How Countries Benefit from Free Trade. Gains from Imports

Table of Contents

In today’s article, we’re gonna talk about how a country can gain from importing goods through international trade. 

Understanding the Market (Without Trade)

So let’s take the market for steel in the United States. Assume that the market before there’s any international trade or anything the equilibrium price of steel in the United States is $562 a ton, so we’ve got our price. Then we’ve got our downward sloping demand curve and we’ve got our upward-sloping supply curve. So that leads to equilibrium in the market and we’ve got an equilibrium price of $562 a ton and then an equilibrium quantity of 10 million tons of steel.

Now we have our consumer surplus in this blue triangle and then our producer surplus is this yellow triangle. Then our total surplus is this entire triangle, it’s just the (consumer surplus + the producer surplus). So we have all that that’s without trade.

Understanding the Market (With Trade)

Now let’s introduce the prospect of trade because we’re gonna say that the world price of steel is $350 a ton. Now you see that there’s a difference in the U.S. if we’re just thinking about the U.S. with no international trade the equilibrium price of steel would be $562 a ton yet in the world price it’s $350 a ton. So because the world price is cheaper than the equilibrium price in the U.S, it is going to be a net importer of steel. So the U.S. is going to import steel because it would be cheaper to buy it from some of the suppliers on the world market. Now what I want to do is I’ve shown you without trade how the market would look and I want to show you what would happen when we introduced the idea of trade.

Changes in Consumer and Producer Surplus

So our equilibrium is equal in price is $562 but the world price is $350. So this we’re gonna have some changes, there’s a consumer surplus and the producer surplus they’re going to shift a little bit. So what’s gonna happen is the following, so our consumer surplus is going to be the whole area over the world price line and under the demand curve. So the blue triangle is going to be our consumer surplus. Now the yellow triangle which is just the tiny little triangle is going to be the producer surplus. 

Now notice the following there are several things that we can see from this, one is that the consumer surplus for the U.S. has increased considerably and it’s increased for a couple of reasons. One is that some of the surpluses shifted from producers to consumers, basically, if we think about it after trading the blue area has increased, the area that used to belong to producers but now it’s been gone to consumers. So that’s just a net change in the surplus, that doesn’t affect the total surplus. What does affect the total surplus is this new green triangle. All that new green area that’s been added so the total surplus and it has increased. Now producers in the U.S. are worse off as they have a tinier sliver but we don’t care. We care about the total surplus, which is our (consumer surplus + the producer surplus). So our total surplus has increased, obviously, producers aren’t going to be happy about that.
But that’s a fact and the reason that we have got a difference between what our consumers are demanding and what our producers are producing. This amount is the amount which we have imported. Let me put some numbers to this, so it’ll make it a little easier to understand. So we can draw outlines and let’s say that the demand for steel at $350 a ton in the U.S. demand for steel exceeds the amount that U.S. suppliers of steel are willing to produce because they’re willing to produce 4 million tons at $350 but the U.S. consumers are demanding 16 million.

So that means that there is (16 million – 4 million) in imports because they buy it from the world market. So that difference of 16 million VS 4 million is the 12 million is imported steel from countries outside the U.S. who have a comparative advantage in producing steel because that’s what it’s cheaper to buy steel on the world market. 

and so this gap here between the 16 million and the 4 million that has 12 million of imports that same that 12 million tonnes of steel is imported and we see that there is an increase in the total surplus and the U.S. consumer’s surplus is huge now. So the consumer surplus is huge but we see that even though the U.S. as a whole is better off because we added that new green triangle that’s been created for the U.S. because of import but the producers, they just have this tiny sliver. So the U.S. steel producers lose outright and so they have an incentive to lobby and say “Maybe we want to tear up or something like that.” but we can see here that clearly because we get this new green area here it clearly the U.S. as a whole, when we consider the cheaper prices to consumers and so forth the U.S. as a whole, is better off by importing steel.

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