[MUSIC] In this course, we are talking about the different facets of globalization some of them are very controversial. And this is one of the ones that arouses the most passion, the most controversial, the most oppositional when we talk about it in the political room, and that is trade. We're going to be discussing in this section the benefits of free trade, and then how trade works, and what we lose when we interfere with it. And there's almost universal agreement among economist on fact that trade, is a win, win game. It's not that some win and some lose it's that we all benefit. So I'm going to demonstrate this to you, it's a topic that can be pretty technical and I'm going to try to go to the very simple, the very intuitive, as long as we can preserve the basic parameters of the model. But in order to begin with the model of free trade, there are a couple of tools that we need to review. And some of these you may know from my previous course, some of them you may know from previous Economics courses. So just very quickly I'd like to look at with you, first of all, the diagram of supply and demand, which underlies most everything we do in Economics. And it's going to look something like this, we draw a graph with quantity on this axis, on the x axis, we put price on the y axis, and then we draw two curves, all right, or two lines. This one which slopes downward we call the demand curve as you probably know and the demand curve shows us that for example, if we're up here at this point of the curve at high prices that people aren't going to want to buy very much, maybe nothing at all. You can see here's a lower price, they don't want to buy a large quantity but over here at this very low price, they want to buy a very large quantity, okay. So that's the demand curve, and then we'll also have a supply curve that slopes upward, this represents how much of this particular good is being supplied by different producers. And what we find is that at low prices the producers are willing to produce nothing or very little because their profits are small and high prices, they're willing to produce large quantities. So we've got the demand curve, we've got the supply curve and it's illustrating whatever good you want to illustrate, this is probably the most useful tool in all of economics. You could use it to illustrate, I don't know, apartment rents in a given city or petroleum or whatever you want to with this curve, okay. Now, what we find with the supply and demand curve is that where those two curves intersect, that's where price will tend to settle. So this we're going to call P sub E, which is an equilibrium price. The price will settle there because if the price is above that level you can see that demand, which we measure here will be less than supply, which we measure here, there will be an excess in the market and price would tend to fall. But it prices below that level and we could pick this price. You can see supply, measured on this curve would be smaller than demand, measured on this curve. And therefore, there would be a shortage in the market and price would tend to rise. So this is the only point of equilibrium in the market, we can also draw an equilibrium quantity, at this point the market is going to rest, okay. So this is a supply and demand diagram. Now we're going to do one other thing with it as we work on this model and that is, we're going to talk about something called the consumer surplus. And something called the producer surplus, so let me just define those for you, because it be relevant to our trade model. The consumer surplus is all of this area under the demand curve to the going price, let me explain why. If we think about this demand curve, it expresses people's willingness and ability to buy whatever good we're analyzing at different prices. So imagine the price were up here, okay, at this price you can see there are some people and we can see them down here. There are some people who'd be willing to buy the good, okay. When they actually go to the market to buy, the price is not up here, it's down here because that's equilibrium price. So those people in a sense carry away a surplus. It's like if I go shopping to Walmart and I know prices are low, and I've put $100 in my pocket to buy a microwave and I walk in and it costs me $40, then I carry away the extra $60, that's what this surplus represents. And you can see all along this curve there are different quantities that people would have been willing to buy at this price for instance, they'd be willing to buy this much. At this price, this much and all of these people take away a hypothetical surplus. In other words, this price is lower for them than what they were willing and able to pay and therefore, they have this surplus and often they'll just take the surplus and spend it on something else. But it raises their welfare, so we call this, this is part of our definition of welfare. We've also got a producer surplus, so there's our consumer surplus. We've got a producer surplus and here the way it works is this. There are producers along this line and they are seeing the different prices and they are deciding how much of this good, whatever it is they're willing to produce, okay. If they can't make any money, they won't produce, if they can make profits they will. So you can see these people, these producers down here for instance, they would put a little bit on the market at this low price, but not very much. But they'd be willing to put something on, now when they go to the market they find that the price is actually all the way up there. So they carry away a surplus, don't they? They were able and willing to produce the good at this low price, they actually get that price instead. And all of these other producers as we go along, you see the price is a little higher, this guy would be willing to put it on the market at this price, he actually gets that price, he carries away a surplus. This one she carries away a surplus as well, and so we get this entire area under the equilibrium price that we call producer surplus, okay, consumer surplus here produce a surplus here. The sum of the two is what we call total welfare the economy, okay. So that's one picture I want you to keep in mind. Another one I'd like you to remember as we go into the model is something that we call the production possibilities curve. [MUSIC]
