Chapter Two The Basic Theory Using Demand and Supply ????????

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Chapter TwoThe Basic Theory Using Demand and
Supply????????
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2.1 Introduction

• Objective
• To analyze free trade equilibrium and gains
  from trade.

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Contents

• Demand and supply curves
• Consumer and producer surplus
• No-trade (Autarky) equilibrium
• Free trade equilibrium
• Effects of free trade

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2.2 Four Questions about Trade

1. Why do countries trade? What determines the
   pattern of trade ?
2. How does trade affect each countrys production
   and consumption?
3. How does trade affect the economic well-being of
   each country?
4. How does trade affect the distribution of income
   among various groups within each country?

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2.3 Demand and Supply

• Demand Curve
• The relationship between the price charged
  and the quantity of a good demanded.
• For a normal good, demand declines when price
  rises.

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2.3 Demand and Supply

• Price elasticity of demand
• Change in quantity demanded ()
• e-
• Change in price ()
• If egt 1, demand is elastic
• If elt 1, demand is inelastic.

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2.3 Demand and Supply

• Consumer Surplus
• ?????
• Consumer well-being from the difference
  between the value of a good and the price paid
  for it.

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At 2000/unit Total value (V) ctu Total
payment (P) tu Consumer surplus V - P c At
1000/unit ?
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2.3 Demand and Supply

• Supply Curve
• The relationship between the price charged
  and the quantity of a good supplied.

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Upward sloping Increasing marginal cost ??????
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2.3 Demand and Supply

• Price elasticity of supply
• Change in quantity supplied ()
• e
• Change in price ()
• If egt 1, supply is elastic
• If elt 1, supply is inelastic.

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2.3 Demand and Supply

• Producer Surplus
• ?????
• Producer well-being from the difference
  between the revenue received and the cost
  incurred.

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At 1000/unit Total Revenue (R) ez Total Cost
(C) z Producer surplus R - C e
At 2000/unit ?
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2.4 No-trade Equilibrium
National supply National Demand
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Consumer surplus c Producer surplus h ch ?
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2.5 Free Trade Equilibrium

• A two-country world
• Home country USA
• Foreign country
• The rest of the world

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No-trade Equilibrium A
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No-trade equilibrium H
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2.5 Free Trade Equilibrium

• Price Change and Trade
• Rest of the world Exporter
• Price
• Production Consumption
• Export Production - Consumption

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2.5 Free Trade Equilibrium

• Price Change and Trade
• USA Importer
• Price
• Production Consumption
• Import Consumption - Production

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• Free Trade Equilibrium

Foreign Exports US Imports
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• Free Trade Equilibrium

• Foreign Exports
• US Imports
• 50 thousand units
• Price 1000/unit

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• Free Trade Equilibrium

What if world price is above or below 1000/unit ?
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Free Trade Equilibrium
800
Gap
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2.6 Effects of Free Trade

• Effects in the importing country
• Effects on consumers
• Effects on producers
• Effects on the whole country

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Producer surplus - a Consumer surplus (abd
) Net national gains bd
One dollar, one vote metric
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2.6 Effects of Free Trade

• Effects in the exporting country
• Effects on consumers
• Effects on producers
• Effects on the whole country

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Producer surplus (jkn) Consumer surplus -
(jk) Net national gains n
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2.6 Effects of Free Trade

• Which country gains more?
• Both countries gain from free trade, but the
  gains may be unequal.

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Which country gains more?
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Comparing (bd) and n
The side with less elastic trade curve gains
more.
n exporters surplus bd importers surplus
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2.7 Summary

• A product will be exported from countries where
  its price was lower without trade to countries
  where its price was higher.
• Trade affects production and consumption in both
  countries. In the exporting country, production
  rises while consumption falls. The opposite is
  true for the importing country.

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Summary

• Both countries gain from free trade. The country
  with a less elastic trade curve or a larger price
  change gains more.
• Within the trading countries, gainers are
  producers of exportable products and consumers of
  imported products losers are producers of
  import-competing products and consumers of
  exportable products.