Changing equilibria from trade

0:00- [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.

0:21And 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.

0:40And 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.

1:01Fair 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.

1:24So 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.

1:46Well, 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.

2:11And 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.

2:31And 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.

2:53So 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?

3:16Well, 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.

3:36And 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.

3:57And 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.

4:28And 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.

4:50And 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.

5:07Now, 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.

5:29'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.

5:47And 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.

6:13And 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.