International trade opens domestic markets to global competition, altering equilibrium prices, quantities, and overall welfare. Understanding these changes is key to analyzing trade outcomes.
Autarky: A closed economy
Definition of autarky
Autarky is a situation where a country does not participate in international trade. In this self-sufficient system, all goods and services consumed by individuals and businesses are produced within the domestic economy.
The equilibrium price and quantity are determined solely by the intersection of the domestic supply and demand curves.
There is no import or export activity, so domestic producers must meet all consumer demand regardless of cost or efficiency.
Autarky often leads to less consumer choice, higher prices, and lower efficiency because the domestic economy cannot benefit from specialization or comparative advantage.
This closed-economy model serves as the baseline for analyzing the effects of opening up to international trade.
Opening to international trade: new price and quantity outcomes
When an economy transitions from autarky to engaging in international trade, it gains access to the world market, where goods can be imported or exported based on relative costs.
How equilibrium changes with trade
If the world price (Pw) is lower than the domestic price (Pautarky), the good will be imported. Domestic consumers can now purchase the good at a lower price, increasing quantity demanded while decreasing quantity supplied by domestic producers.
If Pw is higher than Pautarky, the good will be exported. Producers will sell more at the higher price, while consumers will reduce consumption due to the price increase.
This shift results in a new equilibrium based not just on domestic supply and demand but on interaction with international prices and trade flows.
The role of comparative advantage
A country tends to export goods in which it has a comparative advantage—that is, the ability to produce at a lower opportunity cost than other nations.
It imports goods in which other countries have the comparative advantage, which leads to a more efficient allocation of global resources and an increase in total economic surplus.
The role of imports and exports in trade
International trade balances domestic shortages or surpluses through imports and exports. These movements help optimize the allocation of goods across borders.
Imports fill the gap when world prices are lower
When a country opens to trade and the world price is below its domestic equilibrium price:
Consumers benefit by purchasing the good at a lower price, increasing the quantity demanded.
Domestic producers face tougher competition, reducing the quantity supplied in the domestic market.
The gap between quantity demanded (Qd) and quantity supplied (Qs) at the world price is filled by imports.
For example:
If Qd = 100 units and Qs = 40 units at the world price, then the country will import 60 units to satisfy excess demand.
Exports fill the gap when world prices are higher
When the world price is higher than the domestic price:
Producers increase output to take advantage of higher prices in foreign markets.
Domestic consumers reduce consumption due to the higher price.
The difference between the increased domestic quantity supplied and the lower domestic quantity demanded is sold as exports.
For example:
If Qs = 120 units and Qd = 80 units at the world price, the country will export 40 units.
Net gains from trade
Imports benefit consumers through lower prices and greater variety, although some domestic producers may lose market share.
Exports benefit producers, who can earn more revenue, but may hurt domestic consumers facing higher prices.
Overall, trade increases total economic surplus, improving national welfare despite redistribution of benefits and losses.
Graphical analysis of trade and market changes
Understanding the effects of international trade is easier when visualized through supply and demand graphs. These models show how prices, quantities, and surplus change under trade.
Import scenario: world price below autarkic price
Step-by-step breakdown:
Autarky equilibrium
Domestic supply and demand intersect at price Pautarky.
Quantity Qautarky is both supplied and demanded at this price.
World price introduced (Pw < Pautarky)
The world price is drawn as a horizontal line below the autarky equilibrium.
At this lower price, domestic consumers demand a larger quantity (Qd) while domestic producers supply a smaller quantity (Qs).
The difference (Qd - Qs) is filled by imports.
Surplus outcomes:
Consumer surplus increases: Consumers buy more at a lower price. The area under the demand curve and above Pw expands.
Producer surplus decreases: Producers sell less and receive lower prices. The area above the supply curve and below Pw shrinks.
Total surplus increases: The gains to consumers outweigh the losses to producers. The increase in total surplus is represented by a triangle between Qs and Qd under the demand and supply curves.
Export scenario: world price above autarkic price
Step-by-step breakdown:
Autarky equilibrium
Domestic supply and demand intersect at Pautarky and quantity Qautarky.
World price introduced (Pw > Pautarky)
The world price is drawn as a horizontal line above the domestic equilibrium.
At this price, producers want to sell more (Qs), and consumers want to buy less (Qd).
The excess quantity (Qs - Qd) is exported.
Surplus outcomes:
Producer surplus increases: Producers sell more at a higher price. The area above the supply curve and below Pw increases.
Consumer surplus decreases: Consumers buy less and pay more. The area under the demand curve and above Pw decreases.
Total surplus increases: The increase in producer surplus exceeds the loss in consumer surplus. The net gain is represented by the triangle between Qd and Qs.
Interpreting changes in surplus
Understanding how consumer surplus, producer surplus, and total surplus are affected by trade is essential for evaluating market outcomes.
Consumer surplus (CS)
Consumer surplus is the difference between what consumers are willing to pay and what they actually pay. It is the area below the demand curve and above the market price.
When imports are introduced (Pw < Pautarky), CS increases because:
Prices fall
Consumers purchase more
They gain from cheaper goods and a wider selection
When exports occur (Pw > Pautarky), CS decreases because:
Prices rise
Consumers buy less
They pay more for a smaller quantity
Producer surplus (PS)
Producer surplus is the difference between the market price and the minimum price producers are willing to accept. It is the area above the supply curve and below the market price.
When imports occur, PS decreases because:
Prices fall
Domestic producers lose market share
They produce less at a lower profit margin
When exports are introduced, PS increases because:
Prices rise
Producers produce more
They sell at a higher profit margin
Total economic surplus
Total economic surplus is the sum of consumer surplus and producer surplus. It measures the overall welfare in a market.
International trade always increases total surplus, as long as there are no artificial barriers (like tariffs or quotas).
The gains from trade arise because goods are produced where they are relatively cheaper and consumed where they are valued more.
The increase in total surplus is represented by the triangle between Qautarky and Qtrade (either Qd or Qs), depending on the scenario.
Formula for deadweight gain from trade:
Change in total surplus = (1/2) (base) (height)
For imports:
Base = Qd - Qs (quantity of imports)
Height = Pautarky - Pw
For exports:
Base = Qs - Qd (quantity of exports)
Height = Pw - Pautarky
This formula helps quantify the net gain from trade in both cases.
Key points for students to remember
Autarky represents a no-trade situation, where all equilibrium outcomes are determined domestically.
Opening to trade brings in the world price, which shifts equilibrium:
If Pw < Pautarky, the good is imported.
If Pw > Pautarky, the good is exported.
Imports benefit consumers through lower prices and more variety, while exports benefit producers through higher prices and larger markets.
The difference between domestic supply and demand at the world price represents the amount traded.
Consumer surplus and producer surplus may move in opposite directions, but total surplus always increases under free trade.
Graphs and surplus calculations are essential tools for understanding and demonstrating the effects of trade on market outcomes.
FAQ
In AP Microeconomics, a "small open economy" is one that is too small to influence the world price through its own trade activity. This means the country is a price taker in international markets. The world price is determined by global supply and demand, not by the actions of any single country, especially a small one. This assumption simplifies trade analysis by allowing us to treat the world price as a flat, horizontal line on supply and demand graphs. The domestic market must accept this price, whether importing or exporting. The constant world price leads to either a shortage or surplus in the domestic market at that price, and trade balances the difference through imports or exports. This assumption is crucial because it isolates the effects of trade on domestic producers and consumers without complicating factors like price manipulation, tariffs, or global feedback loops. It helps focus the analysis on how domestic markets respond to external prices, not how they influence them.
If the domestic price under autarky equals the world price, then opening the economy to trade has no effect on the domestic market. In this rare case, there is no incentive to either import or export the good because the domestic equilibrium already matches the global equilibrium. At this price, the quantity supplied domestically equals the quantity demanded, and no trade occurs because there’s no comparative price advantage for either consumers or producers. The domestic market remains unchanged—price, quantity, consumer surplus, producer surplus, and total surplus all stay the same. Graphically, the supply and demand curves intersect at the world price, and there’s no gap between Qd and Qs, so there are no imports or exports. While this outcome is theoretically possible, it’s uncommon in real-world markets. More often, differences in production costs, technology, or resource endowments between countries create price gaps that generate gains from trade.
In a single market for a specific good, a country will either import or export that good based on how its domestic price compares to the world price. It cannot both import and export the same good at the same time in perfect competition. If the world price is lower than the domestic price, the country will import; if it is higher, the country will export. This is because market equilibrium adjusts to one price level, and trade flows adjust to balance supply and demand at that price. However, in the broader economy, a country can simultaneously import some goods and export others based on comparative advantage. Additionally, if product differentiation exists (like in monopolistic competition), it's possible for two countries to import and export similar but differentiated goods (e.g., different brands of cars). But in standard AP Microeconomics models assuming perfect competition and homogeneous goods, only one direction of trade happens per good.
Opening an economy to trade typically increases market efficiency compared to autarky. In an autarkic market, goods are not necessarily produced by the lowest-cost producers, leading to inefficient allocation of resources. When a country opens to trade, it begins importing goods that are relatively expensive to produce domestically and exporting goods it can produce more efficiently. This shift toward specialization based on comparative advantage results in a better use of global resources. For consumers, trade allows access to lower prices and greater variety. For producers, it creates opportunities to scale and access larger markets. From an efficiency standpoint, trade reallocates resources to where they are most productive, maximizing total economic surplus. This gain is represented in trade graphs by a triangle known as the net gains from trade. Trade removes deadweight loss that would otherwise exist in autarky and promotes a more optimal distribution of goods in response to consumer preferences and production capabilities.
Some producers oppose free trade because, although total economic surplus increases, the benefits of trade are not evenly distributed. In an import scenario, domestic producers often face lower prices due to competition from cheaper foreign goods. This reduces their revenues and market share, sometimes leading to downsizing, wage cuts, or business closures. Even if the economy as a whole benefits from trade through increased consumer surplus and efficiency, individual producers or industries may lose significantly. These producers may not easily shift to more competitive sectors due to fixed capital, lack of retraining, or regional economic conditions. The result is economic dislocation and job losses in vulnerable industries. This is why trade policy often becomes politically sensitive. Governments may intervene with trade barriers or subsidies to protect domestic industries, even if such policies reduce overall efficiency. In essence, producer opposition stems from concentrated losses, whereas the gains from trade are diffused across many consumers who may not perceive the benefits as strongly.
Practice Questions
Assume a country initially does not trade and is in autarky. The domestic equilibrium price of wheat is 4 per bushel. Using a supply and demand graph, explain the effects on the domestic market. Identify changes in consumer surplus, producer surplus, and total surplus.
When the country opens to trade and the world price is 6, domestic consumers buy more wheat at the lower price, increasing consumer surplus. Domestic producers, facing lower prices, reduce output, leading to a decrease in producer surplus. Imports fill the gap between the higher quantity demanded and lower quantity supplied. Overall, total surplus in the market increases due to the gains from trade, as the increase in consumer surplus outweighs the loss to producers. The area representing net gains from trade is the triangle between the supply and demand curves from Qs to Qd.
A country opens to international trade in a good where the world price is higher than the domestic autarky price. Using a graph and economic reasoning, explain the effects on domestic price, quantity, exports, and surplus outcomes.
With a world price above the autarky price, domestic producers increase output to sell more at the higher price, while consumers reduce their quantity demanded. The domestic price rises to match the world price. The excess supply is exported, equal to the difference between quantity supplied and quantity demanded at the new price. Producer surplus increases due to higher prices and greater sales, while consumer surplus decreases because of higher prices and reduced consumption. Despite the consumer loss, total economic surplus rises as the gains to producers exceed the losses, creating net benefits from trade shown as a triangle on the graph.
