Welfare + Efficiency and International Trade Flashcards
welfare and efficiency in markets
economists measure the net benefit to buyers and sellers who engage in economic transactions
- this net benefit is referred to as consumer and producer surplus
definition: consumer surplus
the difference between the maximum price a consumer is willing to pay and the price they actually pay for the good
- the maximum price they are willing to pay reflects the marginal benefit to the consumer and the price they pay reflects the marginal cost to the consumer for procuring the good
- hence, consumer surplus measures the net benefit to the consumer
producer surplus
the difference between the lowest price the seller is willing to sell for and the price actually received for the good
- the lowest price is the marginal cost of producing it and the selling price in effect reflects the marginal “benefit” to the seller
- hence, producer surplus measures the ‘net benefit’ to the producer
total surplus in equilibrium (total surplus diagram)
total surplus is maximised when the market is in equilibrium
the market is then efficient, because the amount of resources devoted to the production
of this good reflects the benefit consumers receive from procuring it
deadweight loss (deadweight loss diagram)
the loss of potential surplus, not transferred to any other party
the DWL occurs because MB ≠ MC
the bigger the DWL, the further we are from efficiency and optimal welfare
hence, where markets are inefficient, economists will have to work out how to minimise the DWL or get rid of it all together
efficiency
we have said that markets tend to allocate resources most efficiently when left to their own devices
so maximum efficiency tends to imply maximum welfare
that is, the total net benefit (i.e. surplus) to buyers and sellers is maximised when markets are efficient
there are exceptions, and this leads to market failure
economists distinguish between three types of efficiency
- allocative efficiency = MB equals MC = consistent with free market equilibrium
- productive efficiency = firms operate at lowest point on the average costs curve
- dynamic efficiency = occurs when firms are willing and able to continually improve production processes and products through research and development
modelling international trade
in this unit we analyse trade from the perspective of a small economy acting as a price-taker = too small to influence world prices
price taker = we take the world price as a given, not set it
equilibrium without international trade
domestic price adjusts to clear market
the sum of consumer and producer surplus measures the total benefits that buyers and sellers receive
gains from trade: exports (diagram)
world price = $12
domestic price = $10
the result is smaller domestic consumption at Qd but higher production at Qs
the difference between Qd and Qs is the amount exported
area F represents the net increase in total surplus as a result of international trade
therefore, when a country exports a product, domestic consumers will be worse off, and domestic producers better off but overall the country is better off
gains from trade: imports (diagram)
world price = $8
domestic price = $10
results in higher domestic consumption at Qd but lower domestic production at Qs
the difference between Qd and Qs is the amount imported
area D represents the net increase in total surplus as a result of international trade
therefore, when a country imports a product, domestic consumers will be better off, and domestic producers worse off but overall the country is better off
tariffs (diagram)
although we can see that international trade creates both winners and losers, the net effect on total surplus is always positive
often, a tariff is imposed on imported goods in an attempt to arbitrarily raise the world price of the good for domestic consumers
effectively, this simply raises the price observed in the market by the amount of the tax
Pw is lower than domestic price
Qs to Qd is imports w/o tariffs
Pw + tariff is above Pw but below Pd
QsT to QdT is imports w/ tariffs
consumers are worse off as a result of the tariff but producers are better off, however, society is overall worse off than if the tariff were never imposed = there is a DWL
why countries restrict trade
protect local jobs = PMV industry = if temporary
problem its good, if fundamental problem its bad
infant industry = industry with potential e.g. uranium but needs help at the start
national security = is it okay for other countries to buy large parts of our land
unfair competition = weak argument
protection as a bargaining chip = weak argument
