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GAINS FROM TRADE

GAINS FROM TRADE. GENERAL EQUILIBRIUM & PARTIAL EQUILIBRIUM. GENERAL EQUILIBRIUM. GENERAL EQUILIBRUIM --- EQUILIBRIUM IN ALL MARKETS --- OR REPRESENTATIVE MARKETS OF THE ECONOMY

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GAINS FROM TRADE

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  1. GAINS FROM TRADE GENERAL EQUILIBRIUM & PARTIAL EQUILIBRIUM

  2. GENERAL EQUILIBRIUM • GENERAL EQUILIBRUIM --- EQUILIBRIUM IN ALL MARKETS --- OR REPRESENTATIVE MARKETS OF THE ECONOMY • FACTOR (INPUT) MARKETS SUCH AS LABOR AND CAPITAL ARE PUT TOGETHER WITH MARKETS FOR GOODS AND EQUILIBRIUMS IN THOSE MARKETS ARE DERIVED • INPUT MARKETS ARE LARGELY DERIVED MARKETS --- DERIVED DEMAND FOR INPUTS SUCH AS LABOR ARE FUNCTIONS OF WHAT HAPPENS IN THE GOODS MARKETS • FOR EXAMPLE, DEMAND FOR CAPITAL = f( CAPITAL PRICE, PRICES OF OTHER INPUTS, PRICES OF GOODS IN WHICH CAPITAL IS USED), WHERE f( . . . . . ) MEANS FUNCTION OF

  3. THE PRODUCTION POSSIBILITIES CURVE PORTRAYS THE INTERACTION OF THE SUPPLY SIDE OF THE MARKET FOR TWO GOODS (OR MANY GOODS, IF IN n-SPACE) • EXAMPLE: GOOD Q = aX, , WHERE Q = SOME PRODUCT (GOOD), AND Y = bX, where Y = ANOTHER PRODUCT, AND X = AN INPUT WITH a, b BEING CONSTANTS (PARAMETERS) • Q = aX, and Y = bX are examples of production functions or processes (of course they are quite simple process descriptions) • SOLVE FOR THE AMOUNT OF INPUT X GOING INTO THE PRODUCTION OF EACH GOOD, AS X = Q/a , X = Y/b

  4. SOLVE FOR THE PRODUCTION POSSIBILITIES CURVE, PPC, AS: • XGOINGINTOQ + XGOING INTO Y = XO , WHERE XO IS THE TOTAL AMOUNT OF INPUT, X, AVAILABLE IN THE ECONOMY (SEE THE DISCUSSION BETWEEN RICARDO AND ED IN CHAPTER 3 OF “THE CHOICE” • BUT THIS IS JUST Q/a + Y/b = XO • SOLVE FOR Q AS A FUNCTION OF Y FROM THIS PPF AS • Q = a(XO) – (a/b)Y --- AGAIN THIS IS THE PPF IN Q AS A FUNCTION OF Y, WHERE a, b > 0 • THE PPC GIVES US THE TRADEOFF OF PRODUCING Q RELATIVE TO Y GIVEN LIMITED RESOURCES (INPUTS) X

  5. WE CAN FIND THE TRADEOFF ( A SLOPE) BY: • CHANGE IN Q AS A FUNCTION OF THE CHANGE IN Y AS • ΔQ/ΔY = -a/b WHICH IS JUST THE NEGATIVE SLOPE OF THE PPC • THIS PORTRAYS A CONSTANT COST PRODUCTION SITUATION IN THIS TYPE OF PPC, SO THE SLOPE IS JUST A NEGATIVE CONSTANT –a/b DEPENDING ON THE VALUES OF a, AND b FROM THE PRODUCTION FUNCTIONS Slope of PPC is –a/b Q Y

  6. NOW SUPERIMPOSE THE DEMAND SIDE (DEMAND FOR Q AND Y) ONTO THE PPC --- IN THE FORM OF THE COMMUNITY INDIFFERENCE CURVE OR UTILITY CURVE • AND WE HAVE THE DEMAND SIDE OF TWO MARKETS --- ONE FOR PRODUCT Q, AND THE OTHER FOR PRODUCE Y • SO SUPPLY AND DEMAND ARE BROUGHT TOGETHER FOR TWO PRODUCTS HERE --- SIMPLE GENERAL EQUILIBRIUM IS DESCRIBED HERE – YOU CAN SOLVE GRAPHICALLY FOR Q AND Y TERMS OF TRADE Utility or CIC curve Q CIC = UTILITY AND MAY BE REPRESENTED, FOR EXAMPLE, BY U(Q,Y), AND MAYBE A FUNCTIONAL FORM LIKE U =Q0.4Y0.53 AS ONE TYPE OF UTILITY FUNCTION Slope of PPC is –a/b Y

  7. NOW LET’S LOOK AT AN INCREASING COST CASE (NONLINEAR SLOPE OF A PPF) ALONG WITH THE CIC CURVE AND GO FROM GENERAL EQUILIBRIUM AT NO TRADE TO A TRADE POSITION START WITH NO TRADE (AUTARKY) WITH THE TANGENCY OF CICO AND THE PPF GOING FROM POINT D ON THE T (FOR THIAMIN) GOOD TO POINT E FOR THE S (FOR SUGAR) GOOD. SO WE ARE AT EQUILIBRIUM WITH NO TRADE AT POINT A, WHICH IS THE TANGENCY OF CICO AND THE PPF WITH TRADE WE GET A NEW TERMS OF TRADE BETWEEN GOOD T AND GOOD S ---- NOTICE THAT WE NOW PRODUCE AT POINT X AND CONSUME AT POINT C ----- SO WE ARE STILL RESTRICTED IN PRODUCTION POSSIBILITIES, BUT WE NOW TRADE AND GET ON A HIGHER CIC AT CIC2 – ECONOMIC WELFARE HAS IMPROVED WE ALSO GET A PRODUCTION EFFECT OF A MOVE FROM POINT A ON THE PPF TO A NEW POINT X – OVERALL PRODUCTION IMPROVES ---WHY DON’T WE MOVE TO POINT D? UNDER AUTARKY WE COULD HAVE PRODUCED IN THE INTERIOR OF THE PPF (INEFFICIENTLY) BUT DID NOT CHOOSE TO DO SO– SO THE MOVE IS FROM A TO X ECONOMIC WELFARE HAS INCREASED UNDER TRADE AT POINT X, WE ARE PRODUCING MORE S AND LESS T ---

  8. WITH TRADE, WE HAVE IMPROVED ECONOMIC WELFARE --- WE ARE NO LONGER RESTRICTED TO CONSUME WHAT WE ARE LIMITED TO PRODUCE BECAUSE OF OUR LIMITED INPUTS TO PRODUCE WE HAVE GAINED THIS ECONOMIC WELFARE IN GENERAL EQUILIBRIUM --- THE IMPROVEMENT COMES IN ALL THE MARKETS (OF COURSE WE HAVE ONLY PICTURED TWO PRODUCTS HERE IN THIS SIMPLE EXAMPLE) ALSO NOTICE, HOWEVER, THAT PRODUCTION OF GOOD T IS DECREASED UNDER TRADE --- WE IMPORT A LARGE AMOUNT OF GOOD T, AND EXPORT A LARGE AMOUNT OF GOOD S TERMS OF TRADE IN RELATIVE PRICE TERMS THE RUB ! THE CONTROVERSY OVER TRADE--- EMPLOYMENT OF INPUTS IN T WILL DECREASE --- UNLESS THERE IS COMPLETE MOBILITY OF INPUTS, LIKE LABOR, THEN LABOR LOSES IN SECTOR T ! PRODUCERS OF T ARE GOING TO GO OUT OF BUSINESS IF THERE IS NOT COMPLETE MOBILITY TO PRODUCE OTHER GOODS MORE EFFICIENTLY COMPARE PRODUCTION AND CONSUMPTION AT EQUILIBIRIUM AT POINT A WITH THE SAME AT POINT X AND C NOTICE THAT THE SLOPE OF THE TERMS OF TRADE AT POINT C IS THE SAME AS THE SLOPE AT POINT X

  9. NOW LET’S LOOK AT THE GAINS OF TRADE FROM THE IMPORT VIEWPOINT USING THE IDEAS OF CONSUMER AND PRODUCER SURPLUS --- WHICH IS PARTIAL EQUILIBRIUM ANALYSIS -- WE ARE LOOKING AT ONE MARKET ( THE GRAPE MARKET IN THIS CASE --- MAYBE CHILE THE PRODUCER AND CANADA THE IMPORTER) EQUILIBRIUM PRICE IS PA DERIVED BY THE INTERSECTION OF SUPPLY OF GRAPES, SG, AND DEMAND FOR GRAPES, DG --- BUT THIS PRICE IS HIGHER THAN THE WORLD PRICE, PW, AS DETERMINED BY THE LOW COST PRODUCER IN THE WORLD --- OPENING UP TO TRADE REDUCES PRICE TO THE WORLD PRICE, PW --- CONSUMERS GAIN THE AREAS, a + b + c IN CONSUMER SURPLUS, WHILE PRODUCERS TRANSFER PRODUCER SURPLUS OF AREA a TO CONSUMERS AT THE LOWER WORLD PRICE, DOMESTIC PRODUCERS ONLY HAVE INCENTIVE TO PRODUCE AT Q1, BUT DOMESTIC CONSUMERS DEMAND Q2 --- SO IMPORTS ARE USED TO MAKE UP THE DIFFERENCE --- THERE IS OVERALL GAIN b + c, BUT DOMESTIC PRODUCERS LOSE PRODUCER SURPLUS -CANADA- THE IMPORT MARKET FOR GRAPES PARTIAL EQUILIBRIUM ANALYSIS HERE WE DO NOT HAVE THE INPUT MARKETS OR OTHER GOODS MARKETS AS YOU NOTICE

  10. NOW LOOK AT THE GAINS FROM TRADE FROM THE VIEWPOINT OF EXPORTS THE EXPORTER HAS LOWER COSTS OF PRODUCTION, SO THE EQUILIBRIUM OF SUPPLY OF HONEY, SH, AND THE DEMAND FOR HONEY, DH, IS AT A LOWER PRICE LEVEL, P’A, THAN WORLD PRICE, P’W---- OPENING UP TRADE BRINGS THE WORLD PRICE INTO THE PICTURE--- SO PRODUCERS CAN NOW EXPORT HONEY AT THE WORLD PRICE, P’W > DOMESTIC PRICE, P’A---- THE RESULT IS THAT PRODUCERS GAIN THE AREAS e + f + g ---- CONSUMERS LOSE CONSUMER SURPLUS OF e + f AND TRANSFER THAT GAIN TO DOMESTIC PRODUCERS BRAZIL EXPORTS HONEY TO EUROPE DOMESTIC DEMAND IS REDUCED, (BECAUSE PRICES ARE HIGHER), TO Q3 WHILE SUPPLY IS INCREASED TO Q4 AS PRODUCERS RESPOND TO THE HIGHER PRICES FOR HONEY--- SO THE EXPORTS AMOUNT TO Q4 – Q3 THE NET GAIN IS AREA g, BUT CONSUMERS LOSE WHILE THERE IS OVERALL GAIN AGAIN, THIS IS ONLY A PARTIAL EQUILIBRIUM ANALYSIS

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