INTERNATIONAL TRADE THEORY

By: Obaid Gulzar

University of Education, Lahore
 Topics to be covered

■ Partial Equilibrium Analysis

■ Assumptions of Partial Equilibrium Analysis
■ Difference between General Equilibrium and Partial Equilibrium
■ Welfare Effects of Trade Policies
■ Offer Curve
 Partial Equilibrium

■ In economics, partial equilibrium is a condition of economic equilibrium

which takes into consideration only a part of the market (with all other parts
remaining constant) to attain equilibrium.

■ As defined by Leroy lopes, "A partial equilibrium is one which is based on

only a restricted range of data, a standard example is price of a single
product, the prices of all other products being held fixed during the
analysis."
 Partial Equilibrium

■ The supply and demand model is a partial equilibrium model where the
clearance on the market of some specific goods is obtained independently
from prices and quantities in other markets.

■ In other words, the prices of all substitute goods and complement goods, as
well as income levels of consumers, are taken as given. This makes analysis
much simpler than in a general equilibrium model, which includes an entire
economy.
 Partial Equilibrium

■ Partial equilibrium analysis examines the effects of policy action in creating

equilibrium only in that particular sector or market which is directly affected,
ignoring its effect in any other market or industry assuming that they being
small will have little impact if any; hence, this analysis is considered to be
useful in constricted markets.
 Assumptions of Partial Equilibrium

■ Commodity price is given and constant for the consumers.

■ Consumers' taste and preferences, habits, incomes are also considered to

be constant.

■ Prices of prolific resources of a commodity and that of other related goods

(substitute or complementary) are known as well as constant.
 Assumptions of Partial Equilibrium

■ Industry is easily availed with factors of production at a known and constant

price compliant with the methods of production in use.

■ Prices of the products that the factor of production helps in producing and
the price and quantity of other factors are known and constant.

■ There is perfect mobility of factors of production between occupation and

places.
Difference Between General and Partial
Equilibrium
Partial Equilibrium General Equilibrium
• Developed by Alfred Marshall. • Léon Walras was first to develop it.
• More than one variable or economy as a
• Related to single variable
whole is taken into consideration
• Based on two assumptions: • It is based on the assumption that various
1.Ceteris Paribus sectors are mutually interdependent.There is
2.Other sectors are not affected due to change an effect on other sectors due to change in
in one sector. one.
• Prices of goods are determined
• Other things remaining constant, price of a simultaneously and mutually. Hence all
good is determined product and factor markets are simultaneously
in equilibrium.
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ A partial equilibrium analysis distinguishes between the welfare of
consumers who purchase a product and the producers who produce it.
Consumer welfare is measured using consumer surplus, while producer
welfare is measured using producer surplus.

■ Revenue collected by the government is assumed to be redistributed to

others. Government revenue is either spent on public goods or is
redistributed to someone in the economy, thus raising someone’s welfare.
 Welfare Effects of Trade Policies: Partial
Equilibrium
Consumer Surplus
■ Consumer surplus is used to measure the welfare of a group of consumers
who purchase a particular product at a particular price.

■ Consumer surplus is defined as the difference between what consumers are

willing to pay for a unit of the good and the amount consumers actually do
pay for the product
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ Suppose that only one unit of a good is available in a market.

■ As shown in Figure 1.1 "Consumer Surplus", that first unit could be sold at
the price P1. In other words, there is a consumer in the market who would
be willing to pay P1. Presumably that person either has a relatively high
desire or need for the product or the person has a relatively high income.
Welfare Effects of Trade Policies: Partial
Equilibrium

Fig 1.1 Consumer Surplus

 Welfare Effects of Trade Policies: Partial
Equilibrium
■ To sell two units of the good, the price would have to be lowered to P2. (This
assumes that the firm cannot perfectly price discriminate and charge two
separate prices to two customers.)

■ A slightly lower price might induce another customer to purchase the

product or might induce the first customer to buy two units. Three units of
the good could be sold if the price is lowered to P3, and so on
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ The price that ultimately prevails in a free market is that price that equalizes
market supply with market demand. That price will be P in Figure 1.1 "
Consumer Surplus" as long as the firms do not price discriminate.

■ Now let’s go back to the first unit that could have been sold. The person who
would have been willing to pay P1 for a unit of the good ultimately pays only
P for the unit. The difference between the two prices represents the amount
of consumer surplus that accrues to that person.
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ For the second unit of the good, someone would have been willing to pay P2
but ultimately pays P. The second unit generates a smaller amount of
surplus than the first unit.

■ We can continue this procedure until the market supply at the price P is
reached. The total consumer surplus in the market is given by the sum of
the areas of the rectangles.
 Welfare Effects of Trade Policies: Partial
Equilibrium
Changes in Consumer Surplus
■ Suppose the supply of a good rises, represented by a rightward shift in the
supply curve from S to S′ in Figure 1.2 "Change in Consumer Surplus".

■ At the original price, P1, consumer surplus is given by the blue area in the
diagram (the triangular area between the P1 price line and the demand
curve).
Welfare Effects of Trade Policies: Partial
Equilibrium

Fig 1.2 Change in Consumer Surplus

 Welfare Effects of Trade Policies: Partial
Equilibrium
■ The increase in supply lowers the market price to P2. The new level of
consumer surplus is now given by the sum of the blue and yellow areas in
Figure 1.2 "Change in Consumer Surplus" (the triangular area between the
P2 price line and the demand curve).

■ The change in consumer surplus is determined as the area between the

price that prevails before, the price that prevails after, and the demand
curve. In this case, consumer surplus rises because the price falls.
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ Two groups of consumers are affected. Consumers who would have
purchased the product even at the higher price, P1, now receive more
surplus (P1 − P2) for each unit they purchase. These extra benefits are
represented by the rectangular area a in the diagram.

■ Also, there are additional consumers who were unwilling to purchase the
product at price P1 but are now willing to purchase at the price P2. Their
consumer surplus is given by the triangular area b in the diagram.
 Welfare Effects of Trade Policies: Partial
Equilibrium
Producer Surplus
■ Producer surplus is used to measure the welfare of a group of firms that sell
a particular product at a particular price.

■ Producer surplus is defined as the difference between what producers

actually receive when selling a product and the amount they would be
willing to accept for a unit of the good.
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ Firms’ willingness to accept payments can be read from a market supply
curve for a product. The market supply curve shows the quantity of the good
that firms would supply at each and every price that might prevail.

■ In other way, the supply curve tells us the minimum price that producers
would be willing to accept for any quantity demanded by the market.
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ Suppose that only one unit of a good is demanded in a market. As shown in
Figure 2.1 "Producer Surplus", some firm would be willing to accept the price
P1 if only one unit is produced.

■ If two units of the good were demanded in the market, then the minimum
price to induce two units to be supplied is P2. A slightly higher price would
induce another firm to supply an additional unit of the good. Three units of
the good would be made available if the price were raised to P3, and so on.
Welfare Effects of Trade Policies: Partial
Equilibrium

Fig 2.1 Producer Surplus

 Welfare Effects of Trade Policies: Partial
Equilibrium
■ Some firm would have been willing to supply one unit at the price P1 but
ultimately receives P for the unit. The difference between the two prices
represents the amount of producer surplus that accrues to the firm.

■ For the second unit of the good, some firm would have been willing to supply
the unit at the price P2 but ultimately receives P. The second unit generates
a smaller amount of surplus than the first unit.
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ We can continue this procedure until the market demand at the price P is
reached. The total producer surplus in the market is given by the sum of the
areas of the rectangles.

■ Thus total producer surplus can reasonably be measured as the area

between the supply curve and the horizontal line drawn at the equilibrium
market price. This is shown as the yellow triangle in the diagram. The area
representing producer surplus is measured in dollars.
 Welfare Effects of Trade Policies: Partial
Equilibrium
Change in Producer Surplus
■ Suppose the demand for a good rises, represented by a rightward shift in
the demand curve from D to D′ in Figure 2.2 Change in Producer Surplus".

■ At the original price, P1, producer surplus is given by the yellow area in
Figure 2.2 "Change in Producer Surplus" (the triangular area between the P1
price and the supply curve)
Welfare Effects of Trade Policies: Partial
Equilibrium

Fig 2.2 Change in Producer Surplus

 Welfare Effects of Trade Policies: Partial
Equilibrium
■ The increase in demand raises the market price to P2. The new level of
producer surplus is now given by the sum of the blue and yellow areas in the
figure (the triangular area between the price P2 and the supply curve).

■ The change in producer surplus, PS, is given by the blue area in the figure
(the area between the two prices and the supply curve).
 Welfare Effects of Trade Policies: Partial
Equilibrium
■ Change in producer surplus is determined as the area between the price
that prevails before, the price that prevails after, and the supply curve.

■ In this case, producer surplus rises because the price increases and output
rises. The increase in price and output raises the return to fixed costs and
the profitability of firms in the industry.
 Offer Curve

■ For analysing the trade equilibrium of a country, another device that is

employed is the Offer Curve or, more precisely, the Trade Offer Curve of a
country.

■ The trade offer curve indicates what quantities of a particular commodity

one country are willing to offer in exchange of certain quantities of another
commodity.
 Offer Curve

■ In other words, the offer curve shows the different quantities of a particular
commodity demanded by one country from the other at the different relative
prices of their products.

■ It is because of this reason that the offer curve is known also as the
reciprocal demand curve. The concept of offer curve was originally given by
Marshall and Edgeworth.
 Offer Curve

■ For the derivation of the offer curve of a country, it is supposed that there
are two countries A and B. Cloth is the exportable commodity of A (and
importable of B), while steel is the exportable commodity of B (and
importable of A).

■ If the price of cloth continues to increase relative to the price of steel, the
offer curve of country A can be derived as shown in Fig. 4.5 under constant
cost conditions.
Offer Curve
 Offer Curve

■ In Fig. 4.5, cloth (A’s exportable) is measured along horizontal scale and
steel (A’s importable) is measured along the vertical scale. Originally the
price ratio of two commodities is indicated by the slope of the line OP.

■ If the price of cloth rises more relative to the price of steel, the slope of the
price- ratio line or international exchange ratio line becomes more and
steeper as shown by the lines OP1, OP2 and OP3.
 Offer Curve

■ As the price of cloth rises relatively more than steel, the demand for cloth in
country B increases at a decreasing rate.

■ On the other hand, country A can absorb more quantities of steel at an

increasing rate. If R, R1, R2 and R3 are the points of exchange, the
quantities exchanged between A and B are OQ of cloth and RQ of steel at R,
OQ1 of cloth and R1Q1 of steel at R1, OQ2 of cloth and R2Q2 of cloth at R2
and OQ3 of cloth and R3Q3 of steel at R3
 Offer Curve

■ The additional quantities of cloth offered by country A decrease in exchange

of the additional quantities of steel. By joining R, R1, R2 and R3, it is
possible to determine the offer curve OA of country A. It slopes positively at
an increasing rate.

■ The derivation of the offer curve of country B is shown through Fig. 4.6.
Offer Curve
 Offer Curve

■ In Fig. 4.6, cloth (B’s importable) is measured along the horizontal scale and
steel (B’s exportable) along the vertical scale. As the price of steel rises
relative to the price of cloth, the steepness of the price ratio lines
decreases. OP, OP1, OP2 and OP3 are the price-ratio lines.

■ Since the price of steel has been increasing at the greater rate, the demand
for it in country A may increase at a diminishing rate.
 Offer Curve

■ The additional quantities of steel offered by country B become lesser and

lesser given certain quantities of cloth offered by A.

■ If exchange takes place at R, R1, R2 and R3 points on the price ratio lines
OP, OP1 OP2 and OP3, the quantities offered are OQ, OQ1, OQ2 and OQ3 of
steel for the quantities of cloth RQ, R1Q1, R2Q2 and R3Q3 respectively.
 Offer Curve

■ By joining the points R, R1, R2 and R3, the offer curve OB of country B can
be determined.

■ This offer curve also slopes positively at an increasing rate from the point of
view of country B but at a decreasing rate from the point of country A
 THANK YOU

In case of any queries, write me down at

obaid.gulzar@ue.edu.pk