Basic Welfare Analysis of
Two-Country Trade
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Welfare Analysis - International Economics - Lecture Slides, Slides of Economics
Topics include in International Economics trade theory, tariffs and other protectionist policies, trade agreements between nations, the World Trade Organization, balance of payments, exchange rates, and the European Monetary Union. Key points for this lecture are: Welfare Analysis, Two-Country Trade, International Trade Changes, Exporting Country, Consumers, Domestic Consumers, Domestic Producers, Importing Country, Trade, Terms of Trade
Typology: Slides
2012/2013
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Basic Welfare Analysis of
Two-Country Trade
Price
Europe + Japan = World Quantity
Recap: If the autarky equilibrium price is the same for both countries, no trade will occur even when trade is allowed. In this case, trade changes nothing.
No Change = No Fun
• If, for any country, free trade relative
prices are the same as its pre-trade (or
autarky) relative prices, then that country
will be neither better off nor worse off as a
result of trade.
- This does not mean that no citizen of that country will be
worse off when autarky ends and free trade begins, but that the losses of those who lose will not exceed the gains of those who gain, so the country as a whole will not lose.
Change = Fun
• And if, for any country, free trade relative
prices are different from the pre-trade (or
autarky) relative prices, then that country
will gain from trade.
- Again, this does not mean that every citizen of the
country will gain from trade, but only that the gains of the gainers will exceed the losses of the losers, so that the gainers will, at least potentially, be able to compensate the losers and still have some gains left over for themselves.
- See the handed-out copy of Chapter 9 of Principles of Economics , fourth edition, by N. Gregory Mankiw
Japan: The Exporting Country
Price of Steel
Quantity of Steel
Domestic supply
Price after trade (^) World price
Domestic Exports demand
Price before trade
Domestic quantity demanded
Domestic quantity supplied
Japan: The Exporting Country
D
C
B
A
Price of Steel
0 Quantity of Steel
Domestic Price supply after trade (^) World price
Exports
Price before trade
Domestic demand
Europe: The Importing Country
Price
of Steel
0 Quantity
Price
after
trade
World
price
of Steel
Domestic
supply
Domestic
demand
Imports
Domestic
quantity
supplied
Domestic
quantity
demanded
Price
before
trade
Europe: The Importing Country
C
B D
A
Price of Steel
(^0) Quantity of Steel
Domestic supply
Domestic demand
Price after trade
World price Imports
Price before trade
The Winners And Losers From
Trade
• Irrespective of whether a country exports a
good or imports it, the gains of those who
gain exceed the losses of those who lose.
• That is, the net change in total surplus is
always positive.
Domestic
supply
Domestic
demand
Price
before
trade
Price
of Steel
0 Quantity
of Steel
A
B
Had the world price been equal to the autarky price, there would have been no trade and, therefore, no gains from trade.
WP 1
WP 2
When the world price is WP 1 , the country imports steel and the gain from trade is A. When the world price is WP 2 , the gain from trade is A + B. That is, the greater the change in price caused by trade, the greater the gains from trade.
Less Change = Less Fun
• If there is an increase in the relative price
of a country’s imported good,
– its national welfare will decrease, and
– the national welfare of the country or
countries that the good is being imported from
will increase.
- See ―The Welfare Effects of Changes in the Terms of Trade‖ in page 116 of KO.
Terms of Trade
• The relative price of the imported good is its
price measured in units of the exported good.
• If this increases, then the relative price of the
exported good, which is its price measured in
units of the imported good, necessarily
decreases.
• The relative price of a nation’s exported good is
also called its terms of trade
- See page 112 of KO.
Europe + Japan = World
Price
Quantity
A B C D E
F
G
H
I J K L M
N O P Q R
There is an increase in Europe’s demand for its imported good. This increases (worsens) its terms of trade and decreases (improves) Japan’s terms of trade.
Growth and Terms of Trade
Europe Japan World
Before After Before After Before After
Consumer Surplus
ABCD ABFG IJ I NP NO
Producer Surplus
E CE LM JKLM R PQR
Total Surplus
ABC D E ABCE FG IJLM IJ K LM NPR N O P Q R
Europe’s growth has a positive effect (FG) and a negative effect (the loss of D) from the worsening of the terms of trade. The worsening of Europe’s terms of trade implies an improvement of Japan’s terms of trade (and the gain of K). The World gains OQ from growth in Europe. Note: O + Q = F + G + K - D.