ECON1101: Microeconomics 1

Chapter 8: International trade

Closed vs. open economy
A closed economy does not trade with the rest of the world.
An open economy trades with the rest of the world.

The PPC for a many-person economy

The production possibilities curve (PPC) shows the maximum amount of one
good that can be produced at every possible level of production of another good.

Slope
At any point on the PPC, its slope indicates the opportunity cost of the
good on the x-axis, in terms of the good on the y-axis.

The low-hanging-fruit principle

The PPC for a many-person economy is outwardly-bowed because the lowhanging-fruit principle states that, the more of a good that is already being
produced, the greater the opportunity cost of increasing production still
further.

Consumption possibilities curve (CPC)

The consumption possibilities curve (CPC) shows the maximum amount of
one good that can be consumed for every possible level of consumption of
another good.

Closed economy
In a closed economy, the CPC is the same as the PPC.

Open economy
In an open economy, the CPC is the same or greater than the PPC. It is a
downward-sloping line that is tangent to the PPC. Its slope is the world
price for the good on the x-axis in terms of the good on the y-axis.

World price
The world price is the price at which a good or service is traded on international
markets.

If the domestic price is greater than the world price

If the price of a good or service in a closed economy is greater than the
world price and that economy opens itself to trade:

The economy will tend to become a net importer of the good or service.
Domestic consumers of imported goods benefit from free trade.

Domestic producers of imported goods are hurt by free trade.

Total economic surplus increases.

If the domestic price is lower than the world price

If the price of a good or service in a closed economy is lower than the
world price and that economy opens itself to trade:

The economy will tend to become a net exporter of that good or service.
Domestic consumers of exported goods are hurt by free trade.
Domestic producers of exported goods benefit from free trade.
Total economic surplus increases.

Protectionism
Protectionism is the use of policies that are intended to protect domestic
industries from foreign competition.

Import tarif
An import tariff is a tax imposed on an imported good.

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increases the domestic price by the tarif.

decreases imports.
decreases consumer surplus.
increases domestic producer surplus.
raises government revenue.
creates deadweight loss production loss and consumption loss.

Import quota
An import quota is a legal limit on the quantity of a good that may be
imported.

It shifts the supply curve by the quota.

It decreases imports.
It decreases consumer surplus.
It increases domestic producer surplus.
If permits are given away for free, it increases importer surplus.
If the government auctions of permits, it increases government revenue.
It creates deadweight loss production loss and consumption loss.