International trade reshapes the forces of supply and demand in the United States, and so our next task is to assess how it changes outcomes in the various markets in which you’ll do business.
The World Market
Let’s start with the shirt you’re wearing right now. I’ll bet that it began life in a foreign factory, probably in a country with a lot of low-wage workers. (Go ahead and check the label. I’ll wait. . . . Was I right?) Your shirt then joined millions of other shirts for the journey to the United States in one of the huge container ships that links the shirt market in the United States with those in China, Vietnam, Indonesia, and the rest of the world.
World supply and world demand determine the world price.
The market for shirts is a truly global market. Thousands of manufacturers around the world compete to sell their shirts to billions of potential buyers located in just about every country on Earth. When shirts are traded internationally, the price is determined by the interactions of all the buyers and sellers around the world. That is, the price is determined in the world market by the intersection of world supply and world demand. World supply describes the total quantity of shirts produced by all manufacturers in the world at each price. Similarly, world demand describes the total quantity of shirts demanded across all shirt buyers in every country, at each price. Figure 2 illustrates how
world demand and world supply jointly determine the world price, which is the price that a traded good sells at in the world market. This world price is the price that consumers pay to buy imported shirts, and the price that producers can get for exporting their shirts.
Figure 2 | The World Market
When the United States is a small player, take the world price as given.
Realize that the United States is only a relatively small player in the global shirt market. This means that the actions of American importers and exporters won’t influence the world price much. That is, in the world market, American buyers and sellers are price-takers, which means that they can take the world price as given. (Only those who are big players relative to world supply or world demand need to think about how their decisions change the world price.)
The Effects of Imports
Let’s now explore how international trade shapes the domestic market. We’ll need some new terminology to do this. The domestic demand curve illustrates the quantity of goods that domestic buyers—that is, all Americans taken together—plan to buy at each price. Likewise, the domestic supply curve illustrates the quantity of goods that domestic producers plan to sell at each price. These curves, which are shown in Figure 3, will be familiar from our earlier study of supply and demand. But we now need to be clear that these curves refer only to American buyers and American sellers.
Figure 3 | The Consequences of Imports
Evaluate the equilibrium when there’s no trade.
To set a baseline of comparison, we’ll start by assessing the likely outcomes if there were no trade. As before, it’s all about where supply meets demand. In the absence of international trade, the equilibrium price is determined by the intersection of the domestic demand and supply curves. In Figure 3, these curves intersect when shirts sell for $20.
Your shirt is arriving.
Evaluate how imports shape domestic markets.
To see what happens when we allow for the possibility of international trade, we’ll follow a simple three-step recipe:
Step one: What will be the price of a traded good?
When the domestic market is linked to the world market through trade, you have new options to consider. For instance, international trade gives buyers the option to import shirts at the world price of $12. As a result, you’ll never pay a seller more than $12 for a shirt. Likewise, international trade means that sellers always have the option to export their shirts at the world price of $12. This means they’ll never accept less than $12 per shirt. And so if buyers never pay more than $12, and sellers never sell for less than $12, the equilibrium price must be $12. For traded goods, the price is equal to the world price.
Step two: At this new price, what quantities will be demanded and supplied by domestic buyers and sellers?
To find the responses of Americans to this new lower price, consult their domestic demand and domestic supply curves. Begin by locating the new price, $12, on the vertical axis in Figure 3, and then look across until you hit the supply curve. Look down, and you’ll see that domestic sellers will supply 40 million shirts when they can get $12 per shirt. And what quantity will domestic buyers purchase? Look across from the $12 price until you hit the domestic demand curve, then look down, and you’ll see that domestic buyers will demand 140 million shirts.
Step three: What quantity will be traded?
Notice that when goods are traded internationally, there can be a large gap between the quantity demanded by domestic buyers and the quantity supplied by domestic sellers. International trade makes up the difference, with imports filling the gap between the quantity demanded by domestic buyers and the quantity supplied by domestic sellers.
Imports lead to lower prices, less domestic production, and more domestic consumption.
Putting the pieces together, we’ve found that when buyers import goods:
The price declines to the world price.
This lower price leads to a lower quantity supplied by domestic sellers, but a higher quantity demanded by domestic buyers.
Imports fill the gap between the quantity demanded and the quantity supplied.
Our simple three-step recipe gives you a forecast about what’s likely to happen as a result of importing foreign shirts. But do imports make you better off? As we’ll see, the answer depends on whether you’re a consumer or producer of shirts.
Imports Raise Economic Surplus
American consumers gain when they import their shirts, because they get lower prices. But American producers lose, because foreign competition forces them to lower their prices or lose customers. The cost-benefit principle suggests that policy makers should make decisions about trade policy based on whether the gains exceed the losses.
To assess the balance of these competing effects, we’ll compare the increase in consumer surplus that buyers gain with the decrease in producer surplus that sellers lose. That’s the exercise we perform in Figure 4. This figure may look complicated at first glance, but by proceeding slowly, you’ll see that it’s actually pretty intuitive.
Figure 4 | The Welfare Consequences of Allowing Imports
Start by assessing economic surplus when there’s no international trade to set a baseline.
In this case, the no-trade equilibrium occurs where the domestic supply and demand curves cross. Remember that domestic buyers earn consumer surplus when they get to buy a shirt at a price that is lower than their marginal benefit. Because the domestic demand curve shows these marginal benefits, the total consumer surplus they earn is the area below the domestic demand curve, but above the price. This is triangle labeled area A in Figure 4. Domestic suppliers earn producer surplus when the price is above their marginal cost. Because the domestic supply curve reflects each producer’s marginal costs, the total producer surplus that they earn is the area that’s above the domestic supply curve and below the price. This is the large triangle of area B + C.
So the total economic surplus with no trade is the area A + B + C. That’s the baseline. What happens when we allow imports?
Cheap imports raise consumer surplus.
Allowing imports leads domestic buyers to pay a lower price, and at this lower price they buy a larger quantity of these cheap shirts. As a result, the consumer surplus of domestic consumers rises. Graphically, consumer surplus is the area below the demand curve but above the price buyers pay, which is now the world price, and so consumer surplus is the large triangle A + B + D. You can see why domestic consumers are happier: The lower price of shirt imports raises their consumer surplus—from area A to the larger area, A + B + D.
Domestic producers lose producer surplus due to foreign competition.
Domestic producers are worse off because a lower world price means that they have to sell their shirts at lower prices, and as a result, they no longer find it profitable to sell as many shirts. Graphically, producer surplus is the area above their domestic supply curve but below the price they now charge, which is now the lower world price. You can now see why producers are less happy: The lower price of shirts reduces their producer surplus—from area B + C to the smaller area C.
The benefits exceed the costs, and imports raise total economic surplus.
So far, we’ve seen that imports raise the consumer surplus enjoyed by American consumers and lower the producer surplus earned by American producers. What’s the net effect?
We’ve figured out that consumers gain , while producers lose a smaller amount, . This means that taken together, Americans—when we take account of their roles as both consumers and producers—gain economic surplus from importing, and this net gain is the area .
Many people are surprised to hear economists say that imports are good for Americans. Often, this is because when they think about “the economy,” they’re thinking about producers—the factories, businesses, and workers who lose some economic surplus. But it’s important not to forget consumers, who derive an even larger benefit from buying cheaper goods.
The gains to buyers from allowing imports exceed the losses to sellers. There’s a neat intuition underlying all of this. The main effect of imports is to lower the price of shirts, and if American producers wanted to, they could sell just as many shirts as before, just as American consumers could buy just as many as before. Indeed, if Americans didn’t change how many shirts they bought or produced, then the economic surplus gained by American buyers due to international trade lowering prices would exactly equal the economic surplus lost by American producers due to these lower prices. But when the price falls, American suppliers minimize their losses by supplying fewer cheap shirts, while American buyers amplify their gains by buying more cheap shirts, often from international sellers. (Imports fill the gap between the decreased production by American sellers and the increased purchases by American consumers.) The net effect is that the amplified gains to buyers outweigh the minimized losses to sellers, and so imports lead Americans—taken as a whole—to enjoy more economic surplus.
Recap: The consequences of allowing imports.
It’s time to summarize what we’ve learned about imports. It’s always best to start with what happens to the price. Cheap foreign competitors cause the price of goods we import to fall. Buyers respond by raising the quantity they demand, while sellers respond by reducing the quantity they supply, with imports filling the difference. The lower price increases the consumer surplus of buyers, and decreases the producer surplus of sellers. And because buyers amplify their gains and sellers minimize their losses, the net effect is for total economic surplus to increase.
Okay, that’s the effect of imports. Now it’s time to apply the same approach to analyzing the market for exports.
The Effects of Exports
Snowmobiles aren’t just a lot of fun, they’re also an engineering marvel, built using technologies first developed in the automobile and aviation manufacturing sectors. This explains why the United States is a global leader in developing, manufacturing, and exporting snowmobiles. Figure 5 shows the domestic demand and supply curves for snowmobiles. If there were no trade, the equilibrium would occur where these curves cross. At a price of $9,000, the 50,000 snowmobiles demanded by domestic buyers exactly matches the 50,000 snowmobiles supplied by domestic sellers. But what happens when American manufacturers like Arctic Cat and Polaris also export their snowmobiles?
Figure 5 | The Consequences of Exports
Evaluate how exports shape domestic markets.
Let’s work through our three-step recipe:
Step one: What will be the price of a traded good?
Internationally, there’s a lot of demand for snowmobiles, and the world price is $12,000. This means that sellers will not sell snowmobiles to domestic American buyers for less than the $12,000 they can get by selling in the world market. Likewise, international trade means that domestic American buyers have the option to import snowmobiles from foreign sellers such as the Canadian company Bombardier for $12,000, and so they will never pay domestic sellers more than $12,000. If suppliers will never sell for less than $12,000, and buyers will never pay more than $12,000, the equilibrium price must be $12,000. For traded goods, the price is equal to the world price.
Step two: At this new price, what quantities will be demanded and supplied by domestic buyers and sellers?
Begin by locating the new price, $12,000, on the vertical axis, and then look across until you hit the demand curve. Look down, and you’ll see that domestic buyers will demand 40,000 snowmobiles at $12,000. And what quantity will domestic producers sell? Look across from the $12,000 price until you hit the domestic supply curve, then look down, and you’ll see that domestic sellers will supply 70,000 snowmobiles.
Step three: What quantity will be traded?
While domestic supply and domestic demand are not equal, the market is still in equilibrium, because of exports to foreign buyers who make up the difference. If domestic suppliers produce 70,000 snowmobiles and domestic buyers purchase only 40,000 of them, then the difference is made up by the 30,000 snowmobiles that are exported each year.
Exports lead to higher prices, more domestic production, and less domestic consumption.
We’ve now figured out the effects of exports. When domestic sellers export their goods:
The price rises to the world price.
This higher price leads to a higher quantity supplied by domestic sellers but a lower quantity demanded by domestic buyers.
Exports fill the gap between the quantity supplied and the quantity demanded.
This tells us how exports reshape the forces of supply and demand. But do exports make you better off? Your view likely depends on whether you’re a buyer or seller of snowmobiles.
Exports Raise Economic Surplus
Previously, we worked out that imports raise the total economic surplus of Americans. What about exports? They also raise the economic surplus of Americans. To see why, let’s keep working our way through the market for snowmobiles, in Figure 6.
Figure 6 | The Welfare Consequences of Allowing Exports
Start by assessing economic surplus when there’s no international trade to set a baseline.
With no international trade in snowmobiles, equilibrium occurs where the domestic supply and demand curves cross. At this no-trade price, buyers earn consumer surplus equal to area A + B, while domestic sellers earn a producer surplus equal to area C. Okay, so the total economic surplus with no trade is equal to area A + B + C. How does it change when we allow exports?
More expensive exports raise producer surplus.
Allowing exports raises the price that domestic sellers get for their snowmobiles, which leads them to sell a larger quantity. As a result, producer surplus rises. Graphically, producer surplus is the area above the domestic supply curve but below the new higher price, which is now the world price, and so it is area B + C + D. Domestic producers are happy to have the opportunity to export because the higher price of snowmobiles raises their producer surplus—from area C to the larger area B + C + D.
Domestic consumers lose consumer surplus due to foreign competition.
Domestic buyers are worse off because they now have to compete with buyers in other countries, and so the price they pay rises to the higher world price, which also causes them to reduce the quantity they demand. Graphically, consumer surplus is the area below the demand curve, but above this higher price, and so it is area A. Exports make domestic consumers less happy because the higher price of snowmobiles reduces their consumer surplus—from area A + B, when there is no trade, to the smaller area A.
The benefits exceed the costs, and exports raise total economic surplus.
So far we’ve seen that exports raise the producer surplus earned by American suppliers and lower the consumer surplus enjoyed by American consumers. What’s the net effect?
We’ve figured out that domestic producers gain , while domestic consumers lose a smaller amount, . This means that taken together, Americans—when we take account of their roles as producers and consumers—gain economic surplus from exporting, and this net gain is shown as area .
Recap: The consequences of allowing exports.
Okay, now let’s summarize what we’ve learned about exports. We’ll begin by analyzing what happens to the price. We export those goods that foreign buyers are willing to pay a lot more for, and this leads the price of goods that we export to rise. That higher price leads domestic sellers to raise the quantity they supply, while domestic buyers reduce the quantity they demand. Exports fill the gap between domestic supply and domestic demand. The higher price increases the producer surplus of sellers, and decreases the consumer surplus of domestic buyers. And because sellers amplify their gains by selling more snowmobiles at the higher price, while buyers minimize their losses by purchasing a smaller quantity, the net effect is for total economic surplus to increase.
Who Wins, and Who Loses? The Politics of International Trade
We’ve covered a lot of ground, but now you’re well positioned to forecast how changing trade patterns will impact your market. I’ve summarized our key findings in Figure 7.
Figure 7 | The Effects of International Trade
Some students try to memorize this whole table. I have a simpler trick: Whenever you face a trade-related question, first think about the reason anyone imports or exports stuff—to get a better price. You import to get a lower price on stuff you buy, and you export to get a higher price on stuff you sell. Get this right, and the rest should be straightforward. Supply-and-demand analysis tells you that higher prices lead domestic buyers to reduce the quantity they demand and domestic sellers to increase the quantity they supply. (Lower prices lead to the opposite.) The consequences for consumer and producer surplus make sense if you simply remember that consumers like low prices while producers prefer high prices.
International trade increases economic surplus, but not everyone wins.
So far, we’ve seen that trade increases the economic surplus enjoyed by Americans. That’s the argument in support of trade. We’ve analyzed goods such as snowmobiles, which U.S. businesses export, and shirts, which Americans import. In both cases, the free flow of goods and services across national borders raises the total economic surplus enjoyed by Americans. We’d see the same thing if we performed the analysis for any other country. The implication is that international trade raises the living standards of both Americans and our trading partners. And it does so both when we are the exporters and when we are the importers.
But trade doesn’t just expand the pie; it also redistributes it. And that means that not everyone gains. Whether you will personally gain or lose from lower prices for shirts (or higher prices for snowmobiles) depends on whether you’re a buyer or a seller of shirts (or snowmobiles). These mixed effects are critical to understanding the political debate about trade, because people often advocate for what’s in their personal interest, rather than what’s in the best interest of the country as a whole.
Import-competing businesses oppose international trade.
The folks arguing most vehemently against international trade are typically those who stand to lose from it. This is why business leaders in industries that have to compete with imports—such as U.S. clothing manufacturers—often lobby for fewer imports. The workers in these businesses might be worried about their jobs, leading them to also argue against free trade.
Beyond import-competing businesses, there are also folks hurt by the fact that they now have to compete with foreign buyers to purchase American-made products. For instance, when U.S. businesses export their snowmobiles, it raises the price, which hurts domestic buyers of snowmobiles. So folks in Alaska who don’t want to pay higher prices for snowmobiles might protest against free trade in snowmobiles.
Exporters and import-dependent businesses support international trade.
Similar logic says that the groups most likely to lobby most strongly in favor of free trade are those who gain from the ability to compete in foreign markets. This is why export-oriented businesses like Arctic Cat and Polaris snowmobiles support efforts to open up new markets in Canada, France, and Finland. The other big supporters of trade are American businesses that import cheaper raw materials such as oil, steel, machinery, and software.
Consumers are rarely an active voice in this debate, but perhaps they should be. After all, it’s likely that you also benefit from trade in the form of cheaper shirts, cell phones, and laptop computers. But consumers often don’t realize that these gains are the result of international trade. Even if they did realize this, they aren’t organized into effective lobby groups, and so their voice is often absent from the political debate.
Do the Economics
For each of the following developments, figure out the effect on the price, and hence whether domestic buyers gain or lose, and whether domestic sellers gain or lose:
The United States resumes importing sugar from Cuba.
Sweden refuses to buy lobsters exported from Maine.
A trade deal makes it easier for U.S. farmers to sell beef in Japan.
Imports of cheap manufactured goods from China increase.
Technology makes it possible for Indian radiologists to read the X-rays of U.S. patients.
, while producers lose a smaller amount, 
. This means that taken together, Americans—when we take account of their roles as both consumers and producers—gain economic surplus from importing, and this net gain is the area 
.
, while domestic consumers lose a smaller amount, 
. This means that taken together, Americans—when we take account of their roles as producers and consumers—gain economic surplus from exporting, and this net gain is shown as area 
.
