WELFARE IMPLICATIONS OF EQUILIBRIUM SUPPLY-AND-DEMAND CURVES IN AN OPEN-ECONOMY

Line integral theory is used to prove that in a closed economy the net domestic social welfare effects of a market distortion can be captured in the distorted market alone by using equilibrium supply and demand curves. Considerable confusion exists in the applied literature about the proper application of this proposition. It is shown that the proposition does not generally hold for open economies. It is shown that in general neither geometric areas behind equilibrium supply curves nor geometric areas behind equilibrium demand curves have any welfare significance.