Question

Question (2)

Consider a country that imports a good from abroad. For each of following statements, say whether it is true or false. Explain your answer.

1. “The greater the elasticity of demand, the greater the gains from trade.”
2. “If demand is perfectly inelastic, there are no gains from trade.”
3. “If demand is perfectly inelastic, consumers do not benefit from trade.”

Answer 1

a) True, The greater the elasticity of demand, the greater the gains from trade. Because we know higher elasticity of demand means Ed > 1 and we know Ed = %change in quantity / %change in price. It means that percentage change in demand is always greater than percentage change in price, because Ed > 1. For example if the price is reduce by 10% than the quantity demand is increase by more than 10 %. Hence we can say that we can gain from trade by reducing less percentage of price and increasing more percentage of quantity demanded.

b) False, there is gain from trade because we know that in perfectly inelastic demand, the demand curve is vertical and parllel to y-axis. The vertical demand curve show that whether price increase or decrease the quantity remain same. If the price of product is reduces it means consumer surplus increase and producer surplus decrease. Hence it show that there is gain from trade.

c) False, The consumer get benefit from trade when demand is perfectly inelastic. Because it is true that quantity demanded is not increase when price falls but consumer surplus increases because consumer pay less price. So when consumer surplus increase consumer get benefit from trade.