CHAPTER 2
THE BASIC THEORY USING
DEMAND
AND SUPPLY
Key Questions About
International Trade
1.
2.
3.
4.
Why do countries trade? What is the basis for
trade, especially the product (commodity)
composition?
For each country, what are the overall gains (or
losses) from trade?
What are the effects of trade on each country’s
economic structure? Production, Consumption.
What are the effects of trade on the distribution of
income within each country? Winners, Losers.
2
Figure 2.1
3
Consumer surplus
Consumer surplus is the increase in the
economic well-being of consumers who are
able to buy the product at a market price
lower than the highest price that they are
willing and able to pay for the product. A
major use of consumer surplus is to
measure the impact on consumers of a
change in market price.
4
Producer surplus
Producer surplus is the increase in the
economic well-being of producers who are
able to sell the product at a market price
higher than the lowest price that would have
drawn out their supply. A major use of
producer surplus is to measure the impact
on producers of a change in market price.
5
Figure 2.2
6
Two national markets and the
opening of trade
 If you were the first person to notice this
situation, could you make a profit?
 Let’s say that the United States is willing to
open up to free trade and integrate into the
world market. If it does this, the world price
will also be the price within the United
States. How much will the United States
want to import?
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Two national markets and the
opening of trade
 What will happen with free trade? When
there is ongoing free trade, what is the
equilibrium world price?
8
Figure 2.3
9
Two national markets and the
opening of trade
 What group is made happier by the shift
from no trade to free trade? What group is a
loser? Can we somehow say that the
country gains from free trade?
10
Figure 2.4
11
Questions
 The United States exports a substantial
amount of scrap iron and steel to Japan and
other countries. Why do some U.S. users of
scrap iron and steel support a prohibition on
these exports?
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Questions

1.
2.
3.
The equation for the demand curve for writing paper in A
country is QD=350-(P/2); the equation for the supply
curve for writing paper in A is QS=-200+5P
What are the equilibrium price and quantity if there is no
international trade?
What are the equilibrium quantities for A if the nation can
trade freely with the rest of the world at a price of
120yuan?
What is the effect of the shift from no trade to free trade
on A consumer surplus? On A producer surplus? What is
the net national gain or loss for A?
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Questions
 Explain what is wrong with the following
statement: “Trade is self-eliminating.
Opening up trade opportunities drives prices
and costs into equality between countries.
But once prices and costs are equalized,
there is no longer any reason to trade the
product from one country to another, and
trade stops.”
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