ECO100 Introduction to Economics | Theory of Microeconomics Demand

1.Using both a demand curve and a supply curve distinguish between a change in the quantity demanded and a change in demand and provide illustrative examples of each.

 

2.Explain the fallacy of President Trump's proposed protectionist policies in terms of the concepts of comparative advantage and absolute advantage.

ce and demand move in opposite direction. That is demand increase when there is an increase in price and decreases with an escalation in price (Stiglitz & Rosengard, 2015). The former is called demand expansion while the latter is known as demand contraction. The change in quantity demanded is captured by movement on the demand curve from one point to another. During demand expansion, it moves from right to left while during contraction is shown by the movement from right to leftward direction on the demand curve. The impact on market following a change in quantity demanded is explained in figure 1 with the aid of following figure using both demand and supply curve.

Figure 1: Change in quantity demanded

In the given figure equilibrium price is indicated as P*. At a higher price that is at P_1, there is a decline in demand as shown by the upward movement on the demand curve from E₁ to A. This leads to an excess supply pushing price down towards equilibrium (Devine et al. 2018).  Corresponds to a lower price, indicated as P_2, demand increases as show by a downward movement on the demand curve from E₁ to D. The increased demand exceeds available supply. This exerts upward push on price.

Change in demand

In a sharp contrast to change in quantity demanded, change in demand capture demand change followed by change in factors other than own price.  The entire demand curve here shifts either rightward or leftward depending on direction of change in corresponding factors. The factors that are responsible for a change in demand include income, price of substitutes or complements, change in taste or preference and the like (Blad & Keiding, 2014) Favorable changes in any of these factors causes demand to increase and demand curve shifts outward accordingly. Unfavorable change on the other hand causes demand to decrease. Decrease in demand is observed from a leftward shift of demand curve.

Figure 2: Increase in demand and equilibrium

As demand increase due to exogenous factors, the demand curve goes outward to D_1. With the existing supply curve outward shift in demand settles new equilibrium at a higher price – output combination.

Figure 3: Decrease in demand and equilibrium

Conversely, demand curve moves inward when there is a decrease in demand. This settles new equilibrium at a lower quantity and price combination.

2.

In the international trade theory, protectionists policy indicates any policy measures unfavorable to free trade. Such policies more often have distortionary effect on economic and political environment (Helpman & Razin, 2014). A recent relevant aspect to this is the protectionist policies undertaken by the President Donald Trump.

Absolute and comparative advantage

Nations participate in international trade depending on their line of specialization. In determining specialization two of the pioneering theories are that of absolute and comparative advantage. The trade theory of absolute advantage summarizes the proposition made by Adam Smith. Under this theory, one country has an absolute advantage over another when the nation is capable of producing a good incurring a lower cost in absolute terms. Contrast to absolute advantage comparative advantage is determined following the opportunity cost involved in production of a good. Country devices a comparative advantage when it can produce a good with a minimal opportunity cost (Viner, 2016). Free trade by allocating resources depending on country’s specialization mostly benefits all the participating nation by providing access a more variety of produced goods and raise world welfare as a whole.

Country’s access to abundant resources determine line of specialization of the nation.  United State has abundant supply of capital and land. The nation thus has an absolute and comparative advantage mostly in capital and agricultural goods. Among the agricultural export of United State, the major is corn, meat, soybean and poultry. US exports capital goods such as commercial aircraft, electric apparatus, machineries, medical equipment and others (census.gov 2018). On the other hand, US imports mainly intermediary and final goods that are labor intensive.

Trump’s protectionist policy and likely consequences

Growing import over the exportable has resulted in a large trade deficit for the nation. Huge trade deficit is given as an argument in favor of the restrictive policies. Trump announced protectionists policy imposes a substantially huge tariff on several goods imported from nations like Japan, China, Mexico and other EU nation. On import of steel a tariff of 25 percent has been imposed.  In case of aluminum, the corresponding tariff rate is 10 percent.

The restrictive policies however are actually counterproductive harming the economic wellbeing of the nation. Trump’s attempt to eliminate all the commercial agreement would lead to trade disputes among US and its trading partners. In a world of globalization and integration Trump’s policies contrasting to global trend would harm American economy. The protectionist policy against China causes a trade war between two of the world’s largest economies. Trump’s policy triggers trade war as other retaliates in the same way (nytimes.com 2018).  Increase in import tariff on many products would increase cost of production. The increased cost inflicted on consumer in form of higher price. There is net loss in social welfare from the resulted tariff.  The following figure shows impact of protectionist policy on economic welfare

Figure 4: Consequences of tariff

After tariff, the increased price lowers consumer surplus. There is a small increase in producer surplus and tariff revenue. The aggregate welfare loss is indicated by the shaded region in the figure.

References

Blad, M. C., & Keiding, H. (2014). Microeconomics: Institutions, equilibrium and optimality (Vol. 30). Elsevier.

census.gov. (2018). Official Source US Export and Import Statistics - Foreign Trade - US Census Bureau. Retrieved from https://www.census.gov/foreign-trade/index.html

Devine, P. J., Tyson, W. J., Lee, N., & Jones, R. M. (2018). An introduction to industrial economics. Routledge.

Helpman, E., & Razin, A. (2014). A theory of international trade under uncertainty. Academic Press.

Phlips, L. (2014). Applied Consumption Analysis: Advanced Textbooks in Economics (Vol. 5). Elsevier.

Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the public sector: Fourth international student edition. WW Norton & Company.

Swanson, A. (2018). Will 2018 Be the Year of Protectionism? Trump Alone Will Decide. Retrieved from https://www.nytimes.com/2018/01/03/us/politics/2018-trump-protectionism-tariffs.html

Viner, J. (2016). Studies in the theory of international trade. Routledge