Download Welfare Analysis of Trade

Trade and tariffs
Welfare analysis
Measuring Welfare:
• (for more detail on welfare analysis, refer to any
microeconomic textbook)
• An approximate measure of changes in welfare can be
obtained using the concepts of consumers’ and producers’
surplus.
– consumers’ surplus is the total value to consumers of
their consumption of a good less the amount they have to
pay for it.
– producers’ surplus is the total revenue received from the
sale of a good less its costs of production
Demand curve and marginal
utility
• Demand curve shows how
much consumers would
buy of a particular good at
any particular price.
• It is based on optimisation
exercise: compare
marginal benefit of extra
unit of good with price.
• Market demand is
aggregated over all
consumers’ demand
curves
– horizontal sum.
Welfare Analysis: Consumer
Surplus
• Since demand curve based
on marginal utility, it can be
used to show how
consumers’ well-being
(welfare) is affected by
changes in the price.
• Gap between marginal
utility of a unit and price
paid shows ‘surplus’ from
being able to buy c* at p*.
price
Triangle is sum of
all gaps between
marginal utility
and price paid
(summed over
total consumption)
p*
Demand
curve
c*
quantity
Welfare Analysis: Consumer
Surplus
• If the price falls:
– consumers obviously better off
– consumer surplus change quantifies this
intuition.
• Consumer surplus rise, 2 parts:
– pay less for units consumed at old price;
measure of this = area A:
• = price drop times old consumption
– gain surplus on the new units consumed
(those from c* to c’)
– measure of this = area B:
• = sum of all new gaps between
marginal utility and price.
price
p*
p’
A
B
Demand
curve
c* c’
quantity
Supply curve and marginal costs
• Supply curve shows how
much firms would offer to
the market at a given
price.
• Based on optimisation:
– Compare marginal cost of
producing extra unit with
price
• Market supply is
aggregated over all firms
– horizontal sum.
Welfare Analysis: Producer
Surplus
• Since supply curve based
on marginal cost, it can be
used to show how
producers’ profit is affected
by changes in the price.
• Gap between marginal cost
of a unit and price received
shows ‘surplus’ from being
able to sell q* at p*.
price
Triangle is sum of
all gaps between
price received and
marginal cost
(summed over
total production)
p*
q*
quantity
Welfare Analysis: Producer
Surplus
•
•
If the price rises:
– producers obviously better off
– producer surplus change quantifies
this intuition.
Producer surplus rise, 2 parts:
– get more for units sold at old price;
measure of this = area A:
• = price rise times old production
– gain surplus on the new units sold
(those from q* to q’)
– measure of this = area B:
• = sum of all new gaps between
marginal cost and price.
price
Supply
curve
p’
A
B
p*
q*
q’
quantity
THE DETERMINANTS OF
TRADE
• Equilibrium Without Trade
– Assume:
• A country is isolated from rest of the world and
produces steel.
• The market for steel consists of the buyers and
sellers in the country.
• No one in the country is allowed to import or export
steel.
Figure 1The Equilibrium without International Trade
Price
of Steel
Domestic
supply
Equilibrium
price
Consumer
surplus
Producer
surplus
Domestic
demand
0
Equilibrium
quantity
Quantity
of Steel
Copyright © 2004 South-Western
The Equilibrium Without International
Trade
• Equilibrium Without Trade
– Results:
• Domestic price adjusts to balance demand and
supply.
• The sum of consumer and producer surplus
measures the total benefits that buyers and sellers
receive.
The World Price and Comparative
Advantage
• If the country decides to engage in
international trade, will it be an importer or
exporter of steel?
The World Price and Comparative
Advantage
• The effects of free trade can be shown by
comparing the domestic price of a good
without trade and the world price of the
good. The world price refers to the price
that prevails in the world market for that
good.
The World Price and Comparative
Advantage
• If a country has a comparative advantage,
then the domestic price will be below the
world price, and the country will be an
exporter of the good.
The World Price and Comparative
Advantage
• If the country does not have a comparative
advantage, then the domestic price will be
higher than the world price, and the country
will be an importer of the good.
Figure 2 International Trade in an Exporting Country
Price
of Steel
Domestic
supply
Price
after
trade
World
price
Price
before
trade
Exports
0
Domestic
quantity
demanded
Domestic
demand
Domestic
quantity
supplied
Quantity
of Steel
Copyright © 2004 South-Western
Figure 3 How Free Trade Affects Welfare in an
Exporting Country
Price
of Steel
Price
after
trade
Exports
A
B
Price
before
trade
Domestic
supply
World
price
D
C
Domestic
demand
0
Quantity
of Steel
Copyright © 2004 South-Western
Figure 3 How Free Trade Affects Welfare in an
Exporting Country
Price
of Steel
Price
after
trade
Consumer surplus
before trade
Exports
A
B
Price
before
trade
World
price
D
C
Producer surplus
before trade
0
Domestic
supply
Domestic
demand
Quantity
of Steel
Copyright © 2004 South-Western
How Free Trade Affects Welfare
in an Exporting Country
THE WINNERS AND LOSERS
FROM TRADE
• The analysis of an exporting country yields
two conclusions:
– Domestic producers of the good are better off,
and domestic consumers of the good are worse
off.
– Trade raises the economic well-being of the
nation as a whole.
The Gains and Losses of an Importing
Country
• International Trade in an Importing Country
– If the world price of steel is lower than the
domestic price, the country will be an importer
of steel when trade is permitted.
– Domestic consumers will want to buy steel at
the lower world price.
– Domestic producers of steel will have to lower
their output because the domestic price moves
to the world price.
Figure 4 International Trade in an Importing Country
Price
of Steel
Domestic
supply
Price
before
trade
Price
after
trade
World
price
Imports
0
Domestic
quantity
supplied
Domestic
quantity
demanded
Domestic
demand
Quantity
of Steel
Copyright © 2004 South-Western
Figure 5 How Free Trade Affects Welfare in an
Importing Country
Price
of Steel
Domestic
supply
A
Price
before trade
Price
after trade
B
C
D
World
price
Imports
Domestic
demand
0
Quantity
of Steel
Copyright © 2004 South-Western
Figure 5 How Free Trade Affects Welfare in an
Importing Country
Price
of Steel
Consumer surplus
before trade
Domestic
supply
A
Price
before trade
Price
after trade
B
World
price
C
Producer surplus
before trade
0
Domestic
demand
Quantity
of Steel
Copyright © 2004 South-Western
Figure 5 How Free Trade Affects Welfare in an
Importing Country
Price
of Steel
Consumer surplus
after trade
Domestic
supply
A
Price
before trade
Price
after trade
0
B
C
D
Imports
Producer surplus
after trade
World
price
Domestic
demand
Quantity
of Steel
Copyright © 2004 South-Western
How Free Trade Affects Welfare
in an Importing Country
THE WINNERS AND LOSERS
FROM TRADE
• How Free Trade Affects Welfare in an
Importing Country
– The analysis of an importing country yields two
conclusions:
• Domestic producers of the good are worse off, and
domestic consumers of the good are better off.
• Trade raises the economic well-being of the nation
as a whole because the gains of consumers exceed
the losses of producers.
THE WINNERS AND LOSERS
FROM TRADE
• The gains of the winners exceed the losses
of the losers.
• The net change in total
surplus is positive.