4.1 - Diagram Flashcards
Free Trade Diagram Analysis
Without any foreign trade, the equilibrium price and quantity in the market will be at P1, Q1. If the government opens up the economy for free trade, the price will decrease to Pw reflecting the cost advantages of countries who have the comparative advantage in this sector. The supply curve is horizontal (perfectly price elastic) at this price as world suppliers can supply this small domestic market without needing increases in price to incentivise greater production. At this higher price, domestic supply contracts to Q2 and domestic demand extends to Q3 causing an excess demand in the domestic market. As there are no restrictions on imports, the excess demand is satisfied by imports of quantity Q2Q3 with consumers now purchasing Q1Q3 more units and at a lower price increasing their consumer surplus.
Free Trade Diagram - Labelling
Price: Decreases from P1 to Pw
Domestic Production: Decreases from Q1 to 02
Domestic Demand: Increases from 01 to Q3
Imports: Q2Q3 units
Domestic Producer Revenue: Decreases from A+B+D+E+F to A
Foreign Producer Revenue: B+C
Consumer Surplus: Increases by D+E+F+G
Producer Surplus: Decreases by D+E
