Professional Documents
Culture Documents
İktisat
İktisat
Economy &
Economics The economy exists at different
scales
• Local
• National e.g. the Turkish
• International e.g. EU
Principle #1: People Face trade-offs.
To get one thing, we usually have to give up another thing.
Making decisions requires trading off one goal against another.
Efficiency vs. Equity
Efficiency means society gets the most that it can from its scarce resources.
Equity means the benefits of those resources are distributed fairly among the
members of society.
Principle #2: The Cost of Something
Is What You Give Up to Get It.
•The opportunity cost of an item is what you give up to
obtain that item.
Principle #3: Rational People Think at the Margin.
•Marginal changes in
costs or benefits
motivate people to
respond.
•Public policies can
create incentives or
disincentives that
alter behavior.
Principle #5: Trade Can Make Everyone Better Off.
Market economy
Planned economy
Adam Smith made the observation
that households and firms
interacting in markets act as if
guided by an “invisible hand.”
Principle #7:
Governments Can
Sometimes Improve
Market Outcomes.
FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production
1
Markets and Competition
▪ A market is a group of buyers and sellers of a particular good or
service.
2
Competition: Perfect and Otherwise
▪ A competitive market is a market in which there are many
buyers and sellers so that each has a negligible impact on the
market price.
▪ Perfect Competition
▪ Products are the same
▪ Buyers and Sellers are price takers
3
Demand
▪ Quantity demanded is the amount of a good
that buyers are willing and able to purchase.
▪ Law of Demand
▪ The law of demand states that, other things equal, the quantity demanded
of a good falls when the price of the good rises.
▪ Demand Schedule
▪ The demand schedule is a table that shows the relationship between the
price of the good and the quantity demanded.
▪ Demand Curve
▪ The demand curve is a graph of the relationship between the price of a
good and the quantity demanded.
4
>> Demand
Price of
Milk
$3.00
2.50
1. A decrease
2.00
in price ...
1.50
1.00
0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Milk
2. ... increases quantity 5
of milk demanded.
▪ Change in Quantity Demanded
▪ Movement along the demand Change in
curve. quantity
▪ Caused by a change in the price of
the product.
demanded
▪ Change in Demand
▪ A shift in the demand curve is
caused by a factor affecting
demand other than a change in
price.
6
>> Change in Quantity Demanded
Price of
Milk A tax that raises the
price of milk results in
B a movement along the
$2.00
demand curve.
1.00 A
D
0 4 8 Quantity of Milk
7
>> Change in Quantity Demanded
▪ Assume the price of milk falls.
▪ More will be demanded because of the income and
substitution effects.
9
10
>> Shifts in the Demand Curve
Price of
Milk
Increase
in demand
Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
Milk 11
>> Shifts in the Demand Curve
▪ Consumer Income
▪ As income increases the demand for a normal good will
increase.
▪ As income increases the demand for an inferior good will
decrease.
$3.00 An increase
2.50 in income...
Increase
2.00 in demand
1.50
1.00
0.50
D2
D1 Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Shirt
13
>> Consumer Income: Inferior Good
Price of bread
$3.00
2.50
2.00
Decrease
An increase
1.50 in demand in income...
1.00
0.50
D2 D1 Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 bread
14
Variables That Influence Buyers
15
SUPPLY
▪ Quantity supplied is the amount of a
good that sellers are willing and able to
sell.
▪ Law of Supply
▪ The law of supply states that, other things equal, the quantity supplied of a
good rises when the price of the good rises.
▪ Supply Schedule
▪ The supply schedule is a table that shows the relationship between the
price of the good and the quantity supplied.
▪ Supply Curve
▪ The supply curve is the graph of the relationship between the price of a
good and the quantity supplied.
16
Supply Schedule and Supply Curve
Price of
Milk
$3.00
2.50
1. An
increase
in price ... 2.00
1.50
1.00
0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Milk
17
2. ... increases quantity of milk supplied.
Changes in quantity supplied & supply curve
▪ Change in Quantity Supplied
▪ Movement along the supply curve.
▪ Caused by a change in the price of the product.
▪ Change in Supply
▪ A shift in the supply curve, either to the left or right.
▪ Caused by any change that alters the quantity supplied at every price.
▪ Input prices
▪ Technology
▪ Expectations
▪ Number of sellers
18
Change in Quantity Supplied
Price of
Milk S
C
$3.00
A rise in the price
of milk results in a
movement along
the supply curve.
A
1.00
Quantity of
Milk
0 1 5
19
20
Shifts in the Supply Curve
Price of
Milk Supply curve, S3
Supply
curve, S1
Supply
Decrease curve, S2
in supply
Increase
in supply
0 Quantity of 21
Milk
Variables That Influence Sellers
22
Supply and Demand Together
▪ Equilibrium Quantity
▪ The quantity supplied and the quantity demanded at the equilibrium price.
▪ On a graph it is the quantity at which the supply and demand curves
intersect.
23
Supply and Demand Together
Demand Schedule Supply Schedule
Equilibrium Demand
quantity
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Milk 25
Markets Not in Equilibrium
(a) Excess Supply
Price of
Milk Supply
Surplus
$2.50
2.00
Demand
0 4 7 10 Quantity of
Quantity Quantity Milk
demanded supplied
26
Markets Not in Equilibrium
(b) Excess Demand
Price of
Milk
Supply
$2.00
1.50
Shortage
Demand
0 4 7 10 Quantity of
Quantity Quantity Milk
supplied demanded
27
Law of supply and demand & change in the
market
▪ Law of supply and demand
▪ The claim that the price of any good adjusts to bring the quantity supplied
and the quantity demanded for that good into balance.
28
How an Increase in Demand Affects the Equilibrium
Price of
Milk 1. Health news increases
the demand for milk . . .
Supply
2.00
2. . . . resulting
Initial
in a higher
equilibrium
price . . .
D
0 7 10 Quantity of
3. . . . and a higher Milk 29
quantity sold.
How a Decrease in Supply Affects the Equilibrium
Price of
Milk 1. An increase in the
price of animal feed reduces
the supply of milk . .
S2
S1
New
$2.50 equilibrium
2. . . . resulting
in a higher
price of milk …
Demand
0 4 7 Quantity of
3. . . . and a lower Milk 30
quantity sold.
Key concepts of the lecture
▪ market ▪ ceteris paribus
▪ competitive market ▪ quantity supplied
▪ quantity demanded ▪ law of supply
▪ law of demand ▪ supply schedule
▪ normal good ▪ supply curve
▪ inferior good ▪ equilibrium
▪ substitutes ▪ equilibrium price
▪ complements ▪ equilibrium quantity
▪ demand schedule ▪ surplus
▪ demand curve ▪ shortage
▪ law of supply and demand
31
Exercise
▪ Years ago through the growing fear of “pig
influenza”, people began to use more anti-
bacterial soaps.
However, unexpectedly the price of anti-
bacterial soap did not increase, even we
observed falling prices.
32
▪ LECTURE 4
▪ Elasticity and Its Applications
▪ from MANKIW & TAYLOR 2014; Ch. 4
1
Elasticity . . .
2
The elasticity of demand
3
Computing the Price Elasticity of
Demand
▪ Example: If the price of a product
increases from $2.00 to $2.20 and
the amount you buy falls from 10 to
8, then your elasticity of demand
would be calculated as:
▪ % change in Q= -20
▪ % change in P= 10
▪ Price elasticity of demand (Ed) = -20
/ 10 = -2
▪ Generally treated in absolute terms:
|Ed | ➔ |-2 | = 2
4
Price elasticities of different
goods/services
Market Own Price Elasticity
Transportation -0,6
Motor vehicles -1,4
Motorcycles & bicycles -2,3
Food -0,7
Cereal -1,5
Clothing -0,9
Women’s clothing -1,2
Source: Baye et al. 1992 5
Using the Midpoint Method
6
The Variety of
Demand Curves
▪ Inelastic Demand
▪ Quantity demanded does
not respond strongly to price
changes.
▪ Price elasticity of demand is
less than one.
7
> The Variety of
Demand Curves
▪ Elastic Demand
▪ Quantity demanded
responds strongly to changes
in price.
▪ Price elasticity of demand is
greater than one.
8
▪ Perfectly Inelastic
▪ Quantity demanded does not
respond to price changes.
▪ Perfectly Elastic
▪ Quantity demanded changes
infinitely with any change in
>> The price.
Variety of ▪ Unit Elastic
▪ Quantity demanded changes
Demand by the same percentage as the
Curves price.
9
The Price Elasticity of Demand
Price
Demand
$5
4
1. An
increase
in price . . .
0 100 Quantity
Price
$5
4
1. A 25% Demand
increase
in price . . .
0 90 100 Quantity
$5
4
1. A 25% Demand
increase
in price . . .
0 75 100 Quantity
12
>>> The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price
$5
4 Demand
1. A 25%
increase
in price . . .
0 50 100 Quantity
13
>>>> The Price Elasticity of Demand
1. At any price
above $4, quantity
demanded is zero.
$4 Demand
2. At exactly $4,
consumers will
buy any quantity.
0 Quantity
3. At a price below $4,
quantity demanded is infinite.
14
Total Revenue and
the Price Elasticity
of Demand
▪ Total revenue is the
amount paid by buyers
and received by sellers of
a good.
▪ Computed as the price of
the good times the
quantity sold.
TR = P x Q
15
Total Revenue
Price
$4
P × Q = $400
P
(revenue) Demand
0 100 Quantity
16
Q
Elasticity and Total Revenue along a Linear Demand Curve
$3
Revenue = $240
$1
Revenue = $100 Demand Demand
18
How Total Revenue Changes When Price Changes: Elastic
demand
Price
Price
$5
$4
Demand
Demand
0 50 Quantity 0 20 Quantity
19
Income Elasticity of Demand
Income el 20
Income Elasticity
▪ Types of Goods
▪ Normal Goods
▪ Inferior Goods
23
The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply
$5
4
1. An
increase
in price . . .
0 100 Quantity
24
> The Price Elasticity of Supply
(b) Inelastic Supply: Elasticity Is Less Than 1
Price
Supply
$5
4
1. A 25%
increase
in price . . .
25
>> The Price Elasticity of Supply
(c) Unit Elastic Supply: Elasticity Equals 1
Price
Supply
$5
4
1. A 25%
increase
in price . . .
26
>>> The Price Elasticity of Supply
(d) Elastic Supply: Elasticity Is Greater Than 1
Price
Supply
$5
4
1. A 25%
increase
in price . . .
27
>>>> The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite.
$4 Supply
2. At exactly $4,
producers will
supply any quantity.
0 Quantity
3. At a price below $4,
quantity supplied is zero.
28
Determinants of Elasticity of Supply
▪ Time period.
▪ Supply is more elastic in the long run.
29
30
Can good news for farming be bad news for farmers?
▪ What happens to wheat farmers and the market for wheat when
university agronomists discover a new wheat hybrid that is more
productive than existing varieties?
▪ Examine whether the supply or demand curve shifts.
▪ What about the elasticity of the demand of wheat?
▪ How the market equilibrium and farmers’ income changes?
31
> Can good news for farming be bad news for
farmers?
Price of
Wheat 1. When demand is inelastic,
2. . . . leads an increase in supply . . .
to a large fall S1
in price . . . S2
$3
Demand
33
Exercise
▪ According to the study of the Ministry of
Health the price elasticity of demand of
cigarettes is -0,2. And people purchase about 500 million cigarettes
each year.
a. If the tax on cigarettes were increased enough to raise the
price of cigarettes by 50 percent, what would be the effect
on the quantity cigarettes demanded? Show your work
explicitly.
b. Is raising the tax on cigarettes a more effective way to reduce
smoking, if the demand of cigarettes is elastic or if it is
inelastic? Briefly explain and justify your answer with
diagrams.
34
ECON1211
IntroductIon
to EconomIcs
LECTURE 5
Supply,
Demand, and
Government
Policies
from MANKIW
& TAYLOR 2013;
Ch. 8
1
Supply, Demand, and Government
Policies
▪ In a free, unregulated market system, market forces establish
equilibrium prices and exchange quantities.
▪ While equilibrium conditions may be efficient, it may be true
that not everyone is satisfied.
▪ One of the roles of economists is to use their theories to assist
in the development of policies.
▪ Government polies:
▪ Price Controls
▪ Taxation
2
Controls on prices
▪ Are usually enacted when
policymakers believe the market
price is unfair to buyers or sellers.
▪ Result in government-created price
ceilings and floors.
▪ Price Ceiling
▪ A legal maximum on the price at which a
good can be sold.
▪ Price Floor
▪ A legal minimum on the price at which a
good can be sold
3
How Price Ceilings Affect Market Outcomes
4
A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Price
Supply
$4 Price
ceiling
3
Equilibrium
price
Demand
0 100 Quantity
Equilibrium
quantity 5
A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price
2 Price
Shortage ceiling
Demand
0 75 125 Quantity
Quantity Quantity
supplied demanded 6
CASE STUDY: Lines at the Gas Pump
Economists blame
government regulations that
limited the price of oil that
companies could charge for
gasoline.
7
The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Price of
Gasoline
Supply, S1
1. Initially,
the price
ceiling
is not
binding . . . Price ceiling
P1
Demand
0 Q1 Quantity of
8
Gasoline
The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Price of S2
Gasoline 2. . . . but when
supply falls . . .
S1
P2
Price ceiling
P1 3. . . . the price
4. . . . ceiling becomes
resulting binding . . .
in a
shortage. Demand
0 QS QD Q1 Quantity of
9
Gasoline
CASE STUDY: Rent Control in the Short Run and Long Run
Controlled rent
Shortage
Demand
0 Quantity of
Apartments 11
Rent Control in the Short Run and in the Long Run
(b) Rent Control in the Long Run
(supply and demand are elastic)
Rental …because the supply and
Price of demand for housing units
Apartment are more elastic, rent
control causes a large
shortage.
Supply
Controlled rent
Shortage Demand
0 Quantity of
Apartments 12
How Price Floors Affect Market Outcomes
13
A Market with a Price Floor
(a) A Price Floor That Is Not Binding
Price
Supply
Equilibrium
price
$3
Price
floor
2
Demand
0 100 Quantity
Equilibrium
14
quantity
A Market with a Price Floor
A binding price floor
(b) A Price Floor That Is Binding causes surplus &
nonprice rationing
Price
• the minimum
Supply wage
• agricultural
Surplus price supports
$4
Price
floor
3
Equilibrium
price
Demand
0 80 120 Quantity
Quantity Quantity
demanded supplied 15
How the Minimum Wage Affects the Labor Market
Wage
Labor
Supply
Equilibrium
wage
Labor
demand
0 Equilibrium Quantity of
employment Labor
16
How the Minimum Wage Affects the Labor Market
Wage
Labor
Labor surplus Supply
(unemployment)
Minimum
wage
Labor
demand
0 Quantity Quantity Quantity of
demanded supplied Labor
17
Exercise
18
TAXES
▪ Governments levy taxes to raise revenue for public projects.
▪ How Taxes on Sellers (and Buyers) Affect Market Outcomes
▪ Taxes discourage market activity.
▪ When a good is taxed, the quantity sold is smaller.
▪ Buyers and sellers share the tax burden.
19
A Tax on Sellers
Price
A tax on sellers
Price Equilibrium S2 shifts the supply
buyers with tax curve upward
pay by the amount of
$3.30 S1
Tax ($0.50) the tax ($0.50).
Price 3.00
without 2.80 Equilibrium without tax
tax
Price
sellers
receive
Demand, D1
0 90 100 Quantity
20
What was the impact of tax?
▪ Taxes discourage market activity.
▪ When a good is taxed, the quantity sold is smaller.
▪ Buyers and sellers share the tax burden.
21
A Tax on Buyers
Price
Price Supply, S1
buyers
pay
$3.30 Equilibrium without tax
Tax ($0.50)
Price 3.00 A tax on buyers
without 2.80
shifts the demand
tax
curve downward
by the size of
Price Equilibrium the tax ($0.50).
sellers with tax
receive
D1
D2
0 90 100 Quantity
22
A Payroll Tax
Wage
Labor supply
Tax wedge
Wage without tax
Wage workers
receive
Labor demand
0 Quantity
of Labor
23
Elasticity and Tax Incidence
▪ In what proportions is the burden of the tax divided?
▪ How do the effects of taxes on sellers compare to those
levied on buyers?
▪ The answers to these questions depend on the elasticity of
demand and the elasticity of supply.
24
How the Burden of a Tax Is Divided
(a) Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic
than demand . . .
Price buyers pay
Supply
Tax
2. . . . the
incidence of the
Price without tax tax falls more
heavily on
Price sellers consumers . . .
receive
3. . . . than
Demand
on producers.
0 Quantity
25
How the Burden of a Tax Is Divided
(b) Inelastic Supply, Elastic Demand
Price
1. When demand is more elastic
than supply . . .
Price buyers pay Supply
2. . . . the Demand
Price sellers incidence of
receive the tax falls
more heavily
on producers . . .
0 Quantity
26
Elasticity and tax incidence
27
▪ price ceiling
▪ price floor
▪ shortage Key concepts
▪ surplus
of the lecture
▪ tax incidence
28
Exercise
▪ If the government places a significant amount of tax on
luxury goods, what do you expect about the share of the
tax burden?
▪ Explain your answer with a supply and demand diagram.
29
ECON1211
IntroductIon
to EconomIcs
Lecture 6
Consumers, Producers and
The Efficiency of Markets
Application: The Costs of
Taxation
from MANKIW & TAYLOR
2013; Chs. 7, 9
1
Welfare Economics
Consumer
surplus
P1
B C
Demand
0 Q1 Quantity
4
How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price
A
Initial
consumer
surplus
C Consumer surplus
P1
B to new consumers
F
P2
D E
Additional consumer Demand
surplus to initial
consumers
0 Q1 Q2 Quantity
5
National Bureau of Economic
Research (NBER)
6
PRODUCER
SURPLUS
Producer surplus is the
amount a seller is paid
for a good minus the
seller’s cost.
It measures the benefit
to sellers participating in
a market.
Cost is the value of
everything a seller must
give up to produce a
good.
Just as consumer surplus
is related to the demand
curve, producer surplus
is closely related to the
supply curve.
The area below the price
and above the supply
curve measures the
producer surplus in a
market.
7
How the Price Affects Producer Surplus
(a) Producer Surplus at Price P
Price
Supply
B
P1
C
Producer
surplus
0 Q1 Quantity
8
How the Price Affects Producer Surplus
(b) Producer Surplus at Price P
Price
Additional producer Supply
surplus to initial
producers
D E
P2 F
B
P1
Initial C
Producer surplus
producer to new producers
surplus
0 Q1 Q2 Quantity
9
Consumer + Producer Surplus =
Total Surplus
▪ Then,
Total surplus = Consumer surplus + Producer surplus
or
Total surplus = Value to buyers – Cost to sellers
10
Consumer and Producer Surplus in the Market
Equilibrium
Price A
D
Supply
Consumer
surplus
Equilibrium E
price
Producer
surplus
Demand
B
Value Cost
to to
buyers sellers
Cost Value
to to
sellers buyers Demand
0 Equilibrium Quantity
quantity
13
1st Application: The Costs of Taxation
▪ Governments levy taxes to raise revenue for public
projects.
Supply
Price buyers Size of tax
pay
Price
without tax
Price sellers
receive
Demand
Supply
Price buyers Size of tax (T)
pay
Tax
revenue
(T × Q)
Price sellers
receive
Quantity Demand
sold (Q)
0 Q2 Q1 Quantity
17
Determinants of the deadweight loss
▪ Deadweight Loss is the fall in total surplus that results from
a market distortion, such as a tax.
▪ Taxes cause deadweight losses because they prevent
buyers and sellers from realizing some of the gains from
trade.
▪ What determines whether the deadweight loss from a tax
is large or small?
▪ Depends on the price elasticities of supply and demand.
18
Tax Distortions and Elasticities
(a) Inelastic Demand
Price
Supply
Size of tax
When demand is
relatively inelastic,
the deadweight loss
of a tax is small.
Demand
0 Quantity
19
Tax Distortions and Elasticities
(b) Elastic Demand
Price
Supply
Size
of
tax Demand
0 Quantity
20
The Deadweight Loss Debate
21
Deadweight Loss and Tax Revenue from Taxes of
Different Sizes
Price (a) Small Tax
Deadweight
loss Supply
PB
Tax revenue
PS
Demand
0 Q2 Q1 Quantity
22
Deadweight Loss and Tax Revenue from Taxes of
Different Sizes
Price (b) Medium Tax
Deadweight
PB loss
Supply
Tax revenue
PS Demand
0 Q2 Q1 Quantity
23
Deadweight Loss and Tax Revenue from Taxes of
Different Sizes
Price (c) Large Tax
PB
Deadweight
loss
Tax revenue Supply
Demand
PS
0 Q2 Q1 Quantity
24
How Deadweight Loss and Tax Revenue Vary with
the Size of a Tax
(a) Deadweight Loss
Deadweight
Loss
0 Tax Size
25
How Deadweight Loss and Tax Revenue Vary with
the Size of a Tax
(b) Revenue (the Laffer curve)
Tax
Revenue
▪ The Laffer curve depicts the relationship between tax rates and
tax revenue.
▪ Supply-side economics refers to the views of Reagan and Laffer
who proposed that a tax cut would induce more people to
work and thereby have the potential to increase tax revenues.
Tax Revenue
0 Tax Size 27
Key concepts of the lecture
▪ welfare economics
▪ willingness to pay
▪ consumer surplus
▪ cost
▪ producer surplus
▪ efficiency
▪ equity
▪ deadweight loss
▪ tax revenue
▪ Laffer Curve
28
Exercise
▪ In 2004 the Turkish government reduced the corporate tax
rates from 30% to 20%.
▪ What is the economic logic behind this policy?
▪ Explain and justify your answer with diagram(s), if
necessary.
29
Exercise
▪ Suppose that a tax is imposed on a market, and is left in
place for several years.
▪ What would you predict about
a) the size of the deadweight loss of the tax in the short run relative
to the long run, and
b) the amount of revenue collected from the tax in the short run
relative to the long run?
▪ Justify your answers with graphs for each case (short-run &
long-run)
30
ECON1211
IntroductIon
to EconomIcs
Lecture 7
Application: International
Trade
1
International trade
2
The determinants of trade
▪ Equilibrium Without
Trade
▪ Assume:
▪ A country is
isolated from rest
of the world and
produces steel.
▪ The market for
steel consists of
the buyers and
sellers in the 3
The Equilibrium without International Trade
Price
of Steel
Domestic
supply
Consumer
surplus
Equilibrium
price Producer
surplus
Domestic
demand
0 Equilibrium Quantity
quantity of Steel 4
The World Price and Comparative
Advantage
5
>> The World Price and Comparative Advantage
▪ If a country has a
comparative advantage, then
the domestic price will be
below the world price, and
the country will be an
exporter of the good.
▪ If the country does not have
a comparative advantage,
then the domestic price will
be higher than the world
price, and the country will be
an importer of the good.
6
International Trade in an Exporting Country
Price
of Steel
Price Domestic
after supply
trade World
price
Price
before
trade
Domestic
Exports demand
0
Domestic Domestic Quantity
quantity quantity of Steel
7
demanded supplied
How Free Trade Affects Welfare in an Exporting Country
Price
of Steel Consumer surplus
before trade
Domestic
Price supply
after
trade World
price
Price
before
trade
Producer surplus
before trade Domestic
demand
8
0 Quantity
How Free Trade Affects Welfare in an Exporting Country
Domestic producers of the good
are better off, and domestic
consumers of the good are worse
Price off.
of Steel Trade raises the economic well-
being of the nation as a whole.
Consumer surplus
after trade Domestic
Price supply
after Exports
trade World
price
Price Gains from
before trade
trade
0 Quantity 9
of Steel
The Gains and Losses of an Importing Country
▪ International Trade in an
Importing Country
▪ If the world price of steel is
lower than the domestic
price, the country will be an
importer of steel when
trade is permitted.
▪ Domestic consumers will
want to buy steel at the
lower world price.
▪ Domestic producers of steel
will have to lower their
output because the
domestic price moves to the
world price.
10
International Trade in an Importing Country
Price
of Steel
Domestic
supply
Price
before
trade
Price World
after price
trade
Domestic
Imports
demand
0 Domestic Domestic Quantity
quantity quantity of Steel
11
supplied demanded
How Free Trade Affects Welfare in an Importing Country
Price
of Steel
Consumer surplus
before trade Domestic
supply
Price
before trade
Price World
after trade price
Gains from
Price trade
before trade
Price World
after trade price
Imports
Producer surplus Domestic
after trade demand
0 Quantity
13
of Steel
The winners and losers from trade
15
The Effects of a Tariff
Price
of Steel
Domestic
supply
Equilibrium
without trade
Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
0 QS QS QD QD Quantity
of Steel
Imports 16
without tariff
The Effects of a Tariff
Price
of Steel
Consumer surplus
before tariff Domestic
supply
Producer
surplus Equilibrium
before tariff without trade
Price World
without tariff price
Domestic
demand
0 QS QD Quantity
of Steel
Imports 17
without tariff
The Effects of a Tariff
Price
of Steel
Consumer surplus
with tariff Domestic
supply
Producer
surplus
after tariff
Tariff Revenue
Equilibrium
without trade
Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
0 QS QS QD QD Quantity
of Steel
Imports 18
without tariff
A tariff reduces the quantity of
The Effects of a Tariff imports and moves the domestic
market closer to its equilibrium
without trade.
Price With a tariff, total surplus in the
of Steel market decreases by an amount
referred to as a deadweight loss.
Domestic
supply
Deadweight Loss
Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
0 QS QS QD QD Quantity
of Steel
Imports 19
without tariff
The Effects of an Import Quota
20
Tariff barriers Jun 19th 2008
▪ Jobs
▪ National Security
▪ Infant Industry
▪ Unfair Competition
▪ Protection-as-a-Bargaining Chip
23
Trade Agreements and the World Trade Organization
▪ GATT ➔ WTO
▪ The General Agreement on Tariffs and Trade (GATT) refers to a
continuing series of negotiations among many of the world’s
countries with a goal of promoting free trade.
▪ GATT has successfully reduced the average tariff among member
countries from about 40 percent after WWII to about 5 percent
today.
24
NAFTA
▪ The North American Free
Trade Agreement (NAFTA)
is an example of a
multilateral trade
agreement.
▪ In 1993, NAFTA lowered
the trade barriers among
the United States,
Mexico, and Canada.
25
European Costums Union
▪ The European Union and Turkey are linked by a Customs
Union agreement, which came in force on 31 December
1995.
26
Key concepts of the lecture
▪ World price
▪ Tariff
▪ Import quota
27
Exercise
▪ Suppose there is a free trade regime, and world price of
grain is quite lower than the domestic price in Homeland.
Then, in response for farmers’ complaints, Homeland’s
government decides to impose a tariff for imported grain.
28
Exercise
▪ Because of deepening economic crisis, old fashioned
protectionism which is based on the use of trade barriers to
protect domestic firms from foreign competition has re-
emerged.
▪ Suppose a small country has increased its tariff for
automotive industry in order to protect its domestic firms
from lower world price because of Chinese and Indian
cheap cars.
▪ What will be the impact of the tariff on consumers’ and
producers’ welfare? Justify your answer on a diagram.
29