Week4_InternationalTrade

Week4_InternationalTrade - INTERNATIONAL TRADE AND ECONOMIC...

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INTERNATIONAL TRADE AND ECONOMIC EFFICIENCY
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PRICES AND COMPARATIVE ADVANTAGE Trade relations are based on the relative levels of domestic [pre-trade] prices and prevailing world prices. Once trade is open, domestic prices are essentially replaced by world prices. If the world price is higher than the [pre-trade] domestic price, the domestic country will export once trade is permitted. Conversely; if the world price is lower, the domestic country will import. As one can see, comparing the world price and the [pre- trade] domestic price indicates whether the domestic country has a comparative advantage. If the domestic price is lower, home country has a comparative advantage [and, as such, is an exporter].
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PRICE TAKING Our analysis assumes that the home country is a small economy compared to the rest of the world. It has no market power. (Its actions have little effect on world markets.) The implications of this assumption are quite straightforward: the home country is a price-taker. A large economy [such as US or China] can alter world prices quite easily. The price-taking assumption is there to simplify our analysis. The conclusions would not change even with price-setting assumptions.
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Figure 1 The Equilibrium without International Trade Consumer surplus Producer surplus Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Equilibrium price Equilibrium quantity
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Figure 2 International Trade in an Exporting Country Price of Steel 0 Quantity of Steel Domestic supply Price after trade World price Domestic demand Exports Price before trade Domestic quantity demanded Domestic quantity supplied
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Week4_InternationalTrade - INTERNATIONAL TRADE AND ECONOMIC...

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