Application of the Second Image of Trade

Application of the Second Image of Trade

Suppose that Toyota has increased its production capacity for automobiles in Japan. How does this affect international trade between the US and Japan? The graph below provides analysis.

Toyota's investment in Japanese production increases the supply curve for autos in Japan and therefore also increases the X curve for autos by increasing the supply of Japan's autos available for export to the US. This shift in the X curve creates a surplus of autos on the international market, which drives down the world market price from P/w to P/w' in the graph.

A variety of adjustments take place as the world market price falls. First, consumers in both countries are encouraged (by the lower price) to purchase more autos in (increases in the Qd in both countries due to the lower price). There are also affects on the Qs in both countries. In the U.S. the lower price is an incentive for domestic firms to reduce auto production (a decrease in the Qs is movement along the supply curve). The same thing happens in Japan. Although Toyota has increased production (shift in the S curve), other Japan firms are encouraged by the falling price to reduce production (movement along the new S curve). So Toyota's increase in production (assuming that it is large enough to have these market effects) both serves to increase the size of the total auto market and discourages other automakers from producing cars because of the falling price.

This is, of course, the same basic conclusion that we made with analysis of the first image, but with additional insights concerning the national as well as international effects of Toyota's strategy. The first image analysis helps us to see the big market forces at work in international trade, while the second image allows us to break down the effects and see how different countries are affected. Which image we use depends in part upon the industry we choose, how important global effects are versus national effects, and what type of question we are trying to answer.