Changing equilibria from trade | APⓇ Microeconomics | Khan Academy

Summary

This video explores how international trade can impact the equilibrium price and quantity in a market. Using simplified examples of two countries, A and B, the instructor explains how opening economies to trade alters the combined supply and demand curves. Trade typically leads to a new equilibrium price between the two original autarkic prices, benefiting some groups while disadvantaging others. Consumers in country A and producers in country B gain from increased surplus, while suppliers in country A and consumers in country B experience reduced surplus. Overall, trade often boosts total consumer and producer surplus, despite creating winners and losers.

Takeaways

• 🌍 Trade can alter the equilibrium price and quantity in a market, as shown by comparing autarky to open economies.
• 📉 Country A and Country B, when in autarky (operating independently), have different demand and supply curves, leading to different equilibrium prices and quantities.
• 💸 In autarky, Country A has a higher equilibrium price (close to $4) and lower quantity compared to Country B (with a price around $1).
• 🤝 When the two countries trade, their combined market creates new equilibrium conditions, with the price now settling between their original prices.
• 📊 The new equilibrium quantity for the combined market increases due to trading, compared to when the countries were isolated.
• 🛒 Consumers in Country A benefit from trade as they now pay a lower price, increasing their consumer surplus.
• 🏭 Producers in Country B benefit by producing more and exporting to Country A, increasing their producer surplus.
• ⚖️ Some groups lose in trade: suppliers in Country A see their producer surplus shrink, and consumers in Country B now pay higher prices, reducing their consumer surplus.
• 📈 The overall consumer and producer surpluses in the combined economy are greater than they were in isolation, though individual outcomes vary.
• 🔄 Opening up economies from autarky usually leads to higher total surpluses, but it also creates winners and losers across different markets.

Q & A

What is the term used to describe a country that operates in isolation without trade?

The term used is 'autarky,' which refers to a country operating independently without trading with other countries.

What happens to the equilibrium price and quantity in an autarky market?

In an autarky, the equilibrium price and quantity are determined solely by the internal demand and supply of that country. For example, in country A, the equilibrium price is just under $4, and the equilibrium quantity is a little under four units.

How does opening trade between two countries affect their equilibrium price and quantity?

When two countries open trade, their supply and demand curves are combined. This generally results in a new equilibrium price and quantity that is different from the autarky situation. In the example, the new equilibrium price is between the two original prices (under $3), and the equilibrium quantity increases to around 10 units.

Who benefits when trade opens between two countries?

The main beneficiaries are the consumers in the country with the higher prices before trade (country A) and the producers in the country with the lower production costs (country B). Consumers in country A pay a lower price, and producers in country B can export more goods at a higher price.

Who loses when trade opens between two countries?

The losers are the producers in the country with higher production costs (country A) who see their producer surplus shrink, and the consumers in the lower-cost country (country B) who have to pay a higher price after trade.

What happens to the consumer surplus in country A when trade is opened?

In country A, consumer surplus increases significantly because the equilibrium price drops from just under $4 to just under $3, allowing consumers to buy more goods at a lower price.

How does the producer surplus change for country B after trade?

In country B, the producer surplus increases because they can sell more goods at a higher price to the foreign market, boosting their overall revenue.

What is the impact of trade on the total consumer and producer surplus of both countries?

Trade increases the total consumer and producer surplus of the combined economies. Although some groups may lose, the overall surplus for both countries is larger when trade is allowed compared to the autarky scenario.

How are imports and exports determined in this trade model?

In the trade model, the difference between the domestic supply and demand is filled by imports or exports. For country A, the quantity of widgets demanded beyond what its suppliers can provide is imported from country B. For country B, the excess quantity produced beyond its domestic demand is exported to country A.

Why do proponents of free trade argue that it is beneficial?

Proponents of free trade argue that it increases the overall consumer and producer surplus by allowing countries to specialize based on their comparative advantages. This leads to lower prices for consumers in high-cost countries and greater market opportunities for producers in low-cost countries.

Outlines

00:00

🔍 Understanding Market Equilibrium in Isolation (Autarky)

This paragraph introduces the concept of autarky, where countries operate independently without trading with others. The instructor uses two countries (A and B) as examples, explaining their respective demand and supply curves in a simplified market for widgets. Both countries have different equilibrium prices and quantities when they are in autarky, with Country A's price being just below $4 and Country B's price slightly over $1. The key point is that in autarky, each country has its own equilibrium based on internal supply and demand.

05:02

🌐 Impact of Opening Economies to Trade

This section explores what happens when Countries A and B open their markets to each other and begin trading. By horizontally adding their demand and supply curves, the combined market now finds a new equilibrium price (around $3) and quantity (nearly 10 units). The instructor explains that with trade, buyers in Country A benefit from a lower price, while suppliers in Country B produce and export more. Meanwhile, the combined consumer and producer surplus is larger than before, showing the overall economic benefits of trade.

📉 Winners and Losers in the Transition to Trade

The final paragraph highlights the winners and losers when moving from autarky to open trade. Consumers in Country A gain a larger consumer surplus due to the lower price, and suppliers in Country B benefit from a larger producer surplus as they export more. However, suppliers in Country A suffer a loss in producer surplus, and consumers in Country B now face higher prices, reducing their consumer surplus. The overall takeaway is that while trade increases total consumer and producer surplus, there are still parties who lose in the process.

Keywords

💡Autarky

Autarky refers to an economic situation where a country is completely self-sufficient and does not engage in international trade. In the video, both Country A and Country B are initially described as autarkies, meaning they operate in isolation without trading with each other. This concept is crucial to understanding how trade alters the equilibrium price and quantity when countries open up their economies.

💡Equilibrium Price

The equilibrium price is the price at which the quantity of goods supplied equals the quantity demanded. In the video, the equilibrium price for widgets in Country A is slightly under $4, and for Country B, it is a bit over $1. This price shifts when the two countries start trading, demonstrating how market integration affects pricing.

💡Equilibrium Quantity

Equilibrium quantity refers to the number of goods bought and sold at the equilibrium price. In the video, before trade, Country A has an equilibrium quantity of slightly under four units, while Country B's equilibrium quantity is similar. After trade, the combined market reaches a new equilibrium quantity of just under 10 units, reflecting the effect of trade on the overall market.

💡Supply Curve

The supply curve shows the relationship between the price of a good and the quantity supplied. In the video, the supply curves of both countries differ, but when the countries open up to trade, their supply curves are horizontally combined. This results in a new supply curve that affects the equilibrium price and quantity in the combined market.

💡Demand Curve

The demand curve represents the relationship between the price of a good and the quantity demanded. Like the supply curves, the demand curves of Country A and Country B are different in autarky, but when the countries open to trade, these curves are horizontally added together, forming a new demand curve that shifts the market's equilibrium.

💡Consumer Surplus

Consumer surplus is the difference between what consumers are willing to pay and what they actually pay. In the video, the consumer surplus in Country A increases significantly after trade, as consumers benefit from a lower price for widgets. Conversely, in Country B, consumers see a reduction in consumer surplus as prices increase.

💡Producer Surplus

Producer surplus is the difference between what producers are willing to sell a good for and the price they actually receive. In Country B, the producer surplus increases after trade, as producers can sell more widgets at a higher price. However, producers in Country A experience a decline in producer surplus due to the lower equilibrium price in the global market.

💡Imports

Imports refer to goods brought into a country from abroad for sale. After trade begins between Country A and Country B, Country A imports widgets from Country B. This is because Country B can produce widgets at a lower cost, making it advantageous for Country A to buy rather than produce the entire quantity domestically.

💡Exports

Exports are goods produced domestically and sold to another country. In the video, Country B becomes an exporter of widgets to Country A after the two countries open to trade. This allows Country B to produce and sell more widgets than it could in autarky, taking advantage of its lower production costs.

💡Free Trade

Free trade is the concept of allowing countries to trade without restrictions such as tariffs or quotas. In the video, the move from autarky to a trading relationship between Country A and Country B exemplifies the benefits of free trade. Proponents argue that it increases overall consumer and producer surplus, even though there are winners and losers in both economies.

Highlights

Country A operates in autarky, meaning it is functioning independently without trade.

In country A's market for widgets, the equilibrium price is slightly below $4, and the equilibrium quantity is just under four units.

Country B is also an autarky with its own supply and demand curves. The equilibrium price in country B is slightly over $1.

Opening trade between country A and country B results in a new equilibrium price between $2 and $3, with the equilibrium quantity just under 10 units.

In the new combined market, country A’s demand at a price of zero is 15 units, while country B's demand is 5 units, leading to a total demand of 20 units.

At a price of five dollars, country A supplies five units while country B supplies 15, leading to a total supply of 20 units.

Opening up trade increases the total consumer and producer surplus for the combined markets, even though some groups lose out.

Country A’s consumers benefit from a lower price (from just under $4 to between $2 and $3), which increases their consumer surplus.

Country B’s suppliers gain because they produce more widgets, increasing their producer surplus.

Country A’s suppliers lose out, as their producer surplus shrinks due to lower equilibrium prices in the combined market.

Country B’s consumers face a higher equilibrium price, reducing their consumer surplus.

The concept of horizontal addition is used to combine supply and demand curves from both countries.

Consumer surplus grows in the combined economy, leading to greater overall efficiency in the market.

Producer surplus also increases in the combined economy, though some producers, particularly in country A, lose out.

Trade generally leads to a larger total surplus (consumer + producer), but it creates winners and losers depending on the country's role in the market.

Transcripts

- [Instructor] In this video, we're going to think about

how trade can alter the equilibrium

price and quantity in a given market.

So what we see here, as we like to do,

are very simplified examples of markets

in various economies.

So first, we have country A,

and let's say it's the market for widgets.

And we're going to assume that country A

is not trading with anyone else.

So it is an autarky, a very fancy word, which just means

that this country is operating independently.

It's operating in isolation.

And so you can see the demand curve

in this market in orange,

and we can see the supply curve.

And you can see,

when this country is operating in isolation,

this market for widgets has an equilibrium price.

It looks like it's a little bit under $4.

I'll just assume that the price is in dollars per widget.

And the equilibrium quantity

looks like it's about a little under four units

per whatever time period we're looking at.

Fair enough.

Now let's look at country B,

and let's assume that they are also operating independently.

It's an autarky in this market.

And so here, we can see a different

demand curve than what we saw in country A

and a different supply curve.

And notice they have a different

equilibrium price and quantity.

So here, the equilibrium price

seems to be a little bit over $1,

and the equilibrium quantity seems to actually be

not that different than what we saw in the first country.

Although, in many situations, it could be very different.

Now let's imagine what would happen

if they opened up their economies to each other.

Well, then you would essentially

horizontally add these two demand curves,

and you would horizontally add these two supply curves

to come up with a new supply curve

and a new demand curve. This is a little bit of a review

of what we've seen in other videos.

But notice, at a price of five,

in total, no one's demanding anything,

no quantity of these widgets.

And then at a price of zero,

country A, the market there is demanding 15,

and country B is demanding five.

So in aggregate, they're demanding 20.

And similarly, you can see that with supply,

that at a price of five,

country A will supply five.

And at a price of five, country B will supply 15.

And so together, they will supply 20 units per time period.

And so we can view this right over here

as our supply and demand curves

for the combined markets because now they're trading.

We are not in an autarky anymore.

And notice what has happened.

Our equilibrium price is now someplace

in between these two equilibrium prices.

So it looks like it's a little bit under $3.

And our equilibrium quantity,

our equilibrium quantity is a little bit under 10 units.

And so you might notice

some interesting things that are happening.

What would happen from a,

someone in country A's point of view,

the people who are the buyers,

the people who are demanding this widget?

Well, now, instead of having to pay almost four,

they're paying someplace in between two and three.

This is the new equilibrium price

if they were to open up their economy.

And so what you have is, is that this,

this amount would be produced by,

in theory, by the domestic manufacturers,

so the first, let's call that 2 1/2 units.

And then the remainder,

where are they going to get those units from?

Well, those are going to be imports.

And let's look at the equilibrium price on country B,

and country B was really the lower cost producer.

And so country B, now we have a,

let's put it a little bit over 2.5,

so let's put it right over there.

And so now you have a situation where the suppliers

in country B are going to be producing a lot,

a lot more than they were before.

And only this amount is coming from their domestic demand.

And then all of this amount right over here,

that is being exported.

And if we're assuming that the world economy

is only made up of country A and country B

or that they're only trading with each other,

these exports become country A's

imports right over there.

And so proponents of free trade will say, hey, look,

the overall consumer surplus is larger

than the combined consumer surpluses that we had before.

Before, you had this consumer surplus in country A.

And country B,

it was all of this.

But still, this entire area is larger

than these two combined.

And you could do it mathematically if you like,

calculate the area of these triangles.

And if you look at the producer surplus,

you'll see a similar story.

The total producer surplus of the combined economies now,

this is going to be larger than this producer surplus

plus this producer surplus.

Now, some,

there will not always be winners in this.

The winners here are the demanders in country A.

Because instead of this little, small consumer surplus

that they had before, now they have this much larger

consumer surplus right over there.

And then the other winners are the suppliers in country B.

'Cause instead of this producer surplus

that they had before,

they now have this producer surplus.

But the losers in this situation

are the suppliers in country A

who now have a much lower producer surplus.

So their triangle has shrunk to that right over there.

And then the other losers in this situation

are the consumers in country B

who now have to pay a higher equilibrium price.

And so their consumer surplus is only this small triangle,

when before it was this whole thing.

So anyway, the big takeaway here is,

is that if you go from autarky to opening up economies,

it can affect what the equilibrium

prices and quantities are going to be.

And oftentimes or usually, it's going to increase

your total consumer and producer surplus.

Although, there will be some winners,

and there will be some losers.