Economics: Trade, Demand, and Consumer Surplus – Study Notes

TA Office Hours and Homework Support

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Canvas/MacMillan Delay and Email Protocol

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  • As of the time of the talk, about 240 students had not opened their modules yet.
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  • Office hours refocus: the speaker also mentions being in office from 01:30–02:30 this afternoon.

Incentives, Excuses, and Technical Issues

  • Eye Cooker: an incentive program that will start counting toward a reward; you need a 60% or higher accuracy rate by the end of the semester to be excused from the final exam. The excusal has no effect on your current grade.
  • Excuses: illness does not qualify for an excusal; the policy stated is that exam excusal does not apply for illness or technology problems.
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Intro to Trade Theory: Absolute vs Comparative Advantage

  • Absolute advantage: concerns the ability to produce more with the same resources.
  • Comparative advantage: concerns producing a good at a lower opportunity cost relative to other goods.
  • The class emphasizes that trade patterns are driven by comparative advantage, not merely by absolute wages or absolute productivity differences.
  • Even though productivity differences explain wage disparities, the fundamental driver of trade patterns is opportunity cost differences (comparative advantage).

The US–Mexico Computer and Shirt Example (Productivity and Wages)

  • Price assumptions used: computer = $300; shirt = $100.
  • Pre-trade production snapshot:
    • US: 12 computers and 12 shirts.
    • Mexico: 1 computer and 6 shirts.
  • Pre-trade wages (average wage per worker across the industry):
    • US: W^{pre}_{US} = rac{300 imes 12 + 100 imes 12}{24} = 200.
    • Mexico: W^{pre}_{MX} = rac{300 imes 1 + 100 imes 6}{24} = 37.50.
  • Note: These calculations illustrate productivity differences as the driver of wage differences rather than trade patterns.
  • Post-trade production and wages (as stated in the lecture):
    • US: 14 computers and 10 shirts; wage rises by 16 to Wpost<em>US=216.W^{post}<em>{US} = 216. (calculated as W^{post}{US} = rac{300 imes 14 + 100 imes 10}{24} = rac{5200}{24} o ext{approximately } 216.67.)
    • Mexico: shifts focus toward shirts; wage rises from 37.50 to 50 (as stated in the video narrative).
  • Key interpretation: post-trade productivity gains increase wages in both countries and increase global production and consumption (worldwide gains from trade).
  • Main punch line: differences in wages across countries primarily reflect differences in productivity, not the causative driver of trade patterns; to close wage gaps, close productivity gaps.

How Comparative Advantage Drives Trade (Intuition and Examples)

  • The pattern of trade is driven by differences in opportunity costs (comparative advantage). This leads to specialization where each country concentrates on goods it produces relatively more efficiently.
  • The graphically illustrated idea: even if one country has an absolute advantage in producing all goods, there will still be gains from trade if each country focuses on the good with the lower opportunity cost.
  • The talk emphasizes that comparative advantage explains international trade patterns as opposed to absolute wage differences alone.

Comparative Advantage Across Dollars and Pesos; Arbitrage Concept

  • A second illustrative use is to show arbitrage across currencies and goods by representing prices in dollars and pesos.
  • Arbitrage is described as buying where price is low and selling where price is high to profit from price differences; it pushes prices toward convergence.
  • Simple goods example (Mexico vs United States): In Mexico, one computer equals six shirts; in the United States, one computer equals one shirt. This price discrepancy creates an arbitrage opportunity, but arbitrage will continue only until prices converge between the two markets.
  • The principle extends to currency markets: if $1 equals more euros or more yen in a different market, traders move funds to exploit the discrepancy until exchange rates converge.
  • The lecture also notes historical examples of arbitrage and global trade routes (contrasting land vs. sea routes during early exploration) and discusses how trade and specialization contributed to increased knowledge, higher production, and higher incomes.

Historical Context: Voyages of Discovery and Knowledge Growth

  • The métiers of exploration (e.g., Columbus) were initially based on imperfect calculations; the broader outcome was enhanced knowledge and expanded trade networks.
  • The growth of trade and division of knowledge across regions (specialization) led to increased overall production and living standards.
  • A broader point: as societies break tasks into specialized knowledge, productivity and knowledge expand, leading to higher consumption and incomes.
  • The material links to real-world implications: trade can have environmental and local-sourcing considerations; a referenced podcast on free-market economics links this to environmental benefits and local-sourcing debates.

Quick Preview: The Structure of Demand, Market Equilibrium, and Gains from Trade

  • The course will cover two chapters focused on the demand side (consumers) and then combine them with supply to discuss market equilibrium, price discovery, and market quantity.
  • Key concepts: consumer surplus, producer surplus, and total gains from trade; at market equilibrium, gains from trade are maximized.
  • Several in-class activities (e.g., Eye Clicker) emphasize that comparative advantage is a central driver of trade patterns, not absolute wages.

Demand, Quantity Demanded, and the Demand Curve

  • Demand is described as a function of price; we typically sketch demand with Price on the y-axis and Quantity on the x-axis in this course’s framework.
  • Distinction between demand vs. quantity demanded:
    • Quantity demanded: a specific amount at a specific price; it is a point on the demand curve and arises from willingness and ability to buy.
    • Demand: the entire relationship between price and quantity demanded; changes in non-price factors shift the entire demand curve.
  • Everyday interpretation: when price changes, you move along the demand curve (change in quantity demanded); when non-price factors change, the entire demand curve shifts (change in demand).
  • Graph orientation note: for this course, the x-axis is still quantity (could be pounds, millions, etc.), and the y-axis is price.
  • Historical note on Marshall: Alfred Marshall drew the demand curve in a way that people find counterintuitive; the class notes this as a historical artifact and mentions that the convention has persisted since the 19th century.

Reading a Demand Curve: Practice and Notation

  • Example reading: If the price is $6, how many units are demanded? In the example, the answer is 26 (based on the graph shown in the lecture).
  • Horizontal reading: you can read off the quantity demanded for a given price, or you can read the price corresponding to a given quantity demanded.
  • Consumer surplus intuition: CS is the area under the demand curve and above the price line for the quantity purchased.
  • Individual vs market CS: Susie, Bill, Natasha, and Joe illustrate how consumer surplus can vary by individual willingness to pay; some consumers gain more surplus than others depending on their WTP and actual price paid.
  • Mathematical interpretation: consumer surplus is the area above the price and below the demand curve; for multiple consumers, you sum the individual surpluses.

Consumer Surplus: Illustrative Example and Calculations

  • Susie: WTP = $20 per unit; price paid = $2 per unit; CS = $18 for her unit.
  • Bill: WTP = $5 per unit; price paid = $2; CS = $3.
  • Natasha (marginal consumer): WTP = $2; price = $2; CS = $0.
  • Joe: WTP = $0.10; price = $2; negative consumer surplus (i.e., he would not buy at this price).
  • Summary concept: CS for each consumer is the difference between their maximum willingness to pay and the actual price, for the units they purchase; the market CS is the sum of individual CS values; statistically, CS can be represented as the area under the demand curve and above the market price.
  • A numeric CS problem is introduced (price at $30) to compute the CS via the appropriate geometric area (often a triangle or trapezoid depending on the demand function).
  • Important learning nuance: changes in price cause movement along the demand curve (change in quantity demanded); shifts in demand (driven by non-price factors) move the entire curve (change in demand).

Summary and Practical Takeaways

  • Comparative advantage explains trade patterns; productivity differences drive wages, and wages rise with post-trade productivity gains.
  • Arbitrage concept: price differences across markets lead to buying low and selling high; prices converge as trade expands and markets interlink.
  • Demand vs. quantity demanded: price changes lead to movement along the demand curve; non-price factors shift the demand curve.
  • Consumer surplus provides a measure of the benefit buyers receive from participating in a market; it is the area between the demand curve and the price line for the quantity bought; total CS is the sum across all buyers in the market.
  • The course connects microeconomic demand analysis with macro implications of trade, productivity, and income growth, emphasizing that gains from trade arise from productivity differences and the resulting reallocation of resources, rather than simply wage differences.

Quick Reference Formulas (LaTeX)

  • Pre-trade US average wage:
    W^{pre}_{US} = rac{300 imes 12 + 100 imes 12}{24} = 200.
  • Pre-trade Mexico average wage:
    W^{pre}_{MX} = rac{300 imes 1 + 100 imes 6}{24} = 37.50.
  • Post-trade US average wage:
    W^{post}_{US} = rac{300 imes 14 + 100 imes 10}{24} = rac{5200}{24} ilde{=} 216.67.
  • Post-trade Mexico average wage (as stated in the lecture):
    WMXpost=50.W^{post}_{MX} = 50.
  • Consumer surplus (unit by unit, illustrative): for a unit with willingness to pay $WTP$ and actual price $P$, CS per unit ≈ $WTP - P$; total CS is the sum across purchased units; geometrically, CS is the area under the demand curve and above the price line for the quantity bought.
  • Arbitrage principle (conceptual): if price differences exist after accounting for exchange rates, buy where price is low and sell where price is high to earn a profit; this pressure pushes prices toward convergence over time.