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University of Toronto Scarborough
Economics for Management Studies
Garth Frazer

Chapter 4Summary1Equilibrium in a closed economy is determined by 3 conditions a producer optimization b consumer optimization and c market clearing2If production and consumption are competitive the closed economy equilibrium is efficient in the sense that the economy attains the highest community indifference curve subject to the feasibility of production3International trade removes the constraint that an economy consumes only what it produces It also replaces the market clearing condition for equilibrium with the much weaker condition that the value of total production must equal the value of total consumption This restriction is exactly equivalent to the total restriction that the value of imports must equal the value of exports Once economy equilibrium is determined by the producer and consumer optimization conditions plus the trade balance condition4A countrys willingness to trade with the rest of the world can be summarized by an excess demand for one of the two goods say X This function gives the countrys desired imports or exports at all possible price ratios This curve slopes downward like a conventional demand curve except that the quantity demanded can be either positive or negative A negative excess demand simply means that the country wishes to export at a given price Excess demand is zero at the countrys autarky price and movement away from autarky is welfareimproving5A second country can be introduced and its excess demand curve derived International equilibrium is found at the price where the exports of one country match the imports of the other country This price is between the autarky price levels of the two countries The autarky price differences determine the direction of trade with the lowprice country exporting the good and the highprice country importing the good6Because of the trade balance restrictions only one market needs to be considered general equilibrium If that market clears so does the other marketChapter 5Summary1Countries can gain from trade if they can trade at any prices different from their autarky prices Any price difference allows a country to gain by selling what is relatively more valuable on world markets and buying on world markets what is relatively more costly to produce at home2There is no particular welfare significance to the direction of trade International price differences determine the most efficient direction of trade Canada and the US gain from exporting primary products because they are very efficient at producing them3Gains from trade are mutual The gains by one country are not at the expense of other countries There are generally many trades that can leave both parties better off Each possible trade leads to a different distribution of the gains with the result that there is some element of conflict as well as an element of cooperation in international trade4There are certain assumptions needed to prove the gainsfromtrade theorem When there are various distortions such as taxes or imperfect competition or when there are nonconvexities due to scale economies gains cannot be guaranteed On the other hand scale economies and imperfect competition are nevertheless likely to be very important sources of gains from trade Thus these problems do not argue against trade the simply emphasize th
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