AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/2/2-9)
Unit 2 · Topic 2.9
2.9 International Trade and Public Policy
Opening a market to trade moves the domestic price to the world price. If the world price is lower, the country imports; if it's higher, the country exports. Total surplus rises either way, though some groups lose. Tariffs and quotas push the price back up, help domestic producers and create deadweight loss.
Key terms
- world price
- imports
- exports
- tariff
- quota
- autarky
Autarky and the world price
Autarky means no international trade: the domestic market sets its own price where domestic supply meets domestic demand. The world price is the price the good sells for on the global market. For a small country, the world price is fixed, so you can draw it as a horizontal line on the domestic supply-and-demand graph.
When the country opens to trade, the domestic price moves to the world price. At that price, domestic buyers and domestic sellers each choose their quantities, and trade fills the gap.
Imports and exports
With imports, the world price line sits below the autarky equilibrium. Read across at the world price: the supply curve shows how much domestic firms make, the demand curve shows how much buyers want, and the horizontal distance between them is the quantity imported. Consumer surplus grows (the triangle below demand and above the lower price is bigger), producer surplus shrinks, and the gain to consumers is larger than the loss to producers.
| World price vs. autarky price | Trade | Domestic consumers | Domestic producers | Total surplus |
|---|---|---|---|---|
| World price is lower | Imports = quantity demanded − domestic quantity supplied | Gain | Lose | Rises |
| World price is higher | Exports = domestic quantity supplied − quantity demanded | Lose | Gain | Rises |
Tariffs
A tariff is a tax on imported goods. A per-unit tariff raises the domestic price from the world price to the world price plus the tariff. At that higher price, domestic production rises, domestic consumption falls, and imports shrink.
Who gains and loses: consumer surplus falls. Domestic producer surplus rises. The government collects tariff revenue: tariff per unit × the new quantity of imports, a rectangle between the two price lines spanning the new import gap. Two triangles of deadweight loss appear between the two price lines. One sits between domestic supply and the world price line, from the old domestic quantity supplied to the new one; it reflects goods now made at home at a higher cost than importing them. The other sits between demand and the world price line, from the new quantity demanded to the old one; it reflects purchases buyers no longer make.
Quotas
An import quota is a legal limit on the quantity of a good that can be imported. Like a tariff, it raises the domestic price, increases domestic production, lowers consumption and creates deadweight loss. The key difference: the government collects no tariff revenue. The extra money from the higher price goes to whoever holds the right to import, often foreign sellers.
You won't need to draw a quota on a graph; just know its effects on price, quantity and surplus.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Free trade, then a tariff
A small country's domestic market has quantity demanded = 120 − 10P and domestic quantity supplied = 15P − 30. The autarky equilibrium is $6 and 60 units. The world price is $4. (a) Find imports with free trade. (b) The country adds a $1 per-unit tariff. Find the new imports, the tariff revenue and the deadweight loss.
Show the solutionHide the solution
- Step 1: (a) At $4: quantity demanded = 120 − 40 = 80, domestic quantity supplied = 60 − 30 = 30. Imports = 80 − 30 = 50 units.
- Step 2: (b) The domestic price rises to $4 + $1 = $5. Quantity demanded = 120 − 50 = 70; domestic quantity supplied = 75 − 30 = 45. Imports = 70 − 45 = 25 units.
- Step 3: Tariff revenue = $1 × 25 = $25.
- Step 4: Production-side deadweight loss = ½ × (45 − 30) × $1 = $7.50. Consumption-side deadweight loss = ½ × (80 − 70) × $1 = $5.00. Total = $12.50.
- Step 5: Check: consumer surplus falls from $320 to $245 (a $75 loss), which equals the $37.50 producer gain + $25 revenue + $12.50 deadweight loss.
Answer: (a) 50 units imported. (b) Imports fall to 25; tariff revenue $25; deadweight loss $12.50.
- Example 2Calculator allowed
Exporting (classic trap)
Using the same domestic market, suppose instead the world price is $8. Does the country import or export, and how much? Who gains and who loses?
Show the solutionHide the solution
- Step 1: The world price ($8) is above the autarky price ($6), so domestic firms can sell abroad for more. The country exports.
- Step 2: At $8: domestic quantity supplied = 120 − 30 = 90 and quantity demanded = 120 − 80 = 40. Exports = 90 − 40 = 50 units.
- Step 3: Domestic producers gain (higher price, more sold). Domestic consumers lose (they pay $8 instead of $6 and buy less). Total surplus still rises.
- Step 4: The trap: assuming that opening to trade always lowers the domestic price. It moves toward the world price, which can be higher.
Answer: It exports 50 units. Producers gain, consumers lose, and total surplus rises.
Common mistakes
- Measuring imports from zero to the domestic quantity demanded. Imports are only the gap between quantity demanded and domestic quantity supplied at the world price.
- Saying a quota raises government revenue. Unlike a tariff, a quota brings in no tariff revenue.
- Forgetting one of the two deadweight-loss triangles from a tariff.
- Saying everyone gains from trade. Total surplus rises, but import-competing producers (or, with exports, domestic consumers) lose.
On the exam
- Free-response questions may describe a domestic market with a horizontal world price line and ask you to identify imports, consumer surplus, or the effects of a tariff. Name each area by the curves and price lines that bound it.
- Multiple-choice questions often ask who gains and who loses from a tariff or quota; domestic producers gain, domestic consumers lose, and society loses overall.
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Check yourself
5 questions on 2.9 International Trade and Public Policy. Pick an answer to see if you got it, and why.
In a small country, the domestic market for bicycles has a straight-line demand curve that slopes downward and a straight-line supply curve that slopes upward. With no trade, the market clears at a price of $600 and a quantity of 500 bicycles.
The country then opens to trade, and the world price of bicycles is $400. At $400, domestic buyers want 700 bicycles and domestic producers supply 300.
At a price of $500, domestic buyers want 600 bicycles and domestic producers supply 400.
Hypothetical domestic market for bicycles in a small country that takes the world price as given
With free trade at the world price of $400, how many bicycles does the country import?
Compared with no trade, which of the following happens when the country opens to free trade at $400?
The government places a tariff of $100 per imported bicycle, so the domestic price rises to $500. How many bicycles are imported, and how much tariff revenue is collected?
What is the deadweight loss caused by the $100 tariff?
Suppose that instead of a tariff, the government sets an import quota of 200 bicycles, which also raises the domestic price to $500. Compared with the $100 tariff, which of the following is true?
0 of 5 answered