Figure 8-5 shows the U.S. market for phones, ignoring international trade for a moment. It introduces a few new concepts: the domestic demand curve, the domestic supply curve, and the domestic or autarky price.

The domestic demand curve shows how the quantity of a good demanded by residents of a country depends on the price of that good. Why “domestic”? Because people living in other countries may demand the good, too. Once we introduce international trade, we need to distinguish between purchases of a good by domestic consumers and purchases by foreign consumers. So the domestic demand curve reflects only the demand of residents of our own country.

Similarly, the domestic supply curve shows how the quantity of a good supplied by producers inside our own country depends on the price of that good. Once we introduce international trade, we need to distinguish between the supply of domestic producers and foreign supply—supply brought in from abroad.

In autarky, with no international trade in phones, the equilibrium in this market would be determined by the intersection of the domestic demand and domestic supply curves, point A. The equilibrium price of phones would be P_A, and the equilibrium quantity of phones produced and consumed would be Q_A. As always, both consumers and producers gain from the existence of the domestic market. In autarky, consumer surplus would be equal to the area of the blue-shaded triangle in Figure 8-5. Producer surplus would be equal to the area of the red-shaded triangle. And total surplus would be equal to the sum of these two shaded triangles.

Now let’s imagine opening up this market to imports. To do this, we must make an assumption about the supply of imports. The simplest assumption, which we will adopt here, is that unlimited quantities of phones can be purchased from abroad at a fixed price, known as the world price of phones. Figure 8-6 shows a situation in which the world price of a phone, P_W, is lower than the price of a phone that would prevail in the domestic market in autarky, P_A.

Given that the world price is below the domestic price of a phone, it is profitable for importers to buy phones abroad and resell them domestically. The imported phones increase the supply of phones in the domestic market, driving down the domestic market price. Phones will continue to be imported until the domestic price falls to a level equal to the world price.

The result is shown in Figure 8-6. Because of imports, the domestic price of a phone falls from P_A to P_W. The quantity of phones demanded by domestic consumers rises from Q_A to Q_D, and the quantity supplied by domestic producers falls from Q_A to Q_S. The difference between the domestic quantity demanded and the domestic quantity supplied, Q_D – Q_S, is filled by imports.

Now let’s turn to the effects of imports on consumer surplus and producer surplus. Because imports of phones lead to a fall in their domestic price, consumer surplus rises and producer surplus falls. Figure 8-7 shows how this works. We label four areas: W, X, Y, and Z. The autarky consumer surplus we identified in Figure 8-5 corresponds to W, and the autarky producer surplus corresponds to the sum of X and Y. The fall in the domestic price to the world price leads to an increase in consumer surplus; it increases by X and Z, so consumer surplus now equals the sum of W, X, and Z. At the same time, producers lose X in surplus, so producer surplus now equals only Y.

The table in Figure 8-7 summarizes the changes in consumer and producer surplus when the phone market is opened to imports. Consumers gain surplus equal to the areas X + Z. Producers lose surplus equal to X. So the sum of producer and consumer surplus—the total surplus generated in the phone market—increases by Z. As a result of trade, consumers gain and producers lose, but the gain to consumers exceeds the loss to producers. This is an important result. We have just shown that opening up a market to imports leads to a net gain in total surplus, which is what we should have expected given the proposition that there are gains from international trade.

However, we have also learned that although the country as a whole gains, some groups—in this case, domestic producers of phones—lose as a result of international trade. As we’ll see shortly, the fact that international trade typically creates losers as well as winners is crucial for understanding the politics of trade policy.

We turn next to the case in which a country exports a good.