Demand Curve and Consumer Surplus

• International Trade is reviewed in Lecture 7
• Exam review is also part of Lecture 7
• This lecture will cover gains from trade and review for Exam 1

HW 4 Questions

• Topics covered include comparative advantage, taxes, tariffs, and deadweight loss.
• Also covered binding and non-binding price controls.
• Other topics include benefits from trade, and elasticity.

Concepts and Distinctions

• Equilibrium and efficiency are key concepts
• Opportunity cost and counterfactual scenarios should be understood
• Positive vs. normative statements, as well as nominal vs. real values are important distinctions
• Stock vs. flow, and income vs. wealth also important distinctions
• Understand savings vs saving
• A competitive market involves individual buyers and sellers
• Buyers and sellers are price takers, so they do not affect the market price
• At the market price, buyers can buy all they want, and sellers can sell all they want

Positive vs Normative

• Positive statements describe the world as it objectively is
• Example: A 25% tariff on steel will reduce consumer surplus
• Normative statements describe how the world should be
• Example: A 25% tariff on steel will make America better off

Comparative Advantage in Steel

• U.S. has available 50,000 labor hours per month.
• U.S. productivity: 1 ton of steel requires 500 hours of labor and 1 ton of soybeans requires 10 hours of labor
• Japan has available 30,000 labor hours per month.
• Japan productivity: 1 ton of steel requires 625 hours of labor and 1 ton of soybeans requires 25 hours of labor

Demand Curves

• Demand curves illustrate the relationship between price and quantity demanded
• If the good is priced at $3,000, consumers will buy 180
• Marginal consumption is valued at $3,000 meaning any consumption up to that point is worth more

Consumer Surplus

• Consumer surplus is the net value consumers receive from paying less than what they value consumption
• Marginal consumption is worth $3,000, implying consumption up to that point is worth more
• If the good is priced at $2,500, then consumers will buy 200, increasing the consumer surplus
• Marginal consumption is worth the price to the consumer

Consumer Surplus and Price

• Consumer surplus is larger when price is lower
• Original consumption of 180 will provide additional CS and at a lower price, consumption increases providing new CS

Consumer and and Producer Surplus

• At a price of $3,000, producers will be willing to supply 180 units
• Producer surplus is the net value sellers receive from receiving more than the production costs

Price Ceilings

• A price ceiling transfers producer surplus to consumer surplus and also creates a deadweight loss
• Equilibrium Price is $3,000
• Total surplus is A + C + D + F + G
• Price ceiling is $2500
• Total surplus then becomes A + C + G

Demand Curve Shifts

• The demand curve illustrates relationship between price and quantity demanded, assuming all other factors remain constant
• Non-price determinants of demand are factors besides price that influence a buyer's demand.
• Changes in non-price determinants shift the demand curve

Shifts in Demand and Supply Curves

• Shifts in the demand curve area caused by: number of buyers, prices of substitutes, prices of complements, income, tastes, expectations
• Shifts in the supply curve are caused by: number of sellers, prices of inputs, taxes on output, productivity, production technology, expectations

Shifting Supply

• Running a budget deficit reduces the supply of loanable funds
• This has an affect on both the interest rate and the amount of available funds

Tax Incidence

• Tax incidence is how the tax burden is distributed
• Tax burden is is who pays how much of the tax
• Tax burden is the difference between what the buyers/sellers pay/receive with tax vs. the amount without the tax
• The difference between what buyers and seller pay is determined by elasticity
• Whoever is less responsive to price pays more of the burden
• Tax incidence is not impacted by who the tax is assessed to

Tax Incidence Example

• Output and after tax prices paid by buyers and sellers do not depend on who pays the tax
• Sellers Taxed: Buyers pay new market price of $11 and sellers keep $9.50 after paying tax
• Buyers Taxed: Sellers receive new market price of $9.50 and buyers end up pay a total of $11 after paying the tax

Tax Burden Example

• Demand being perfectly inelastic means the consumer bears the entire burden of the tax
• Sellers Taxed: Buyers pay a new market price of $11.50, and sellers keep $10 after paying an output tax.
• Buyers Taxed: Sellers receive same market price of $10 and buyers pay $11.50 after paying the tax

A Tariff Example

• Analyzing the effect of imposing a 100% tariff on Chinese imports
• Walmart represents U.S. importers and consumers
• Measure quantity of Chinese imports before and after
• Measure the price Walmart pays for imported Chinese goods before and after tariff
• Measure the price China receives before and after tariffs

Markets

• Markets involve potential buyers and sellers interacting
• Markets facilitate voluntary exchange
• Competition exists with many buyers and sellers
• Perfect competition: perfectly elastic Demand and Supply

Equilibrium Types

• Matching markets exist
• These markets require an identity of buyers/sellers/goods
• In matching markets, price alone does not clear the market
• Commodity markets exist
• These markets provide standardized goods where price clears the market

Market Efficiency

• Competitive market equilibrium is efficient
• Total surplus is maximized
• Buyers who value the good most receive it
• Sellers with the lowest production costs supply the good
• Buyers that value the good more than the costs receive it

Demand and Supply Example

• It is important to distinguish what buyers and sellers should trade
• Determine the efficient Q that is traded

Trading Pairs

• It is important to understand which buyers and sellers should or should not have traded
• It is also important to determine why some buyers and sellers should have failed to transact

International Trade Analyses

• Production takes place both Domestically and in the rest of the world
• Countries are price takers, which assumed a small economy meaning that actions have no effect on world prices
• In free trade, the world price will have an affect on the buyers and sellers
• No buyer will pay more than what is offered on the world state, and no seller will accept less

Specialization Through Trade

• No Trade: US Consumption is limited by US Production
• US can specialize based on comparative advantage with trading with a county like Japan
• US can export beans and import planes

Trade and Consumption

• Without trade, consumption equals production
• Trade can determine domestic production
• Trade will determine domestic consumption

Domestic Pricing

• Domestic price is a determinant of both production and consumption
• The domestic production costs limit consumption

World Price

• Comparative advantage equals lowest opportunity cost
• Domestic and world price both represent opportunity costs
• Comparing domestic and world price can determine the level of comparative advantage

Domestic Price Example

• If Domestic price is less than world price, the domestic country has comparative advantage and exports the good
• If Domestic price is greater than world price, the domestic country does not have comparative advantage and imports the good

Opening Economy

• An opening economy leads to winners and losers
• World price determines production/consumption, not just the domestic level
• World production cost limits consumption
• There will be both a PS transfer to CS and new CS created
• The gains tend to be larger for winners than for the loss for losers

Tariff

• A tariff is a tax on goods produced abroad and sold domestically
• A tariff is specifically a tax on imported goods
• Free trade with a domestic price will be equal to the world price
• Tariffs on imports will cause prices to rise above world price
• The price increase equals the amount of the tariff in a small economy

Tariff Results

• Implementing output tariffs creates both winners and losers: It raises revenue and increases PS
• Tariffs also reduce CS and creates inefficiency
• Tariff gains to the winners being smaller than the losses to losers

Examples of Trade Barriers

• Other benefits of international trade include:
• Increases variety of goods
• Lower costs through economies of scale
• There is increased competition through open trade
• Resources move from the least to the most productive industries with trade
• There is an Enhanced flow of ideas that facilitates the spread of technology

Arguments Against Free Trade

• There are common arguments against free trade
• Free trade destroys domestic jobs
• There is pressure to compete on a level playing field
• Some "infant industries" need protection and that sectors vital to national security must remain protected

Free trade impact on jobs

• Trade reduces domestic jobs but creates new ones
• Total unemployment does not generally rise do export job gains

Level Playing Field

• "Free trade is desirable only if all countries play by the same rules"
• It increases total surplus even if countries don't play by the rules
• There are low-cost products subsidized by the other country's taxpayers
• The gains exceed the losses to exporters

Infant Industries

• "New industries need temporary trade restrictions to help them get started."
• It is difficult to implement "temporary" policy in practice and protection isn't necessarily useful

National Security

• The industry might be vital to national security
• This should be carefully evaluated but firms are incentivized to push for protections.

Free Trade Summary

• The effects of free trade can be determined by comparing the domestic price before trade with the world price.
• A low domestic price means that the country becomes a good exporter.
• A high domestic prices indicate that the country will turn into an importer of any product.

Trade Summary

• When a country allows trade
• exporters in those fields will grow and consumers will lose
• otherwise domestic markets will face pressures
• the sum gains generally exceeds all losses -A tariff generally eats into each of the gains overall

Explore the relationship between demand curves and consumer surplus. Understand how price changes, technological advancements, and government policies influence consumer surplus. Learn to interpret demand curves and predict market outcomes.