I. The fundamentals of international trade
B. Supply and demand trade geometry

    What we want to determine now is how social welfare changes when we have the chance to trade with other countries

1. Supply and demand trade geometry for a small country

    Domestic-market S&D works just fine for the case of a small open economy--see worksheet 
    the usual S&D from Econ.101

    Key results:
    (1) Efficiency: Countries gain from trade:
        Exporting country gains from trade = area C
        Importing country gains from trade = areas BC

    (2) Equity: Some individuals within countries gain and others lose from trade:
    Producers gain and consumers lose for export products
    Consumers gain and producers lose for import products
    Caveat: the main drawback to S&D analysis is that it can be misleading about who the economy's true winners and losers from trade turn out to be. We'll take a closer look at that in the next part of the course.

    Regarding prices: For a small country, domestic prices converge to unchanging world prices:
    For the country's low-cost item: exports drive the price up to the world level
    For the country's high-cost item: imports drive the price down to the world level

    A small country's prices under free trade are determined by global S&D conditions that are completely out of the control of the country itself.

    LDCs have complained a lot about their declining terms of trade, so we'll want to get a good handle on it later on

    Regarding the gains from trade: A small country captures for itself all of the gains from its trade. Since global prices are unchanged, it's as if the other countries don't even know the trade is going on.

2. Supply and demand trade geometry for a large country

    Recall: A large country => its trade affects global prices
    --not large as in size of GDP
    --large in terms of the goods you export or import:
        S.Afr. in diamonds / Brazil in coffee / Saudi Arabia in oil / US in motion pictures
    More likely as an exporter than as an importer.

    What important differences arise when large countries are involved?
        --Direction of trade: unchanged--export low O/C goods
        --Gains from trade: now both sides of the market achieve quantifiable gains since prices change
        --Terms of trade: the biggest difference

    The precise question is--where will the final trade price end up?
    The answer depends on global supply and demand conditions as they play out in the trade markets that link country markets to each other.

    It's the large-country case that prompts the use of:
        International market S&D diagrams. see worksheet