ECON 1 Lecture Notes - Lecture 11: Deadweight Loss, Underconsumption, Market Power

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3 Jun 2018

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Chapter 9: International Trade

- PW = world price of a good, the price in the world markets

- PD = domestic price without trade

- If PD < PW ,

o The country has the comparative advantage in the good

o Under free trade, the country exports the good

- If PD > PW ,

o The country does NOT have a comparative advantage

o Under free trade, the country imports the good

- Assumption: A small economy is a price taker in world markets; aka its actions have no effect on PW

o This is not always true, especially for the US, bc:

o No seller would accept less then PW, since they could sell the good for PW in world markets

o No buyer would pay more than PW , be they could buy the good for PW in world markets

- Example: a country that exports soybeans

o Without trade:

▪ PD - $4

▪ Q – 500

▪ PW - $6

o Under free trade:

▪ Domestic consumers demand 300

▪ Domestic producers supply 750

▪ Exports: 450

o Without trade

▪ Consumer Surplus = A+ B

▪ Producer Surplus = C

▪ Total surplus: A+B+C

o With trade

▪ CS = A

▪ PS = B+C+D

▪ Total surplus: A+B+C+D

- Example: a country that imports plasma TVs

o Without trade

▪ PD - $3000

▪ Q – 400

o In world markets

▪ PW - $1500

o Without trade

▪ CS = A

▪ PS = B+C

▪ Total surplus: A+B+C

o With trade

▪ CS = A+B+D

▪ PS = C

▪ Total surplus: A+B+C+D

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Document Summary

Pw = world price of a good, the price in the world markets. If pd < pw : the country has the comparative advantage in the good, under free trade, the country exports the good. If pd > pw : the country does not have a comparative advantage, under free trade, the country imports the good. Example: a country that imports plasma tvs: without trade, pd - , q 400. In world markets: pw - , without trade, cs = a, ps = b+c, total surplus: a+b+c, with trade, cs = a+b+d, ps = c, total surplus: a+b+c+d. The welfare effects of trade: whether a good is imported or exported, trade creates winners and losers. Tariff: a tax on imports: ex: cotton shirts, pw - , consumers must pay for the imported shirt, domestic producers can charge for a shirt, the price facing domestic buyers and sellers is pw+t.

Related Questions

1. True or False: Increases in imports will always lead to NET job losses in the U.S. domestic economy.

Would this be false?

2. True or False: If all countries could restrict imports and promote exports, world output would rise.

Would this be false as well?

3. Which of the following statement is FALSE?
A.Quotas restrict the quantity of a good that is imported into a country.
B.One result of quotas is that consumers of the good facing the quota will pay a higher price for the good.
C.Domestic producers of the good will benefit because they face less foreign competition.
D.Government collects the revenue from quotas.

Is it B?

4. True or False: If country A has an absolute advantage in producing many goods and services over another country B, then country A will NEVER have an incentive to trade with country B.

I want to say its False because regardless if country A has an absolute advantage it still needs to trade with country B. I think?

In the country of Wiknam, there is only one firm that produces and sells soccer ball. Initially, international trade is prohibited in the country. The following equations describe the monopolist's demand, marginal revenue, total cost and marginal cost: Demand: P = 10 - Q Marginal Revenue: MR = 10 - 2Q Total Cost: TC = 3 + Q + 0.5Q2 Marginal Cost: MC = 1 + Q Q stands for quantity and P is the price measured in Wiknamian dollars.

a) How many soccer balls does the monopolist produce? At what price are they sold? What is the monopolist's profit? Show all your calculations.

b) One day, the King of Wiknam decrees that henceforth, there will be free trade- either imports or exports- of soccer balls at the world price of $6. The firm now becomes a price taker in a competitive market. What happens to the domestic production of soccer balls? What happens to domestic consumption? Does Wiknam export or import soccer balls?

c) Suppose that the world price was not $6, but instead, happens to be exactly the same as the domestic price without trade as determined in part a) above. Would allowing trade change anything for the Wiknamian economy? Explain

purplewolf822

3. Gains from trade

Consider two neighboring island countries called Euphoria and Contente. They each have 4 million labor hours available per week that they can use to produce rye, jeans, or a combination of both. The following table shows the amount of rye or jeans that can be produced using 1 hour of labor.

Country	Rye	Jeans
Country	(Bushels per hour of labor)	(Pairs per hour of labor)
Euphoria	8	32
Contente	12	24

Initially, suppose Contente uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Euphoria uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Euphoria produces 24 million bushels of rye and 32 million pairs of jeans, and Contente produces 12 million bushels of rye and 72 million pairs of jeans. Assume there are no other countries willing to trade goods, so, in the absence of trade between these two countries, each country consumes the amount of rye and jeans it produces.

Euphoria's opportunity cost of producing 1 bushel of rye isï¼ ï¼ of jeans, and Contente's opportunity cost of producing 1 bushel of rye isï¼ ï¼ of jeans. Therefore, ï¼ ï¼has a comparative advantage in the production of rye, andï¼ ï¼ has a comparative advantage in the production of jeans.

Suppose that each country completely specializes in the production of the good in which it has a comparative advantage, producing only that good. In this case, the country that produces rye will produce ï¼ ï¼million bushels per week, and the country that produces jeans will produce ï¼ ï¼ million pairs per week.

In the following table, enter each country's prod uction decision on the third row of the table (marked "Production").

Suppose the country that produces rye trades 26 million bushels of rye to the other country in exchange for 78 million pairs of jeans.

In the following table, select the amount of each good that each country exports and imports in the boxes across the row marked "Trade Action," and enter each country's final consumption of each good on the line marked "Consumption."

When the two countries did not specialize, the total production of rye was 36 million bushels per week, and the total production of jeans was 104 million pairs per week. Because of specialization, the total production of rye has increased byï¼ ï¼million bushels per week, and the total production of jeans has increased by ï¼ ï¼million pairs per week.

Because the two countries produce more rye and more jeans under specialization, each country is able to gain from trade.

Calculate the gains from tradeâthat is, the amount by which each country has increased its consumption of each good relative to the first row of the table. In the following table, enter this difference in the boxes across the last row (marked "Increase in Consumption").

	Euphoria		Contente
	Rye	Jeans	Rye	Jeans
	(Millions of bushels)	(Millions of pairs)	(Millions of bushels)	(Millions of pairs)
Without Trade
Production	24	32	12	72
Consumption	24	32	12	72
With Trade
Production
Trade action
Consumption
Gains from Trade
Increase in Consumption

ECON 1 Lecture Notes - Lecture 11: Deadweight Loss, Underconsumption, Market Power

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