THE GAINS AND LOSSES OF AN IMPORTING COUNTRY

Now suppose that the domestic price before trade is above the world price. Once again, after free trade is allowed, the domestic price must be equal to the world price. As Figure 9-4 shows, the domestic quantity supplied is less than the domestic quantity demanded. The difference between the domestic quantity demanded and the domestic quantity supplied is bought from other countries, and Isoland becomes a steel importer.

Figure 9-4

International Trade in an

Importing Country. Once

trade is allowed, the domestic

price falls to equal the world

price. The supply curve

shows the amount produced

domestically, and the

demand curve shows the

amount consumed

domestically. Imports equal

domestic quantity

demanded and the domestic

quantity supplied at the world

price.

In this case, the horizontal line at the world price represents the supply of the rest of the world. This supply curve is perfectly elastic because Isoland is a small economy and, therefore, can buy as much steel as it wants at the world price.

Now consider the gains and losses from trade. Once again, not everyone benefits. When trade forces the domestic price to fall, domestic consumers are better off (they can now buy steel at a lower price), and domestic producers are worse off (they now have to sell steel at a lower price). Changes in consumer and producer surplus measure the size of the gains and losses, as shown in Figure 9-5 and Table 9-2. Before trade, consumer surplus is area A, producer surplus is area B + C, and total surplus area is A + B +C. After trade is allowed, consumer surplus is area A + B +D, producer surplus is area C, and the total surplus is area A + B + C + D.

Figure 9-5

How Free Trade Affects Welfare in an Importing

Country. When the domestic price falls to equal

the world

price, buyers are better off

(consumer surplus rises from A

to A + B + D), and sellers are

worse off (producer surplus

falls from B + C to C). Total

surplus rises by an amount

equal to area D, indicating that

trade raises the economic

well-being of the country as a whole.

Table 9-2

Changes in Welfare from Free Trade: The Case of an Importing Country. The table

examines changes in

economic welfare resulting

from opening up a market to international trade.

Letters refer to the regions marked in Figure 9-5.

These welfare calculations show who wins and who loses from trade in an importing country. Buyers benefit because consumer surplus increases by the area B + D. Sellers are worse off because producer surplus falls by the area B. The gains of buyers exceed the losses of sellers, and total surplus increases by the area D.

This analysis of an importing country yields two conclusions parallel to those for an exporting country:

When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are worse off.

Trade raises the economic well-being of a nation, for the gains of the winners exceed the losses of the losers.

Now that we have completed our analysis of trade, we can better understand one of the Ten Principles of Economics in Chapter1: Trade can make everyone better off. If Isoland opens up its steel market for international trade, that change will create winners and losers, regardless of whether Isoland ends up exporting or importing steel. In either case, however, the gains of the winners exceed the losses of the losers, so the winners could compensate the losers and still be better off. In this sense, trade can make everyone better off. But will trade make everyone better off? Probably not. In practice, compensation for the losers from international trade is rare. Without such compensation, opening up to international trade is a policy that expands the size of the economic pie, while perhaps leaving some participants in the economy with a smaller slice.

[1] In philosophy, one speaks of ontologies as systematic theories about what exists. In the context of AI systems using human knowledge, we identify the ontology with the set of formal terms with which one represents knowledge, since the representation completely determines what "exists" for the system.