EC120 Lecture Notes - Lecture 19: Deadweight Loss, Demand Curve, Comparative Advantage
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Let"s start with the case of no international trade. The market for textiles in isolands consists solely of isolandian buyers and sellers: when an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. This figure shows consumer and producer surplus in an equilibrium without international trade for the textile market in the imaginary country of isoland. If the world price of textiles is lower than the domestic price, then isoland would become an importer of textiles. By comparing the world price and the domestic price before trade, we can determine whether isoland is better or worse at producing textiles than the rest of the world. Pw (world market price) , pd (domestic price) 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. The isolandians are said to be price takers in the world economy.