Question

Summarize an international Trade Model and utilize it to show the changes in production and gains from trade after a country begins to trade; and to predict the impacts on different factors of production of trade-opening.

Answer 1

Consider two economies A and B which are strictly non trading economy. They never trade with each other, whatever they produce, they consume in their respective economy. As they do not trade with each other the prices in each economy of products are high because lets assume A is productive in producing cars and B in bikes. Initially they do not trade and the prices in country A of bikes are high and prices in country B of cars are high. Consumer surplus and producer surplus is given below of the markets.

Now assume a case where A and B have started trading. Country B exports bikes to country A and Country A exports cars to country B. It results in reduction of prices in cars and bike sin both the countries which results in increasing consumer surplus and decreasing producer surplus for both countries.

Increased consumer surplus is area of ADBE and decreased producer surplus is area of ABCD. ADBE > ABCD, so overall the economic conditions improve and resources are well utilized.

The factor of production which helps in production of goods are available cheaper that previous rates, because once the economy starts trading they use factor of production from that country where it is available at cheaper rates or that economy which have comparative advantage of that specific product.