Key Diagrams - Gains from Trade - Impact of Innovation from Domestic Supply

Domestic suppliers faced with competition from low-price imports might be able to innovate and find cost-reductions that allow them to compete profitably. This video offers an explanation.

Trade can lead to an increase in consumer surplus but producer surplus for domestic steel producers can fall. This assumes that their supply costs remain unchanged. Often a dynamic effect of trade is to drive cost-reducing innovations. We walk through this in the video.

If domestic producers are able to lower their own supply costs when faced with low-cost import competition, then they will be better able to compete at price P2.

As we will see, their production can rise to Q4 and this increases their producer surplus.

This is an excellent “developed diagram” to use because it allows you to evaluate some of the effects of international trade. Trade helps to make markets more contestable and domestic producers have an incentive to raise productivity and find other efficiencies to remain competitive & profitable in the long run.