We will now look at international trade. International trade means anything that happens outside of a given nation.
Closed Economy
This is a graph of domestic supply and demand for a closed economy. Domestic means that it happens within a nation. A closed economy is one that does not trade with any other nation. In this graph, the price will be represented by Pd and the quantity will be represented will be represented by Qd.
There are two more terms we to look at. First is the consumer surplus. Consumer surplus is the difference between the total amount consumers are willing to pay and the total they actually pay. This means consumers are willing to pay more for the good or service they bought.
Next is the producer surplus. This is the difference between what producers are willing to supply and the price they actually received. When there is a producer surplus, this means producers were willing to charge less for their good or surplus.
Free World Trade
We will now look at an economy that allows free world trade with no restrictions. If the world trade price is lower than the domestic price, consumers will want to purchase more. We will assume that the world price is represented by Pw.
- If you follow the Pw line straight across, you see that it crosses the domestic supply curve first. Domestic suppliers will only supply Qwd.
- Continue to follow the Pw line until it crosses the domestic demand line. The Pw line intersects with that demand line at Qw. Domestic suppliers cannot meet the quantity demanded at lower prices.
- The distance between Qw and Qwd will be the amount of product that will have to be imported to meet the quantity demanded at the world price. In this instance, consumer surplus increases while producer surplus decreases.
The winners in a free world trade economy are the consumers, while the losers are the domestic producers.
Quotas and Tariffs
Some domestic producers want the government to place a quota or tariffs on imports to combat the competition from free-trade.
- A quota limits the number of foreign products brought into a country.
- A tariff is a tax on any foreign product sold domestically.
A tariff or quota has the effect of increasing the price from Pw to Pt. By following the Pt line across, you will see that domestic suppliers can now increase their production. From Qwd to Qtd, continue to follow the Pt price you will see domestic consumers will now decrease their purchases from Qw to Qt. Foreign producers will import the differences from Qt to Qtd.
The winners with a tariff or quota are domestic producers; the losers are domestic consumers and foreign producers.
- Domestic consumers will now pay more for less of a product.
- Producers will lose because they are limited in the amount of money they can earn.
In this, we see the consumer surplus with a tariff or quota has decreased while the domestic producer surplus has increased. The shaded region is the revenue earned by foreign companies when was tariff or quota is in place and it now limited to only this area.
The Government
The last group to look at is the government. The government is not affected either way with a quota.
The government will gain by establishing a tariff. The government will receive additional money with a tariff. In this case, the revenue they receive will be the size of the tariff which is the difference between Pt and Pw multiplied by the amount of goods that are imported. This is represented by the difference Qt and Qtd. The tax revenue for the government is represented by the shaded area.
With the use of supply and demand graphs, it is easy to see the winners and losers in an open and a closed economy.
- In a closed economy, consumers will pay the most and have the least quantity. Domestic suppliers will most money and have the most quantity.
- In a completely open economy, consumers will play the least while domestic producers will lose the most.
