What happens, conceptually speaking, when imports are introduced to a competitive domestic market? At a recent Dialogue with the Fed lecture, B. Ravikumar, senior vice president and deputy director of research, explored potential gains (and losses) from trade.
He explained how in a hypothetical domestic steel market, there is a maximum level of producer surplus and consumer surplus. So, he asked, what’s trade going to do? He asked the audience to imagine there are foreign competitors who are willing to sell steel at a lower price than observed in the domestic market.
“The quantity that’s going to be purchased on the market would no longer be equal to the crossing point of the demand and supply curve,” he said.
Some producers “get lost” in the process, he noted. “It’s all these producers who used to have a marginal cost of production which is higher than what’s available to me on the world market. They can no longer be in business because the consumers would rather buy the steel from outside that’s at a lower price compared to steel from the inside that’s at a higher price.”
But, he said, the introduction of imports allows for overall gains as result of opening up the market. Although the area he refers to as producer surplus shrinks, the total area of producer and consumer surplus increases. “There is some redistribution possibility to make everyone better off.”