Models are essential tools of scientific analysis. They are important to economics as they are to meteorologists or aeronautical engineers or any other social sciences.  Models are simplified views of reality. At their best, models explain relationships among variables and allow economists to project the impact of specific economic policies and concepts on an industry or a whole nation. At a minimum, models provide a framework allowing an individual to analyze and connect seemingly unrelated events and to grasp the logic behind a series of economic developments. Without a model, one is forced to take an ad hoc view of events and is often completely powerless to relate developments in one area to events in another. Microeconomic models, then, are the starting point for any economic analysis and one needs to spend time understanding how they work and how to use them.  They are extremely useful for analyzing the microeconomics of trade and investment; that is, how trade and investment affects individual markets and industries, your company, and your product. On the other hand, macroeconomic models are developed to study the effects of international trade and direct investment on the total economy. These two models are to the economist what the hammer and saw are to the carpenter’s basic equipment. They are the tools required for understanding dynamic fields, such as tariffs, quotas, international organizations, anatomy of the corporation, candidate product, candidate markets, cultural model, methods of entry and entry strategies, finance, foreign exchange market , and currency fluctuations just to mention few.
A briefly review the basics of market supply and demand are necessary in order to be able to concentrate on three issues: How international trade affects the quantity of goods domestic industries produce and the price they receive for their output. The impact of international trade on wages, employment opportunities, and returns on invested capital. Macro or economy wide economic developments which may benefit or harm an industry when a country begins to trade.

Market Supply and Demand
The microeconomics of international trade can be analyzed employing market supply and demand schedules and curves. Microeconomics, is the study of economic phenomena as they affect individual markets and, therefore, individuals, households, and industries and firms.
A demand curve is a graphical representation of a demand schedule. A demand schedule shows the quantity of a good demanded at various prices and illustrates that as the price of a commodity drops more of it will be purchased. This means that a demand curve will slope down from left to right, also illustrating the principle that at a lower price some individuals acquire more of the good and others are induced to buy it for the first time.
The equilibrium clearing market price is established when the quantity demanded equals the quantity supplied, or at the price and quantity where the demand and supply curves intersect. The price, however, will be the equilibrium price only if other things remain equal. An increase in demand due to an increase in income, for example, will shift the demand curve to the right and raise the equilibrium price and the equilibrium quantity.
On the supply side, an increase in labor productivity, for example, will shift the supply curve to the right. This means that more units of the commodity will be supplied at all prices. Given the shift in the supply curve, the economy will move down its demand curve until the quantity supplied equals the quantity demanded.
A supply schedule shows the quantity that will be supplied at various prices providing everything else is held constant. When graphed, a supply schedule becomes a supply curve. The supply curve is positive slope indicates that a greater quantity of a good or service will be offered for sale as its price rises. The standard explanation of the upward slope of the supply curve emphasizes rising unit costs of production, that is, it costs more to produce the second unit of output than the first, more to produce the third than the second, and so on.
Why do unit costs of production rise as output expands? In order to produce greater output, the industry will have to hire more labor, purchase additional raw materials, and utilize ever more capital equipment. If the industry is small compared with the total economy, it can purchase an unlimited supply of raw materials and labor at a steady price. Whether it purchases a large or small quantity of labor, one small industry's actions will not dramatically impact the overall wage rate. If the wage rate is $10, a small industry can hire as much labor as it desires at this rate.
On the other hand, if an industry needs to purchase large quantities of specific raw materials that are in relatively short supply or are not available in the market in order to expand production, it may have to pay a higher price or go to foreign markets to obtain them. This demand for specialized inputs can be true for labor as well. Some occupations are specialized and require extended training so that it is impossible for an untrained individual to enter the specialized labor market on short notice; a plumber cannot become a doctor on short notice nor, for that matter, can a doctor become a plumber in the short run. Therefore, when an industry needs to hire specialized labor, it usually has to offer such labor a higher wage (increasing opportunity costs and production possibilities) in order to obtain its services. But if we can assume that labor is homogeneous, then we can also assume that an industry is able to hire an unlimited quantity of labor at a given wage rate.
Capital equipment, unlike unskilled labor, is not homogeneous and cannot be shunted from one industry to another. Delivery vans, trucks, and computers can be transferred from one industry to another with relative ease. But a loom cannot be used for printing a newspaper nor can a printing press be employed to weave cloth. Because a significant proportion of the existing capital stock cannot move between industries in the short run, we can assume for purposes of discussion that capital equipment is immobile.
Given these assumptions plus the assumption that raw materials are relatively unimportant in the production process, the supply curve has a positive slope.
Suppose the demand for wheat increases, raising its price, and that the typical firm attempts to capitalize on the higher demand by expanding its output. As the firm hires additional labor, output increases but at a decreasing rate, or the law of diminishing returns holds. With the quantity of capital fixed, the quantity of capital per worker decreases as additional workers are hired. Because each worker combines with less capital, labor productivity, or output per laborer, falls as more are hired. Given a constant wage rate, total wages increase by a set amount as each additional worker is hired. Output, however, increases at a decreasing rate and this means that labor costs per unit of output increase as a greater quantity is produced. Higher labor costs per unit of output explains the supply curve’s positive slope.
If we assume that there are several firms in the wheat industry, all with similar supply schedules, the supply of wheat then the demand for wheat the quantity of wheat offered for sale equals the quantity of wheat demanded, thus, the equilibrium price in the wheat market.

Shifts of Supply and Demand:
A demand curve shows the quantity demanded at various prices providing everything else is constant. Economic conditions, however, seldom remain constant and, as they change, supply and demand curves can shift either to the left or to the right.
First consider demand. If incomes rise, people will demand more of a whole multitude of products at every price. For example, given a hefty boost in their income or decrease in taxes, individuals will demand more travel. Therefore, the demand curve for travel services will shift to the right. If the price of a substitute good goes up, people will demand more of a particular product at all prices. The best known illustration of such substitution relates the price of Coca-Cola and the demand for Pepsi-Cola. If the price of Coca-Cola rises, the demand curve for Pepsi-Cola will shift to the right. In addition to a rise in income or an increase in the price of a substitute commodity, a change in tastes will cause a demand curve to shift. The development of DVD’s caused the demand curve for video cassettes to shift to the left. In conclusion, any development that increases the demand for a given commodity at all prices shifts the demand curve to the right. Such a shift means that individuals will purchase more of the commodity at every price even though they will still buy less of it at high prices compared with low prices.
Supply curves also shift to the left or to the right for various reasons. If more firms enter a particular industry, the market or industry supply curve will shift to the right Even if the number of firms remains constant, but each firm increases its capital stock or the size of its plant and equipment, the industry supply curve will shift to the right. For example, an increase in the amount of capital per worker will raise labor productivity and boost output per worker. As a result, the supply curves shifts to the right. In turn, assuming the wage rate is constant, the greater productivity will reduce labor costs per unit of output. A technological breakthrough will also shift the supply curve to the right. The supply curve can also shift to the left. An increase in the price of inputs, for example a higher wage rate, will raise labor costs per unit of output and shift the supply curve to the left.

Measuring the Impact of Changes in Price Elasticity
It is important to know why supply curves and demand curves shift. But it is equally important to know how much a change in price will affect the quantity demanded and the quantity supplied. Suppose the supply curve shifts to the right As a result, the price drops and the economy moves down along the demand curve to a new equilibrium price and quantity. How much the price drops and how much the quantity demanded increase is the concept of elasticity Since the slope of the demand curve tells us how much the quantity demanded increases following a decrease in the price, if we measure the slope, we should have the answer. Prices are measured in different units of money, such as nickels, dimes, and dollars, while quantities are computed in bolts of cloth, tons of steel, bushels of wheat, and other units of measurement. There is no way of easily way of comparing the effect of  decline in price on the demand for steel with its impact on the demand for bananas. Although measuring the slope is a good place to start, it is not in itself sufficient to make a comparison easy.
This difficulty is a major reason why economists employ a measure called price elasticity to calculate the effect of a change in the price on the quantity demanded or supplied. Expressed formally, the price elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in price, or:
ED = % ?Q/% ? P
Where, ED equals the price elasticity of demand. If the quantity demanded rises by 5 per cent following a 1 percent decrease in the price, the price elasticity of demand equals -5. (The negative sign of the price elasticity of demand reflects the inverse relationship between the quantity demanded and the price.) In this case, since the percentage change in quantity demanded exceeds the percentage change in the price and the resulting quotient is greater than 1, measured in absolute terms, it tells us that demand is heavily influenced by price. In such cases, demand is said to be price elastic. If the resulting quotient is less than 1, measured in absolute terms, the quantity demanded is not responsive to changes in price and demand is said to be price inelastic. The price elasticity of supply can be measured in a similar manner. Although it is not strict, one can normally get an indication of the elasticity of the demand curve, and the supply curve, by observing the slope of the curve. If it is flat, it is elastic; if it is steep or vertical, it is inelastic. If it is  one then it is unitary elastic.
A change in price will, providing other things remain constant, lead to a change in the quantity demand. The impact of a change in income on the demand for a commodity is measured by income elasticity, or by the percentage change in the quantity demanded divided by the percentage change in income. The cross-elasticity of demand measures the percentage change in the demand for one good, Pepsi-Cola, relative to the percentage change in the price of another, Coca- Cola. If the cross-elasticity of demand is positive, the goods are substitutes. An increase in the price of Coke increases the demand for Pepsi. If the cross-elasticity of demand is negative, the goods are complements, a decrease in the price of ski holiday packages, for example, will increase the demand for ski equipment.  It is important to know how to compute elasticity, but it is more crucial to grasp how elasticity can be employed as a tool in economic analysis. The success or failure of an economic policy often turns on the question of how responsive the quantity supplied and demanded is to a change in price. For example, when the Federal Reserve attempted to talk down the value of the dollar in the 1990s. Elasticity analysis tells us whether policies would be successful if there is a percentage change in the quantity demanded of yens if the price of the dollar in terms of yens decreases or if the elasticity of demand would be grater than one or elastic. Thus the success of the Fed’s policies depends in good measure upon the elasticity of the demand. Why were American officials so anxious to push down the value of the dollar? In their view, yen appreciation would raise the dollar price of Japanese goods in the United States. And when Americans confronted the higher prices, they would purchase fewer Japanese products. In turn, if Americans spent a lower total sum of dollars on Japanese products, the United States trade deficit with Japan, which was running at a yearly rate of approximately $40 billion at that time, would be reduced.
Elasticity analysis tells us that the policy would be successful only if the percentage change in the quantity of Japanese goods bought exceeded the percentage change in the price, or if the elasticity of demand was greater than one or elastic. Thus, the success of the policy depended in good measure upon the elasticity of demand.
The price elasticity of demand varies among products. As one might suspect, basic food- stuffs such as onions and potatoes have low demand elasticities, while the demand for sporting goods is highly elastic.
In the world economy, the study of elasticity centers on individual countries rather than individual commodities. Thus we measure the elasticity of demand for a nation's exports and the nation's elasticity of demand for imports. For example, we may ask: How much will a 5 percent change in price change the volume of a nation's imports, exports, or both? We also ask: Given a 3 percent change in income, how much will imports increase?

Demand, Supply, And International Trade
The basics of market supply and market demand permits us to ask: How are market supply and demand, output and consumption affected a closed economy. When an economy begins to trade, the domestic price must be compared with world or international price since producers can now sell their products in either the domestic or world market and consumers can purchase either domestically produced or foreign-produced commodities. If both the domestic price and the world price are equal, the nation, or more accurately its industries and firms, will neither export nor import the good and, it is assumed, consumers will only purchase domestically produced goods. However, if world and domestic prices are different, trade will take place.
The world price is drawn as a horizontal line because it is assumed that the nation is a small country, at least from the economic if not the geographic or physical point of view. Its consumption and production of a commodity is such a small proportion of the world's total consumption and production that regardless of the amount of a commodity it consumes or produces, the world price of the commodity will not be affected. As a result, the world's elasticity of demand and supply of the commodity under consideration is infinite from the nation's point of view. Given these assumptions plus the assumption that the country is an efficient producer of the commodity, the world price line is also the world's demand curve for the commodity from the nation's point of view.
Because the nation is an efficient producer of this commodity, the domestic price of commodity is below the world price prior to trade. When trade begins, foreigners purchase domestic units of the commodity because of its low price and, in the process, drive the domestic price up to the assumed world price. Domestic firms pickup production.. Domestic consumers, confronted with the higher price, reduce their consumption of the commodity, and the excess of production over domestic consumption is exported. Because exports lead to greater production and presumably higher profits, the producers of the commodity will champion international trade. Consumers, by contrast, will not be pleased with the results of higher prices brought about by international trade. Let us assume that our country is a large producer  of the commodity under consideration and the quantity of it  that our nation supplies influences the world price; then the world price will decline as the nation produces more of the commodity.
In such a case, the world demand schedule, will have a negative slope, although presumably it will be flatter, more elastic, than the domestic demand schedule. Given the same initial world price or intercept as in the small country case, the nation will end up producing and exporting less at a lower price. However, except in rare cases, trade still pays for the nation's wheat producers. They will produce more of the commodity and sell it at a higher price given trade than they would in a non- trade situation. By the same token, the nation's producers of other commodities will still be hurt by trade but not by as much as in the initial case when the world supply curve is infinitely elastic. Because domestic production falls, profits decline in the domestic industry of other commodity. Trade brings good news to consumers of other commodities, but bad news to the domestic producers of other commodities.
When viewed in this light, the end results of international trade, its benefits relative to its costs, appear indeterminate. For consumers, the price of other commodities has dropped while the price of the commodity under consideration has increased. Some firms and their owners are better off, while others suffer. The model explains why certain industries are pro-trade while others are antitrade. For example, this analysis shows why the American aircraft industry favors trade while the U .S. textile industry, for the most part, opposes it.

Trade and Economic Welfare
International trade can actually increase a country's economic welfare. The impact of trade on consumer surplus and producer surplus tells us why. Consumer surplus is the amount an individual is willing to pay for a good minus the amount she actually pays for it. Consider the demand for wheat and assume for the moment that there is only consumer. Assume she would be wining to pay $11 for her first unit of wheat consumed, $10 for the second unit of wheat consumed and so on. The idea is that each additional unit of wheat gives her less utility or satisfaction than the previous unit (law of diminishing marginal utility). She is, therefore, willing to pay more for the first unit of wheat than the second, more for the second than the third, and so forth.
How many units of wheat she purchases depends on the market price. If the market price is, for example, $6 per unit, she will purchase 6 units of wheat and receive a surplus of $15. The first unit of wheat was worth $11 to her but she only had to pay $6 for it. Clearly she is $5 ahead on the first unit of wheat and just as clearly she is $4 ahead on the second unit of wheat. And she also obtains a surplus on the third, fourth and fifth units of wheat she purchases. She does not, however, receive a surplus on the sixth unit of wheat since she pays $6 for it or exactly what it is worth to her. But it is clear that the greater her consumer surplus the better off she is.
Producer surplus equals the amount of money a producer receives for selling a product minus the sum needed to induce him to produce it. Suppose there is only one wheat producer and he needs to be paid $1 to produce one unit of wheat, $2 to produce a second unit, and $3 to produce a third, and so on. He must be paid higher amounts to produce each additional unit of wheat since the more time he spends producing wheat, the less time he has to do other things. If demand meets supply at a price of, for example,  $6 and six units of wheat, the producer surplus win equal $15. The wheat producer receives $6 for the first unit of wheat he produced since an units of wheat sell for $6, even though he would have produced that unit of wheat for $1. He therefore, receives a $5 surplus on this unit of wheat. On the second unit, he receives a surplus of $4 and, therefore, he collects a total surplus of $15 in this example.
By increasing consumer and producer surplus, international trade expands national economic welfare, trade raises the price of a commodity  and reduces the price of another and affects consumer, and producer surplus in both markets.

Trade and Income Distribution
Consumers and producers as a whole may gain, but the expansion of the production of one commodity, for example autos, and the decrease in another, for example, textile production. This means that auto producers gain from trade while textile producers lose. This puts a different light on the situation. Yet it is quite likely that these gains and losses will be temporary. Over the longer term, higher profits in the auto sector should induce resources to migrate from the declining and less profitable textile sector to the expanding and more profitable auto sector. Due to this migration, the auto supply curve will shift to the right and the textile supply curve to the left. As a result, both exports and imports will expand. But what is more significant is that the expansion and contraction in the industries will tend to level profit rates between them. That means that although there will almost always be short-run transitory costs and benefits when an economy begins to trade, there may be no long- run or permanent trade adjustment costs or benefits.
Remember that it takes time for resources to move from one industry to another. In the short run, wages may decline or workers may be let go in the textile industry while workers may receive higher compensation in the auto industry as they work additional hours at overtime wage rates. As a result, there will be transitory adjustment costs and transitory benefits when trade begins.
It is normally assumed that any and all transitory costs and benefits vanish over the intermediate to long run as workers move from one industry to another. Because of this assumption, workers, whether in the auto or textile industry, will not obtain permanent benefits nor suffer permanent adjustment costs as a result of trade. But what if all labor is not alike and the supply curves for particular types of labor are not infinitely elastic like they are in the domestic market? In such cases, transitory costs and benefits are certain and it is possible that there will be permanent or extended adjustment costs and benefits as well. For example, the auto industry employs skilled labor while the textile industry employs unskilled labor.
Even if both auto and textiles can be produced by utilizing various combinations of skilled and unskilled labor, it is assumed that the ratio of skilled to unskilled workers employed in production of cars is always higher than the proportion of skilled to unskilled labor employed in the textile industry regardless of the wage rate paid to skilled compared to unskilled workers.
The presence of transitory and permanent costs is one reason why some groups oppose trade. Even though international trade should raise national income, this will not count for much in the view of those individuals who must bear the transitory and permanent costs associated with trade.
International trade benefits some owners of capital and harms others. However, unlike the case of labor, losses will be limited in most instances. A loss will last only as long as the capital equipment (such as the molding machines and looms) in existence when trade beginnings is still in use or still has the potential to be used.

Gains and loses from trade: NAFTA
The possible gains and losses associated with international trade are vital. In 1994, Canada, Mexico, and the United States formed a free-trade area called NAFTA (North American Free Trade Agreement). Its supporters admit that certain American industries will be hurt as U.S. trade barriers, especially those with Mexico, are either eliminated or substantially reduced. Apparel, furniture, glassware, shoe manufacturing industries, and other low-tech industries will be affected adversely by NAFTA. In addition, despite last minute maneuvering, citrus producers and vegetable farmers most likely suffer because of the agreement.
There is, of course, another side to NAFTA;: the opening up of the Mexican market to U.S. industries.  As American companies invest in Mexico, purchasing power is created which in return Mexicans use to purchase US goods and services. American automobile, computer, and telecommunication equipment sales to Mexico have increased, as has been sales of other high-tech products. In addition, NAFTA is a bonanza to the U.S. agricultural products such as wheat and the American financial services industry. On balance, the majority of economists believe that NAFTA is a plus rather than a minus for the American economy.
The emphasis on the costs associated with trade tends to obscure the benefits. Benefits have not received nearly as much attention as the costs side. If a nation reduces trade, there will be temporary and very likely permanent adjustment costs. Nor should it be forgotten that if trade raises national income, it is at least possible to compensate an individual so that she does not suffer a permanent loss in income. By contrast, if trade restrictions reduce income, it will be impossible to compensate groups for either the transitory or permanent losses they incur.

Macroeconomics: Market Supply and Demand, and International Trade
The macroeconomics or total economy has been ignored, an omission that appears perfectly justifiable at first glance. Macroeconomics, after all, talks about the general average price level, the general wage rate, and the total level of output. And so far we have argued that trade takes place because the relative prices of domestically produced commodities differ from world prices. In other words differences in relative prices, not differences in general price levels. Therefore, the inclusion of macroeconomic considerations assumes that macroeconomic stability exists and this  runs against the traditional  analysis that a closed economy in microeconomics. That approach is not warranted in the case of an open economy. In the open economy, international and domestic macroeconomic developments impact individual national markets for better and for worse.
For example, if a closed economy undergoes a bout of inflation, it is often assumed that all prices in all sectors of the economy rise by the same degree so that nothing much happens in one individual market compared to others. An increase in the price level will lead to an increase in wages so that, in the end, price and wages have in creased by, say, 10 percent across the board. But the higher wages permit workers to consume the same number of real goods as they did prior to the rise in the general price level. Thus, the demand curves for commodities shift to the right. It turns out that the physical production and consumption of both commodities is exactly the same both prior to and after the inflation.
But in an open economy, inflation raises all domestic prices relative to world prices, a step that reduces the nation's international competitiveness and hurts its ability to compete in world markets.
Source: Walther, Ted; "The World Economy"; Wiley, 1999.