Presented by Sandra Haro

APPLICATION
OF TRADE
WHEN THE
WORLD PRICES
ARE LESSER
THAN
DOMESTIC
PRICES. . .
WHAT HAPPENS TO TRADE??
When the world prices prevailing in the rest of the
world market are lesser than the domestic prices
that are prevailing in the domestic market there
emerges a tendency to import, since the
commodities are available at a cheaper price
abroad.

With at the domestic demand and domestic

supply the domestic market is at equilibrium at
point E with domestic prices PD prevailing in the
domestic market before trade.

If the economy allows trade and also world prices

prevailing are less than the domestic prices PD
there is a downward pressure onto the domestic
prices to become equal to the world prices, the
moment prices fall to PW there emerges an
excess demand in the domestic market.
EFFECT OF TRADE
This excess demand is then fulfilled
through imports from the rest of the world
BEFORE TRADE AFTER TRADE
that is the shortages being met by the
imports and the economy is in equilibrium.

CONSUMER SURPLUS A A+B+D

The given table states that the consumer
surplus before trade was represented by
the area A which increased to area A+B+D,
PRODUCER SURPLUS B+C C
making consumers better of since world
prices were lower. Consumer surplus
represented by the area B+C was reduced
to area C, Total surplus increased from TOTAL SURPLUS A+B+C A+B+C+D

area A+B+C to area A+B+C+D implying that

area D is gains from trade.( according to
the diagram)
WHEN THE
WORLD PRICES
ARE MORE
THAN
DOMESTIC
PRICES. . .
 WHAT HAPPENS TO TRADE?
When trade happens it enhances the choices and makes
everyone better off. But when the trade happens
between two or more countries and economy opens up
there comes out the problem of difference in prices i.e.
of world prices and domestic prices

•When the world prices are greater than the domestic

prices
The prevailing domestic price is PD corresponding to
the market equilibrium where domestic demand and
supply curve intersects. Area A+C and B represents the
consumer and producer surplus respectively
World prices prevailing are greater than
the domestic prices represented by PW.
Due to this it exerts an upward pressure
on the domestic prices.
Due to which the demand contracts and
supply extends which results in surplus in
the economy. And this surplus will now
be exported and still
And also due to the upward pressure the
consumer surplus from area A+C to just A
while on the other hand the producer
surplus rises from area B to B+C+D.
 EFFECT OF TRADE
In the pre-trade scenario the total BEFORE AFTER
CHANGE
TRADE TRADE
surplus was the area A+B+C while in the
after trade scenario the total surplus has
CONSUMER
A+C A -C
rose to area A+B+C+D wherein the area D SURPLUS

is the additional surplus.

PRODUCER
Hence the area D emerges as the welfare SURPLUS
B B+C+D C+D

gains from trade

TOTAL
A+B+C A+B+C+D D
SURPLUS
TARIFFS
AND ITS
IMAPCTS
 Tariffs
Tariffs: A tax on goods produced abroad and sold
domestically

Why are tariffs imposed?

Tariffs are imposed for several reasons.

They protect domestic industries by making imported
goods more expensive, thereby preserving jobs and
fostering economic self-sufficiency.
Governments use tariffs to generate revenue, funding
public services and infrastructure.
Tariffs can also address trade imbalances by encouraging
domestic production.
 EFFECTS Let us consider the example of Wheat. A tariff raises the price of
imported wheat above the world price by the amount of the

OF TARIFFS
tariff.

Domestic suppliers also raise the price of textiles and as a result

of this increased price the domestic quantity demanded reduces
from QD¹ to QD² and domestic quantity supplied increases from
QS¹ to QS² as shown in fig..

Thus, the tariff reduces the quantity of imports from QS¹QD¹ to

QS²QD² and moves the domestic market closer to its equilibrium
without trade.

Now let us look at the gains and losses from tariffs which can be
known from changes in producer surplus, consumer surplus and
government revenue. Before the tariff, the domestic price equals
the world price but once the government imposes a tariff, the
domestic price exceeds the world price.
 EFFECTS OF TARIFF
ON SURPLUS
The consumer surplus before was the area A+B+C+D+E+F
which reduces to area A+B, the producer surplus increases
from area G to area C+G and the government revenue
increases from 0 to E (quantity after tariff imports × size of
tariff).The total surplus reduces from A+B+C+D+E+F+G to BEFORE AFTER
CHANGE
A+B+C+E+G. TARIFFS TARIFFS
The area D+F shows the fall in total surplus and represents
the deadweight loss of the tariff. Area D represents the CONSUMER A+B+C+D+
A+B -(C+D+E+F)
deadweight loss from overproduction of textiles, and are F SURPLUS E+F
represents the deadweight loss from the underconsumption
of textiles. PRODUCER
G C+G +C
SURPLUS
A tariff causes deadweight loss because tariff like most
taxes distorts incentives and pushes the allocation of scarce
TOTAL A+B+C+D+
resources away from the optimum. A+B+C+E+G -(D+F)
SURPLUS E+F+G