The Supply and Demand Model for Trade

1. The Supply and Demand Model for Trade Two-country model Price-taker model

2. International Trade • Imagine the situation where NZ and Fiji are willing to trade with one another. ?

3. International Trade • New Zealand is a more efficient producer of beef than Sweden is. (NZ has a comparative advantage in beef) • In the back of your books draw two diagrams 1. One for NZ demand and supply of beef 2. One for Sweden's demand and supply of beef One country will have a lower price……

4. Markets for Beef – Without Trade Sweden New Zealand Price ($) S S Price ($) Pe Pe D D QA QB Quantity Quantity The price differences between NZ and Sweden represents the differences in efficiency of producers in each country. (NZ has a comparative advantage in Beef so NZ can produce beef cheaper and sell at a lower price)

5. International Trade for Beef Sweden New Zealand Price ($) Price ($) S S PA PB WP D D QDnz QSs QA QDs Quantity QB QSnz Quantity Import level Export Level

6. Effects of trade in between NZ and Sweden • Effects to NZ (country with the comparative advantage) • Higher world price has caused the price of beef to rise in NZ • Domestic Consumption has fallen (due to the increase in price) • Domestic Production has risen. • Effects to Sweden (Country with comparable disadvantage in beef production) • Price of beef has fallen • Domestic consumption has increased • Domestic production has decreased

7. Notes – Supply and Demand models of international trade The S&D model can be used to show trade between countries. • Large trading nations AND • Smaller ‘price taker’ nations. • Three assumptions of the model • No transport costs • Only two countries trade this good • The prices on each axis are for the same currency

8. Price Taker’s (Small countries) • NZ is a price taker • A price taker must accept or take the price that is set in the world market. • Whether a good is imported or exported depends on where the World price is, in relation to the Domestic product. • World price= the price at which a good or service is traded on international markets • Domestic Price= The price at which a good or service is traded on home market.

9. For trade to occur… • When there is a difference between the two equilibrium prices, there is potential for trade. • Trade will occur between the two equilibrium prices for each country. • The World Price will be the point where imports equal exports (not necessarily half way between).

10. International Trade for Beef Sweden New Zealand Price ($) Price ($) S S PA PB WP D D QDnz QSs QA QDs Quantity QB QSnz Quantity Import level Export Level

11. Changes in World Price • If a large country’s (in terms of output of the good) demand or supply curve shifts, this will cause a change in World Price. • For the World Price to decrease: • The exporting country’s supply would increase or the demand would decrease. • The importing country’s supply would decrease or the demand would increase. • For the World Price to increase: • The exporting country’s supply would decrease or the demand would increase. • The importing country’s supply would increase or the demand would decrease.

12. Changes in the World Price • ‘Price-taker’ countries are unable to influence the World Price as they are too small in terms of their output for that good. • If the World Price increases: • For an exporting country the quantity exported will increase due to an increase in the price (less is consumed by New Zealanders, more is produced domestically). • For an importing country the quantity imported will decrease due to an increase in the price (less is consumed by New Zealanders, more is produced domestically). • The opposite of these two scenarios will occur if the world price decreases.

13. Example… COUNTRY A COUNTRY B 35 30 25 20 15 10 5 35 30 25 20 15 10 5 QA QB X M

14. Importing country Exporting country One-country model (price takers) S S Pe WP Pe WP D D Qs Qe Qd Qd Qe QS M X