Changing equilibria from trade | APⓇ Microeconomics | Khan Academy

In this video, we're going to think about how trade can alter the equilibrium price and quantity in a given market.

So, what we see here, as we like to do, are very simplified examples of markets in various economies. First, we have Country A, and let's say it's the market for widgets. We're going to assume that Country A is not trading with anyone else. So, it is an autarchy—a very fancy word which just means that this country is operating independently. It's operating in isolation.

You can see the demand curve in this market in orange, and we can see the supply curve. When this country is operating in isolation, this market for widgets has an equilibrium price. It looks like it's a little bit under $4. I'll just assume that the price is in dollars per widget, and the equilibrium quantity looks like it's about a little under four units per whatever time period we're looking at.

Fair enough. Now, let's look at Country B, and let's assume that they are also operating independently. It's an autarchy in this market. Here, we can see a different demand curve than what we saw in Country A and a different supply curve. Notice they have a different equilibrium price and quantity.

The equilibrium price seems to be a little bit over a dollar, and the equilibrium quantity seems to actually be not that different than what we saw in the first country, although in many situations it could be very different. Now, let's imagine what would happen if they opened up their economies to each other.

Well, then you would essentially horizontally add these two demand curves and you would horizontally add these two supply curves to come up with a new supply curve and a new demand curve. This is a little bit of a review of what we've seen in other videos, but notice at a price of five in total, no one's demanding anything—no quantity of these widgets.

At a price of zero, Country A, the market, is demanding 15 and Country B is demanding five. So, in aggregate, they are demanding 20. Similarly, you can see that with supply; at a price of five, Country A will supply five and at a price of five, Country B will supply 15. Together, they will supply 20 units per time period.

We can view this right over here as our supply and demand curves for the combined markets. Because now they're trading, we are not in an autarchy anymore. Notice what has happened: our equilibrium price is now someplace in between these two equilibrium prices. It looks like it's a little bit under $3, and our equilibrium quantity is a little bit under 10 units.

You might notice some interesting things that are happening. What would happen from someone in Country A's point of view—the people who are the buyers, the people who are demanding this widget? Well, now instead of having to pay almost four, they're paying someplace in between two and three. This is the new equilibrium price if they were to open up their economy.

This amount would be produced, in theory, by the domestic manufacturers—let's call that 2 and a half units. Where are they going to get those remaining units from? Well, those are going to be imports. Let's look at the equilibrium price on Country B. Country B was really the lower cost producer, so now we have a price a little bit over 2.5—we'll put it right over there.

Now, you have a situation where the suppliers in Country B are going to be producing a lot, a lot more than they were before, and only this amount is coming from their domestic demand. All of this amount right over here is being exported. If we're assuming that the world economy is only made up of Country A and Country B, or that they're only trading with each other, these exports become Country A's imports right over there.

So, proponents of free trade will say, "Hey, look, the overall consumer surplus is larger than the combined consumer surpluses that we had before." Before, you had this consumer surplus in Country A and Country B; it was all of this—but still, this entire area is larger than these two combined. You could calculate the area of these triangles mathematically if you like.

If you look at the producer surplus, you'll see a similar story. The total producer surplus of the combined economies is now going to be larger than this producer surplus plus this producer surplus. Now, there will not always be winners in this. The winners here are the demanders in Country A because instead of this little small consumer surplus that they had before, now they have this much larger consumer surplus right over there.

The other winners are the suppliers in Country B because instead of this producer surplus that they had before, they now have this producer surplus. But the losers in this situation are the suppliers in Country A, who now have a much lower producer surplus—so their triangle has shrunk to that right over there.

The other losers in this situation are the consumers in Country B, who would now have to pay a higher equilibrium price. Their consumer surplus is now only this small triangle, while before it was this whole thing.

So anyway, the big takeaway here is that if you go from autarchy to opening up economies, it can affect what the equilibrium prices and quantities are going to be. Often times, or usually, it's going to increase your total consumer and producer surplus, although there will be some winners and there will be some losers.