1. International Trade: Small Country Basics
Udayan Roy
September 2006
This presentation looks at autarky, free trade, and their welfare analysis – using consumer and producer surplus – from the small country point of view.

2. Questions What determines whether a country imports or exports a good?
Who gains and who loses from free trade among countries?
What are the arguments that people use to advocate trade restrictions?

3. Equilibrium Without Trade
Assume:
A country is isolated from rest of the world and produces steel.
The market for steel consists of the buyers and sellers in the country.
No one in the country is allowed to import or export steel.

4. Figure 1: The Equilibrium without International Trade
Price
of Steel
Domestic
demand
Consumer
surplus
Domestic
supply
Equilibrium
price
quantity
Producer
surplus
Quantity
of Steel

5. The Equilibrium Without International Trade
Domestic price adjusts to balance demand and supply.
The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.

6. The World Price and Comparative Advantage
If the country decides to engage in international trade, will it be an importer or exporter of steel?

7. The World Price and Comparative Advantage
The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good.
The world price refers to the price that prevails in the world market for that good.

8. The World Price and Comparative Advantage
If a country’s domestic price of a product is below the world price
the country is said to have a comparative advantage in the production of this product, and
this country will be an exporter of the good.

9. The World Price and Comparative Advantage
If a country’s domestic price of a product is above the world price
the country does not have a comparative advantage in the production of this product, and
this country will be an importer of the good.

10. Figure 2 International Trade in an Exporting Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Domestic
quantity
demanded
Domestic
quantity
supplied
Price
before
trade
Exports
Quantity
of Steel

11. Figure 3 How Free Trade Affects Welfare in an Exporting Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Exports D C B A
Price
before
trade
Quantity
of Steel

12. Figure 3 How Free Trade Affects Welfare in an Exporting Country
Price
of Steel
Domestic
demand
Consumer surplus
before trade
Domestic
supply
Price
after
trade
World
price
Exports D C B A
Price
before
trade
Producer surplus
before trade
Quantity
of Steel

13. How Free Trade Affects Welfare in an Exporting Country

14. The Winners And Losers From Trade
For an exporting country:
Domestic producers of the good are better off, and
Domestic consumers of the good are worse off.
Trade raises the economic well-being of the nation as a whole. That is, the gain to producers exceeds the loss to consumers.

15. International trade in an importing country
If the world price of steel is lower than the pre-trade domestic price, the country will be an importer of steel when trade is permitted.
Domestic consumers will be able to buy steel at the lower world price. Therefore,
Domestic consumers will increase their consumption
Domestic producers of steel will have to lower their prices to compete
Domestic producers will reduce production.
The excess of domestic consumption over production will have to be imported

16. Figure 4 International Trade in an Importing Country
Price
of Steel
Domestic
demand
Domestic
supply
Price
before
trade
Price
after
trade
World
price
Domestic
quantity
supplied
Domestic
quantity
demanded
Imports
Quantity
of Steel

17. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price
Domestic
demand
of Steel
Domestic
supply C B D A
Price
before trade
Price
after trade
World
price
Imports
Quantity
of Steel

18. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price A
Domestic
demand
of Steel
Consumer surplus
before trade
Domestic
supply
Price
before trade C B
Producer surplus
before trade
Price
after trade
World
price
Quantity
of Steel

19. Figure 5 How Free Trade Affects Welfare in an Importing Country
Price
Domestic
demand
of Steel
Consumer surplus
after trade
Domestic
supply C B D A
Price
before trade
Price
after trade
World
price
Imports
Producer surplus
after trade
Quantity
of Steel

20. How Free Trade Affects Welfare in an Importing Country

21. The Winners And Losers From Trade
How Free Trade Affects Welfare in an Importing Country
Domestic producers of the good are worse off, and
Domestic consumers of the good are better off.
Trade raises the economic well-being of the nation as a whole because the gains of consumers exceed the losses of producers.

22. The Winners And Losers From Trade
Irrespective of whether a country exports a good or imports it, the gains of those who gain exceed the losses of those who lose.
That is, the net change in total surplus is always positive.

23. Gains From Trade The gains from trade can be expressed as the sum of
the gains from exchange, and
the gains from specialization.

24. Gains From Exchange
Free trade will lead to gains even for a country whose production levels, for whatever reason, remain what they were in autarky. These gains are called the gains from exchange.

25. Gains From Specialization
Typically, however, free trade also leads to changes in production levels as a nation becomes more specialized in the production of the good in which it has a comparative advantage. The gains due to this specialization in production are called the gains from specialization.

26. Exporting Country Price of Steel Domestic demand Domestic supply Price
after
trade
World
price
Exports D C B A
Price
before
trade
D = gains from trade
Quantity
of Steel

27. Gains From Exchange Price of Steel Domestic demand Price after trade
Domestic Supply
of Steel
Domestic
demand
Exports
D = gains from exchange
Price
after
trade
World
price D C B A
Price
before
trade
Quantity
of Steel

28. Price of Steel Domestic demand Domestic supply Price after trade World
D = gains from exchange; E = gains from specialization; D + E = total gains from trade
Price
of Steel
Domestic
demand
Domestic
supply
Price
after
trade
World
price
Exports D C B A E
Price
before
trade
Quantity
of Steel

29. Opposition to Free Trade
Free trade need not benefit every citizen of a country
Free trade may be opposed by those who stand to lose from trade
The gains of those who gain (which, after all, exceed the losses of those who lose) can be used to compensate those who lose from trade
If this is done, everybody would support free trade

30. The Lessons for Trade Policy
Other benefits of international trade
Increased variety of goods
Lower costs through economies of scale
Increased competition
Enhanced flow of ideas

31. Common Arguments For Restricting Trade
Jobs
National Security
Infant Industry
Unfair Competition
Protection-as-a-Bargaining Chip