This article is part of my review guide for Principles of Microeconomics. It is an organized version of concepts from notes I have taken during reading and lectures. It is not meant to be your first introduction to the topic, but instead, should be a clarification of things you are already familiar with. It is a REVIEW tool used to brush up before an exam.
When does a nation become an importer?
When a nation opens its borders to international trade, it will take the world price in place of its own equilibrium price. For example, lets look at the market for plastic spoons. Say the going price for a box of plastic spoons in the country of Spoonalia is $12, but the world price only $5. If Spoonalia opens to trade, it will have to use the price of $5. If it keeps its price for spoons at $12, no one will buy them because they can get them for a lot cheaper internationally.
A nation will import a good when the world price is below the domestic market equilibrium price. This is because the lower world price has a higher demand. Fewer producers are willing to supply product at the low rate, which creates a domestic shortage. A lower world price also reduces producer surplus and increases consumer surplus. That means consumers benefit from an import, while producers are harmed.
The difference in quantity demanded minus the quantity of units produced domestically is a shortage. The nation fills this shortage with imports.
When does a nation export?
If the world price that a nation adopts is more than its own domestic equilibrium price, a surplus of product will be produced. This is because more firms will want to supply more product at a higher price. Because consumers are less willing to pay a higher price, the demand decreases. The surplus of product is handled.
When a nation exports, consumer surplus is decreased because of the higher rates, and producer surplus increases because they benefit from more revenue. The difference between the quantity supplied, and the actual quantity demanded is the amount of surplus product. This is the same amount that gets exported.
What happens when a tariff is added?
A tariff is the government's way of manipulating the effect of an import, and also raises its own revenue. As you can see from the first set of graphs above, producer surplus is severely limited when a good can be imported for cheaper. This crunch on domestic firms can hurt industries and jobs, and so the government will step in in order to protect these companies.
A tariff, increases the price of a good that is internationally traded. If Spoonalia has to use a price of $5, the government might choose to add a tariff of $3 to the import. This will raise the price to $8. When the price goes up, supply rises, and demand decreases.
The equilibrium created by the world price + tariff is closer to Spoonalia's normal market equilibrium. Producer surplus is a little better off and additional government revenue is generated (orange square.) However, as you can see by the grey shaded area there is some deadweight loss involved with a tariff.
Spoonalia will still import spoons, but it will import much less because of the price increase caused by the tariff. It encourages consumers to purchase domestically produced spoons.
Jade on December 06, 2012:
Appreciate this review. I have a microeconomics final in 2 hours. Thanks! :)