Chapter 4 Why Nations Trade: A Partial Equilibrium View

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Chapter 4Why Nations Trade A Partial
Equilibrium View
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The Goals of this Chapter

• Introduce a two-country partial equilibrium model
  of international trade.
• Use the partial equilibrium model to illustrate
  how consumers and producers are affected by
  international trade.
• Use the partial equilibrium model to analyze the
  effects of exchange rate changes, changes in
  demand, and transportation costs.
• Introduce international marketing and show how it
  complements comparative advantage by helping to
  determine the value of products that are traded
  internationally.
• Explain how the need for international marketing
  introduces a fixed cost to international trade
  that tends to prevent the smooth adjustments
  predicted by the standard international trade
  models.

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Measuring the Welfare Gains from
ExchangeProducer Surplus and Consumer Surplus

• Producer surplus The net gains to producers of a
  product, equal to the total revenue minus the sum
  of marginal (variable) costs.
• Consumer surplus The net gains for consumers of
  a product, equal to the sum of all marginal gains
  minus the market price paid for the products.

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• Equilibrium price 6
• Equilibrium quantity 50

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• Equilibrium price 65
• Equilibrium quantity 50
• Producer surplus 125 (5x50 250/2 125)

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• Equilibrium price 6
• Equilibrium quantity 50
• Producer surplus 125 (5x50/2 250/2 125)
• Consumer surplus 75 (3x50/2 150/2 75)

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• Equilibrium price 6
• Equilibrium quantity 50
• Producer surplus (5x50)/2 250/2
• 125
• Consumer surplus 75 (3x50)/2 150/2 75
• Total gains from exchange equals consumer surplus
  plus producer surplus
• Gains from exchange (8x50)/2 400/2
• 200

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The Two-Country Partial equilibrium Model

• The textbook emphasizes two-country models in
  order to remind you that what happens in one
  country affects markets in other countries.
• Partial equilibrium models assume all other
  things remain equal in other markets, obviously
  an unrealistic assumption.
• But, a two-country partial equilibrium model can
  isolate how, all other things equal, a change in
  a market in one country affects the market for
  the same product in another country.
• Specifically, the two-country partial equilibrium
  model lets us estimate the changes in consumer
  and producer surplus in the two countries.

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The Welfare Gains from Trade

• Heartland producers gain surplus.
• Heartland consumers lose surplus.
• Orient producers lose surplus.
• Orient consumers gain surplus.
• Worldwide, net welfare gains from trade in corn
  are the sum of the net gains in Heartland and in
  Orient.

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Summarizing the Welfare Gains and Losses in Both
Countries

• Heartland producers gain BC 41.25
• Heartland consumers lose B 33.75
• Heartlands net welfare gain C 7.50
• Orients producers lose b 30.00
• Orients consumers gain bc 45.00
• Orients net welfare gain c 15.00

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Applying the Two-Country Partial Equilibrium Model

• Now that you understand the two-country partial
  equilibrium model and how to calculate the
  welfare gains from international exchange, you
  are ready to apply the model.
• One interesting case is to examine the welfare
  effects of an increase in foreign demand for a
  product.
• Specifically, suppose that in a certain market,
  demand increases in the foreign country that
  currently imports the good.

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The Net Gains from Trade Increase in Both
Countries after the Rise in Demand in Orient

• An increase in foreign demand raises the price of
  corn in both countries.
• Producers in Heartland gain welfare.
• Consumers in Orient gain welfare.
• The net gains from exchange increase in both
  countries.

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Applying the Two-Country Partial Equilibrium Model

• Another case, discussed in Case Study 4.2 in the
  textbook, is to analyze the welfare effects in a
  given product market after a change in the
  exchange rate.
• Suppose that the exchange rate of 1.00 5 euros
  changes to 1.00 8 euros, which constitutes and
  appreciation of the dollar.
• Suppose also that the United States is the
  exporting country in a certain market.

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The International Market for Hoses after the
Dollar Appreciation

• The net gain from trade for Europe declines to
  the area b.
• The volume of The net gain from trade for the
  United States declines to area a.
• trade declines from 0f to 0g.
• Overall, in this market the gains from trade
  decline.

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Analyzing the Effect of Transport Costs on
International Trade

• The partial equilibrium model can be used to
  analyze how transport costs affect international
  trade.
• Transport costs in effect drive a wedge in
  between the price received by an exporter and the
  price paid by a foreign importer.
• Transport costs increase the cost of products to
  the final user, and it should not be surprising
  that they reduce both the volume of trade and the
  gains from trade.
• The analysis of transport costs uses the concepts
  of consumer and producer surplus.

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• Consumer surplus is equal to the area A
• Producer surplus is equal to the area B
• The net gains from exchange are equal to the
  areas A B

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• Transport costs of 40 raise the effective
  international supply curve from S to ST.
• Transport costs drive a wedge between what
  suppliers receive and consumers pay.
• The volume of trade falls from 40 to 20.
• Producer surplus is reduced to area b.
• Consumer surplus is reduced to area a.

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• Decreasing transport costs increase trade.
• The international supply curve shifts down to
  ST2.
• The equilibrium price falls to 60.
• The gains from trade rise from a b to a b c
  d.

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Trade and Transport Costs

• An increase in transport costs reduces the gains
  from trade for both the importing and exporting
  countries.
• A decline in transport costs increases the gains
  from trade.
• Most of the increase in trade during the past two
  centuries is due to improvements in the
  efficiency of transportation.

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The Effect of Trade on Price Competition

• The partial equilibrium model is also useful for
  analyzing the gains from trade under imperfect
  competition.
• International trade increases the number of
  potential suppliers, which tends to increase
  price competition.
• Increased price competition reduces monopoly
  profit and deadweight losses.
• The effect of increased competition can be
  visualized by comparing consumer and producer
  surplus under imperfect competition and under
  perfect competition.

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• Imperfectly competitive firms face a
  downward-sloping demand curve D.
• Profit-maximizing firms equate marginal revenue
  equal marginal cost.
• Prices exceed marginal cost.
• The quantity supplied, q, is less than the
  quantity, Q, that would be supplied under perfect
  competition.
• Total welfare is reduced by the deadweight
  loss, which is equals to area D.

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• When firms face the horizontal demand curve in a
  competitive global market, price declines from p
  to P.
• Consumption shifts from c to C.
• The competitive market eliminates the deadweight
  loss.

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International Trade and International Marketing

• The term comparative advantage is seldom used by
  international exporters and importers.
• Instead, marketers are concerned about
  competitive advantage, which refers to a firms
  advantage in providing its customers or potential
  customers with value.
• Value is the net sum of a products perceived
  benefits, such as quality, convenience, and
  prestige, relative to its price.
• Specifically, we define a products value, V, as
  V B/P, where B and P are the products benefits
  and price, respectively.