3/4 ECO Detailed Study Notes on Domestic Supply and Demand Modelling

Overview of Supply and Demand Model Changes

Modifying supply and demand model to focus on domestic supply and demand.
Foreign consumers and producers are not visualized in the model but impact prices domestically.

Autarky: A state where trade is illegal, referred to as a fancy term for no trade.
- Example used is the domestic oil market; domestic economy relies solely on local supply and demand.
- Historical context: Japan before Commodore Perry and North Korea's car market.
- North Korea: Cars produced domestically, low supply and quality due to lack of technology and expertise.

Price and quantity of oil determined by just domestic supply and demand.
Consumer surplus: Difference between price and willingness to pay.
Producer surplus: Difference between cost of production and price.
- Consumer Surplus: Area above the price line, reflects consumer welfare.
- Producer Surplus: Area below the price line, reflects producer welfare.

Comparison of market conditions in autarky and with free trade.
- Initial scenario: Price of oil at $100 in autarky.
- Introduction of free trade leads to a global price of $40 per barrel.
- Domestic consumers will prefer to buy oil at $40 due to lower prices from foreign competitors.
Shift in price forces domestic suppliers to lower their prices to remain competitive.

Price Drop: From $100 to $40.
- Impact on Domestic Quantity Supplied: Decrease, as higher production costs become unprofitable.
- Impact on Domestic Quantity Demanded: Increase, due to lower prices making oil more accessible.

New equilibrium: Domestic consumers want to buy more oil than domestic producers can supply, resulting in imports.
- Imports: Quantity difference between domestic demand and supply.
- Example scenario of countries exporting oil: Venezuela, Saudi Arabia.

Consumer surplus increases due to lower prices and expanded market access.
- Area above the price at $40 represents increased consumer surplus.
Producer surplus decreases due to lower pricing pressures and competition.
- The concern about the net effects on overall welfare, weighing consumer gains against producer losses.
Total surplus comparison: Gains from trade arise when total surplus with free trade surpasses surplus without it.

Tariffs: Taxes imposed on imports aimed at protecting domestic industries.
Burden of tariffs typically falls on consumers, not producers or foreign suppliers, as domestic consumers pay higher prices.

Origins: Early reliance on tariffs for government revenue in the U.S.; a major reform from the 1960s onwards.
Decline in tariffs post-1950s and their reduction due to increased global cooperation.

Chicken Tax: A 25% tariff on foreign truck imports intended to protect U.S. auto manufacturers.
Rationale for the tariff: Protect domestic industries from foreign competition, but results in a shortage of variety for consumers.

General economist consensus: Tariffs raise costs for consumers and do not benefit domestic industries significantly.
Studies show tariffs tend to lead to more job losses in downstream industries than jobs protected in the tariffed industries.
- Example from steel tariffs highlighting job loss exacerbation in related industries such as autos.
Arguments in favor of tariffs are often grounded in economic sentiment toward jobs and security, but their efficacy is largely questioned.

Under tariffs, consumer surplus is reduced while producer surplus may increase.
Deadweight loss arises from inefficiency in production and reduced consumption.
- Deadweight Loss: Resource costs where no benefit arises for consumers or producers, leading to inefficiency.
Government revenue from tariffs becomes a crucial component of discussions surrounding their benefits.

Market for Jeans:
- Initial equilibrium price of $40 in autarky with quantity of 400.
- Free trade price drops to $10; demand increases leading to imports.
- Imposition of a $20 tariff effectively raises the price to $30, leading to changes in quantity supplied and demanded.