In a closed economy, a country is not affected by the world market price; they set their own pricing based on demand. When a country decides to open the market to trade, there are several things that should be considered.
Note. From Principles of Economics by Mankiw, 2024, Cengage Learning.
In a closed economy, domestic quantity produced is determined by the intersection of the supply and demand curves or the equilibrium price and quantity. On the image above we can see that consumer surplus without trade is represented by areas A and B, or the areas above the equilibrium price without trade. Producer surplus in this closed economy is represented by area C, and total surplus is represented by A + B + C.
Exports and Surplus
- World price: Once a country opens up to exporting, domestic products must be priced at the world market price to remain competitive.
- Higher price: In this scenario, the world price is higher than the price before trade.
- Domestic supply increases: Producers supply more because of the higher price available.
- Domestic demand decreases: Consumers purchase less because of the higher price.
- Exports: The difference between the domestic quantity supplied and quantity demanded at the world price represents exports.
- Consumer surplus falls: Consumer surplus decreases by Area B because it is below the new world price.
- Producer surplus increases: Area B becomes part of producer surplus. Area D, which represents exports, also contributes to producer surplus.
- New producer surplus: Producer surplus is represented by Areas B + C + D.
- Total surplus increases: Total surplus is represented by Areas A + B + C + D.
- Overall effect: Opening the country to exports increases total surplus, with the gain represented by the additional exports.
In summary, for an exporting country:
- The domestic price rises to the world price.
- Consumers lose (higher price, less consumption ® lose area B).
- Producers gain more than consumers lose (gain B + D).
- The economy as a whole is better off by area D – the gains from trade.
Mankiw, N. G. (2024). Principles of Economics. Cengage Learning.
Need More Help?
Want additional support? Sign up for our group sessions. Take a look at the full workshop schedule. For help signing up and accessing the Academic Support Center, see the How to Book ASC Sessions Page.