International Trade Theory and Market Equilibrium Analysis

Understanding Dumping in International Trade

Dumping is the practice of selling at a lower price in the external market than in the domestic market. Two conditions are required for this to occur: segmentation of the market and imperfect competition in at least one of the two markets. Sometimes, dumping is also defined as selling below the cost of production.

Trade Creation and Trade Diversion

Trade creation is the expansion of trade that results from the formation of a Free Trade Area (FTA) or a Customs Union (CU).

Trade diversion is a shift in the pattern of trade from low-cost world producers to higher-cost CU or FTA members.

Free Trade Areas vs. Customs Unions

Both types of arrangements remove trade barriers between member countries. However, they differ in their approach to external trade:

• In a Free Trade Area (FTA), countries are free to maintain their own individual barriers to other countries. Example: NAFTA.
• In a Customs Union (CU), members also agree to set up a common external tariff for non-member countries. Examples: The EU, MERCOSUR.

Market Analysis: Lawnmower Trade Case Study

Consider the market for lawnmowers in a small country. The domestic demand curve is P = 100 – (1/10)Q_D and the domestic supply curve is P = 10 + (1/5)Q_S.

Equilibrium in Autarky

To find the equilibrium market price and quantity assuming no imports or exports (autarky), we set Demand equal to Supply:

• Demand: Q_D = 1000 – 10P
• Supply: Q_S = 5P – 50

Calculation:
100 – 1/10Q = 10 + 1/5Q
90 = 3/10Q
900 = 3Q
Q* = 300
P* = 70

Impact of Opening to International Trade

If the government opens the economy to outside trade and the world price is $60, we determine the trade status as follows:

• Demand at $60: 100 – 1/10Q_D = 60 → Q_D = 400
• Supply at $60: 10 + 1/5Q_S = 60 → Q_S = 250
• Trade Balance: Since demand (400) exceeds domestic supply (250), the country will be importing lawnmowers.
• Total Imports: 400 – 250 = 150 units.

Effects of Import Quotas on Market Equilibrium

If the government imposes an import quota of 30 lawnmowers, the new market equilibrium is calculated by adding the quota to the domestic supply:

• New Supply Equation: Q_S(total) = (5P – 50) + 30
• Equilibrium Condition: 5P – 20 = 1000 – 10P
• Price Calculation: 15P = 1020 → P = 68

At this new equilibrium price of $68:

• Domestic Supply: Q_S = 5(68) – 50 = 290 units
• Domestic Demand: Q_D = 1000 – 10(68) = 320 units