This is “Basic Assumptions of the Partial Equilibrium Model”, section 7.1 from the book Policy and Theory of International Economics (v. 1.0).
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This section analyzes the price and welfare effects of trade policies using a partial equilibrium model under the assumption that markets are perfectly competitive.
In partial equilibriumAn economic analysis in which the effects are examined only in the markets that are directly affected. Supply and demand curves for the market of interest are typically used in a partial equilibrium analysis. analysis, the effects of policy actions are examined only in the markets that are directly affected. Supply and demand curves are used to depict the price effects of policies. Producer and consumer surplus is used to measure the welfare effects on participants in the market. A partial equilibrium analysis either ignores effects on other industries in the economy or assumes that the sector in question is very, very small and therefore has little if any impact on other sectors of the economy.
In contrast, a general equilibrium analysis incorporates the interaction of import and export sectors and then considers the effects of policies on multiple sectors in the economy. It uses offer curves to depict equilibria and measures welfare with aggregate welfare functions or trade indifference curves.
Two cases are considered regarding the size of the policy-setting country in international markets. The effects of policies vary significantly depending on the size of a country in international markets.
If the country is a “large countryA country is large if any change in its trade volume for a product is sufficiently large to affect the price of that product in the rest of the world.” in international markets, then the country’s imports or exports are a significant share in the world market for the product. Whenever a country is large in an international market, domestic trade policies can affect the world price of the good. This occurs if the domestic trade policy affects supply or demand on the world market sufficiently to change the world price of the product.
If the country is a “small countryA country is small if any change in its trade volume for a product is too small to have any effect on the price of that product in the rest of the world.” in international markets, then the policy-setting country has a very small share in the world market for the product—so small that domestic policies are unable to affect the world price of the good. The small country assumption is analogous to the assumption of perfect competition in a domestic goods market. Domestic firms and consumers must take international prices as given because they are too small for their actions to affect the price.
Jeopardy Questions. As in the popular television game show, you are given an answer to a question and you must respond with the question. For example, if the answer is “a tax on imports,” then the correct question is “What is a tariff?”