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Chapter 9

ECON 1000 Chapter Notes - Chapter 9: Trade Restriction, Import Quota, Deadweight Loss


Department
Economics
Course Code
ECON 1000
Professor
Troy Joseph
Chapter
9

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ECON 1000
CHAPTER 9- APPLICATION: INTERNATIONAL TRADE
The determinants of trade
The equilibrium without trade
When an economy cannot trade in world markets, the price adjusts to balance domestic supply
and demand.
The world price and competitive advantage
The price prevailing in world markets is referred to as the world price. If the world price of
textiles is higher than the domestic price, then they will export textiles once trade is permitted.
Conversely, if the world price of textiles is lowe than the domestic price, then they will import
textiles.
In essence, comparing the world price and the domestic price before trade indicates whether
they have a comparative advantage in producing textiles. The domestic price reflects the
opportunity cost of textiles. If the domestic price is low, the cost of producing it is low,
suggesting that they have a comparative advantage in producing textiles relative to the rest of
the world. If the domestic price is high, then the cost of producing textiles is high, suggesting
that foreign countries have a comparative advantage in producing textiles.
The winners and losers from trade
To analyze welfare effects of free trade, economists begin with the assumption that they are a
small economy compared to the rest of the world. This assumption means that their actionas
have little effect on world markets. They are said to be the price takers in the world economu.
That is, they take the world proce of textiles as given. They can be an exporting country by
selling textiles at this proce or an importing country by buying textiles at this price.
The gains and losses of an exporting country
Once free trade is allowed, the domestic price rises to equal the world price. No seller of tetiles
would accept less than the world price, and no buyer would pay more than the world price.
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After the domestic price has risen to equal to the world price, the domestic quantity supplied
differs from the domestic quantity demanded. The supply curve shows the quantity of textiles
supplied and their sellers. They become an exporter.
Although domestic quantity supplied and domestic quantity demanded differ, the tetile
markets is still in equilibrium because there is now another participant in the market: the rest
of the world.
Now consider the gains and losses from opening up trade. Clearly, not everyone benefits. Trade
forces the domestic price to rise to the world price. Domestic producers of textiles are better
off because they can now sell textiles at a higher price, but domestic consumers of textiles are
worse off because they have to buy textiles at a higher price.
Before trade is allowes, the price of textiles adjusts to balance domestic supply and domestic
demand. Consumer surplus, the area between the demand curve and the before trade price is
area A + B. Producer surplus, the area between the supply curve and the before trade price is
the area C. Total surplus before trade, the sum of consumer and producer surplus is area A + B
+ C.
After trade is allowed, the domestic price rises to the world price. Consumer surplus is reduced
to area A. Producer surplus is increase to area B + C + D, Thus total surplus with trade is area A +
B + C + D
Therefore:
When a country allows trade and becomes an exporter of a good, domestic producers of the
good are better off and domestic consumers of the good are worse off.
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