GLEF Tutorial
Global and Regional Economic Integration
QIU Jinyuan (linusqiu@[Link])
October ,
/
Table of Contents
Open Up to Trade and Gain from Trade
! Open Up to Trade and Gain from Trade
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Autakry Environment
Open Up to Trade and Gain from Trade
Consider a domestic economy that produces a single consumption good. Suppose the quantity
demanded is given by
D−p
Qd =
d
and the quantity supplied by
p
Qs =
s
where p is the price and D, d, s > 0 are parameters.
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Autakry Equilibrium
Open Up to Trade and Gain from Trade
. Derive the autarkic equilibrium quantity QA and price pA .
Qd = Qs
D−p p
=
d s
s·D D D − pA pA
⇒ pA = , QA = = =
s+d s+d d s
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Autakry Equilibrium
Open Up to Trade and Gain from Trade
. Derive consumer and producer surplus under autarky, CSA and PSA .
1 d D2 (D − pA )2
CSA = (D − PA ) · QA · = · =
2 2 (s + d) 2·d
1 s D 2
pA
2
PSA = PA · QA · = · =
2 2 (s + d)2 2·s
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Open to Trade
Open Up to Trade and Gain from Trade
Suppose the domestic economy opens up to trade with a foreign country of comparable size. The
foreign economy functions identically to the domestic, but its parameters may differ unrestrictedly.
Denote its variables with an asterisk.
D−p p
Qd = , Qs =
d s
D∗ − p p
Qd =
∗
, Qs = ∗
d∗ s
So actually two countries will have similar autarkic equilibrium
s·D D D − pA pA
pA = , QA = = =
s+d s+d d s
s ·D
∗ ∗
D∗
D − pA
∗ ∗
p∗A
p∗A = ∗ , Q∗
A = = =
s + d∗ s∗ + d ∗ d∗ s∗
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Open to Trade
Open Up to Trade and Gain from Trade
. Derive the condition for which the domestic economy is a net importer. Assume that this condition
holds.
The domestic economy is a net importer if the autarkic price in the domestic economy is higher
than the world price and autarkic price in the foreign economy. This implies that the domestic
consumers are willing to pay more for the good that are produced from the foreign country.
s·D s∗ · D∗
pA > p∗A ⇔ > ∗
s+d s +d
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Open to Trade
Open Up to Trade and Gain from Trade
. Derive the domestic import demand curve Md and export supply curve Xs (indicating supply of goods
to be imported to domestic consumers) as functions of pA and p∗A .
D−p p
Md = Qd − Qs = −
d s
sD − (s + d)p sD
= plug in pA = ⇔ sD = (s + d)pA
sd s+d
(s + d)(pA − p)
=
sd
p D∗ − p
Xs = Q∗s − Q∗d = ∗ −
s d∗
(s + d ) p − s D
∗ ∗ ∗ ∗
s∗ D∗
= plug in p∗
A = ⇔ s∗ D∗ = (s∗ + d∗ ) p∗A
s∗ d∗ s∗ + d ∗
(s∗ + d∗ ) (p − p∗A )
=
s∗ d ∗
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Open to Trade
Open Up to Trade and Gain from Trade
. Draw a graph showing the quantity of goods traded internationally Qw and the world price pw under
free trade as functions of pA and p∗A .
p p p
Q Q Q
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Gain from Trade
Open Up to Trade and Gain from Trade
. Draw a graph showing domestic consumer and producer surplus under free trade, CSW and PSW , as
functions of pw .
p p p
Q Q Q
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Gain from Trade
Open Up to Trade and Gain from Trade
. Are these greater or smaller than their autarky equivalents? How can you tell?
(D − pw )2 p2w
CSw = , PSw =
2d 2s
(D − pA )2 p2
CSA = , PSA = A
2d 2s
So to compare CS and PS, we only need to compare pw and pA . Because pA > p∗A and pw is the
weighted average of p∗A and pA , pw < pA . It means that:
PSw < PSA , CSw > CSA
After opening to trade, consumers gain but producer loss.
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Tariff
Open Up to Trade and Gain from Trade
. The domestic country imposes a tariff T per unit of imported good. Label on the graph the quantity
traded internationally under tariffs QT and the world price pT .
Proposition: In fact new equilibrium pT < pw because the lower demand induced by tariff. But the
real import price is pT + T > pw .
p p p
Q Q Q
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Tariff
Open Up to Trade and Gain from Trade
. Label on the graph domestic consumer and producer surplus and government revenue under tariffs,
CST , PST , and GRT .
— a + b + c + d" : loss of CS
— a: gains of PS
— c + e is government revenue.
— b + d" is the deadweight loss.
— e is the terms-of-trade gain extracted from
foreign.
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Tariff Loss
Open Up to Trade and Gain from Trade
. Derive a condition for which domestic welfare under tariffs (the sum of consumer and producer
surplus and government revenue) is lower under tariffs than under free trade.
— a + b + c + d" : loss of CS
— a: gains of PS
— c + e is government revenue.
— b + d" is the deadweight loss.
— e is the terms-of-trade gain extracted from
foreign.
— To show that a tariff reduces welfare, it is
equivalent to showing:
b + d" > e
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