The Basic Theory Using Demand and Supply
This chapter focuses on why we study theories of international trade and presents the basic theory using supply and demand curves.
Trade is important to individual consumers, to workers and other factor owners, to firms, and therefore to the whole economy.
Trade is also controversial, with perpetual battles over government policies toward trade. To understand all of this, we need to develop theories of why people trade as they do.
It is useful to organise the analysis of international trade by contrasting a world of no trade with a world of free trade, leaving analysis of intermediate cases (e.g., non-prohibitive tariffs) for Part II. The analysis seeks to answer four key questions about international trade:
1. Why do countries trade? What determines the pattern of trade?
2. How does trade affect production and consumption in each country?
3. What are the gains (or losses) for a country as a whole from trading?
4. What are the effects of trade on different groups in a country? Are there groups that gain and other groups that lose?
Theories of international trade provide answers to these four questions.
- Basic demand and supply analysis can be used to provide early answers to these four questions, as well as to introduce concepts that can be used in more elaborate theories.
Recall Demand=DD=f (own price, income, other prices, tastes and preferences).
Also Normal Good-Income goes up consumer buys more. Inferior Good-Income goes up consumer buys less
Using motorbikes as an example, the chapter first reviews the basic analysis of both demand (the demand curve, other influences on quantity demanded, movements along the demand curve and shifts in the demand curve. See figure 12.1-Can you derive the equation of that demand curve?
Elasticity of demand- Measures responsiveness of quantity demanded to changes in price.
In absolute terms
E > 1 Elastic
E=1 Unitary elastic