + 1.50 P Questions 1. 2. 3. 4. What are the equilibrium price and quantity without international trade? What are the equilibrium quantities if Sweden can trade with the rest of the world at P=250? What is the effect of the shift from no trade to free trade on Swedish consumer surplus? On Swedish producer surplus? What is the net national gain or loss for Sweden? What is the effect if the international price is P=120? 35 Another Example c b a 42 42 •8 Key Points 1. Why do countries trade? What is the basis for trade, especially the product (commodity) composition? We have shown that • if the world price is lower than the autarky price, the home country becomes better off by importing • If the world price is higher than the autarky price, the home country becomes better off by exporting 43 Key Points 2. What are the overall gains (or losses) from trade for each country? • • If the home country imports, producers lose and consumers gain If the home country exports, producers gain and consumers lose The gains exceed the losses in either case • Does that mean autarky is the worst possible policy? • 44 44 Key Points 3. What are the effects of trade on each country’s economic structure? Production, Consumption? • • Production falls if the country imports, rises if the country exports Consumption rises if the country imports, falls if the country exports 4. What are the effects of trade on the distribution of income within each country? Winners, Losers? • • Haven’t dealt with that at all yet! Also haven’t talked about why the world price might why differ from the country’s autarky price 45 •9 THE END 46 •10 ...
View Full Document

This note was uploaded on 02/15/2011 for the course FBE 462 at USC.

Ask a homework question - tutors are online