THE WINNERS AND LOSERS FROM TRADE

To analyze the welfare effects of free trade, the Isolandian economists begin with the assumption that Isoland is a small economy compared to the rest of the world so that its actions have little effect on world markets. The small-economy assumption has a specific implication for analyzing the steel market If Isoland is a small economy, then the change in Isolands trade policy will not affect the world price of steel. The Isolandians are said to be price takers in the world economy. That is, they take the world price of steel as given. They can sell steel at this price and be exporters or buy steel at this price and be importers The small-economy assumption is not necessary to analyze the gains and losses from international trade But the Isolandian economists know from experience (and from reading Chapter 2 of this book) that making simplifying assumptions is a key part of building a useful economic model. The assumption that lsoland is a small economy greatly simplifies the analysis and the basic lessons do not change in the more complicated case of a large economy.