Assume that there are only two countries in the world, Atlantica and Pacifica. Both countries produce...

Assume that there are only two countries in the world, Atlantica and Pacifica. Both countries produce and consume surfboards. The pre-trade equilibrium price of surfboards in Atlantica is $300 and the pre-trade price of surfboards in Pacifica is $400.

a) Draw a three-graph diagram to depict the Pacifica, Atlantica, and international markets for surfboards. Assume that free trade opens up between Pacifica and Atlantica yielding an international price of $375 with 10,000 surfboards being traded. Be sure to label all intercepts, axes and each country’s exports or imports.

b) In terms of the country’s overall welfare, is Atlantica better or worse off after opening to trade? Calculate the dollar value of the net effect of trade for Atlantica.

c) In terms of the country’s overall welfare, is Pacifica better or worse off after opening to trade? Calculate the dollar value of the net effect of trade for Pacifica.

d) Within each country, who benefits and who loses from opening to trade?

Solutions

Expert Solution

a) In the above diagram, we have shown demand and supply conditions for three markets-Pacifica, international market and Atlantica.

If open to free trade, Atlantica will be the exporter and Pacifica will be the importer. Trade price=$375 and quantity of imports=quantity of exports=10,000.

b) Atlantica is better with trade because at higher price, its supply > demand, thereby, it can export.Here, producer's surplus increases and consumer's surplus decreases.Also, net social welfare > 0. Dollar value of the net effect of trade is 50*10,000=$50,000

c) Pacifica is worse with trade because at lower price of $375, its demand>supply, resulting in imports. Thus, producer's surplus decreases more than increase in consumer's surplus. Net social welfare becomes negative.Dollar value of the net effect of trade is - 25*10,000 = -$250,000

d) Within Pacifica, consumption falls but production increases for exports. Within Atlantica, consumption rises due to imports but production falls. On consumption basis Atlantica gets benefited whereas, on production basis, Pacifica gets benefited.

Rahul Sunny answered 1 year ago

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