Ch. 2: The Basic Theory Using Demand and Supply

Effects of Trade

Nation o Decrease in price o Decrease in quantity supplied o Increase in quantity demanded Rest of the World o Increase in price o Increase in quantity supplied o Decrease in quantity demanded

Inferior good

a good for which, other things equal, an increase in income leads to a decrease in demand

Normal good

a good for which, other things equal, an increase in income leads to an increase in demand

Buying something in one market and reselling it in another market to profit from a price difference is known as

arbitrage

For the importing country in the market for international trade, the shift from no trade to free trade causes the market price to

decrease.

Suppose the export quantity supplied exceeds the import quantity demanded in the market for international trade. In this case the world price would be expected to

decrease.

For the exporting country in the international market for trade, the shift from no trade to free trade causes consumption to ______ and consumer surplus to ______.

decrease; decrease

For the importing country in the market for international trade, the shift from no trade to free trade causes domestic production to ______ and producer surplus to ______.

decrease; decrease

Producer surplus is the increase in the economic well-being of producers who are able to sell a product at a price ______ the lowest price that would have induced them to sell.

higher than

For the exporting country in the international market for trade, the shift from no trade to free trade causes the market price to

increase.

Given a fixed, downward sloping demand curve, if the market price of the product decreases, then the consumer surplus received by consumers will

increase.

If the market demand curve for a good shifts leftward in response to a decrease in consumer income, then the good is described as a ____________ (normal/inferior) good.

normal

The market for international trade (in a specific good) in a two-country world consists of a demand for imports and a supply of exports. The country having the lower pre-trade national price generates the

supply of exports.

The increase in the economic well-being of consumers who are able to buy a product at a market price lower than the highest price they are willing to pay is called consumer __________.

surplus

Consumer surplus will be larger than producer surplus if

the demand curve is steeper (more inelastic) or the supply curve is flatter (more elastic).

Welfare Effects of Free Trade

Effects in the Importing Country o The shift from no trade to free trade lowers the market price o Consumers: Increase in quantity consumed o Producers: Lower profit and production Effects in the Exporting Country o Increase in market price o Producer surplus increases o Consumer consumption and surplus decreases

True or False: If there is no international trade, then equilibrium occurs at the price at which the market clears domestically, with national quantity demanded being less than national quantity supplied.

False

National market with no trade

If there is no international trade, then the equilibrium occurs at the price at which the market clears domestically, with national quantity demanded equal to national quantity supplied. A = no-trade equilibrium c = consumer surplus D = national demand S = national supply h = producer surplus

A change in which one of the following variables will NOT cause the market supply curve to shift?

The price of the product.

True or False: A major use of producer surplus is to measure the impact of a change in the price of a good on the net gain of producers.

True

In a graph of a downward sloping demand curve, the consumer surplus is measured by the area _____ the price line and _____ the demand curve.

above; below

The total cost of producing and selling a product is the entire area _____ the supply curve up to the total quantity supplied.

below

In the absence of international trade, when national markets attain equilibrium,

both consumers and producers benefit.

Arbitrage

buying something in one market and reselling the same thing in another market to profit from a price difference

Elastic demand

demand in which changes in price have large effects on the amount demanded

Inelastic demand

demand in which changes in price have little or no effect on the amount demanded

When displayed graphically, with quantity demanded measured horizontally and price measured vertically, a market demand curve will slope

downward.

One-dollar, one-vote metric

each dollar of gain or loss is valued equally regardless of who experiences it

If the price elasticity of supply is greater than 1.0, then the supply is said to be

elastic.

If the quantity demanded is substantially responsive to a price change, then demand is said to be

elastic.

In assessing the net national welfare effect of moving from no trade to free trade, economists typically adopt the value judgment that each dollar of gain or loss is valued _____ who experiences it.

equally, regardless of

In general, if one demand curve is steeper than another and both are plotted with the same axes, then the steeper demand curve is the _____ elastic of the two.

less

Suppose the import quantity demanded exceeds the export quantity supplied in the market for international trade. In this case, the world price must be too _____ for a free-trade equilibrium.

low

The market for international trade (for a specific good) in a two-country world consists of a demand for imports and a supply of exports. The demand for imports is generated from the excess demand of the country having the ______ pre-trade national price.

lower

A competitive firm will supply another unit of a good if its price exceeds the _____ cost of producing it.

marginal

Adding up the quantities supplied at each price by all producers of a given product yields the _____ supply curve, which is presumed to be _____.

market; upward sloping

The separate gains derived by the importing and exporting countries from the opening of trade

may or may not be equal.

When the price of a product changes, there is a ______ the given supply curve.

movement along

Why do countries trade?

o Demand and supply conditions differ between countries, so prices differ between countries if there is no international trade. o Trade begins as someone conducts arbitrage to earn profits from the price difference between previously separated markets. o A product will be exported from countries where its price was lower without trade to countries where its price was higher.

Which country gains from trade?

o If we use the on-dollar, one-vote metric, then both do. o Each country's net national gains from trade are proportional to the change in its price that occurs in the shift from now trade to free trade. o The country whose prices are disrupted more by trade gains more.

Demand curve

o Steep slope = low responsiveness of quantity to a change in price (less elastic) o Flatter slope = more responsiveness to a change in price (more elastic)

Which of the following are determinants of how much a consumer demands of a product?

o The consumer's income o The consumer's tastes and preferences o The prices of other products o The price of the product

Within each country, who are the gainers and losers from opening trade?

o The gainers are the consumers of imported products and the producers of exportable products. o Those who lose are the producers of import-competing products and the consumers are exportable products.

How does trade affect production and consumption in each country?

o The move from no trade to a free-trade equilibrium changes the product price from its no-trade value to the free-trade equilibrium international price or world price. o The price change in each country results in changes in quantities consumed and produced. o In the country importing the product, trade raises the quantity consumed and lowers the quantity produced. o In the country exporting country, trade raises the quantity produced and lower the quantity consumed of the product.

Producer surplus

o the difference between the current market price and the cost of production for the firm o measures the net gain or producers who are able to sell the good at a price higher than the lowest price that would have drawn out their supply

The supply curve and the marginal cost curve are

one and the same.

The price elasticity of supply is the ______ increase in quantity supplied resulting from a 1 percent increase in market price.

percent

Price elasticity of demand

percent change in quantity demanded divided by percent change in price

Using the "one-dollar, one-vote" value judgment, it can be asserted that the shift from no trade to free trade yields a ______ net national welfare effect for the exporting country.

positive

The separate benefits that consumers and producers obtain when the national market clears are

positive, but not necessarily equal.

Consumer demand

preferences for goods and services influenced by tastes, the price of the product, the prices of other products, and income

The gains between the participating countries from opening trade are divided in direct proportion to the _____ changes that trade brings to the individual countries.

price

The price elasticity of demand is the percent change in _____ resulting from a 1 percent increase in _____.

quantity demanded; price

Suppose the price of a good is $800 in market A but only $600 in market B. On the assumption that transportation and transaction costs are negligible, an arbitrager would _____ in market A and _____ in market B.

sell; buy

Consider the market for music concerts. When changes occur in consumer tastes, consumer incomes, or the prices of other forms of entertainment, the market demand curve for concerts will

shift.

A low buyer responsiveness to a change in price is indicated by a _____ demand curve.

steep

The basic theory of trade usually results from the interaction of competitive demand and ___________.

supply

Consumer surplus

the difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer pays

Net national gains from trade

the difference between what one group gains and what the other group loses

Demand for imports

the excess demand (quantity demanded minus quantity supplied) of a good within the national market

Supply of exports

the excess supply (quantity supplied minus quantity demanded) of a good in the rest-of-the world market

International price or world price

the free-trade equilibrium price

Elasticity

the percentage change in quantity demanded or supplied as a result of a one percent change in price

Price elasticity of supply

the percentage change in quantity supplied divided by the percentage change in price

The two major influences determining the quantity of a product a firm chooses to make available for sale are

the product's price and its production/selling costs.

Opportunity cost

the value of other goods and services that are not produced because resources are instead used to produce this product