Problem I. Demand and supply curves for two large countries are given by figure 1. Answer the following questions.
1. Consider the autarky situation.
(a) Calculate CS, PS, GS, and TS for both countries. (3 points)
2. Now, suppose countries open to trade.
(a) Which country imports and which exports? (0.5 point)
(b) Derive import demand for importer and export supply for exporter. You can either draw both curves with appropriate labeling and placing numbers or write equations. (2 points)
(c) Find the new equili
ium price, trade quantity, and consumption as well as production in each country. (2 points)
(d) Calculate CS, PS, GS, and TS in both countries. Which country gains? How big are the gains? (4 points)
3. Now, suppose the importing country government wants to protect domestic producers. To do so, it imposes specific import tariff equal to $2 per physical unit of the imported good.
(a) Find the new equili
ium prices, trade quantity, and consumption as well as production in each country. (2.5 points)
(b) Calculate CS, PS, GS, and TS for each country. How big are the gains/losses for each country relative to free trade? How does the world's total welfare change? (5 points)
4. Now, consider a case where the importer does not impose any tariff but the exporting country enforces specific export tax equal to $2 per physical unit of the exported good.
(a) Find the new equili
ium prices, trade quantity, and consumption as well as production in each country. (2.5 points)
(b) Calculate CS, PS, GS, and TS for each country. How big are the gains/losses for each country relative to free trade? How does the world's total welfare change? (5 points)
5. Now suppose the case with both import tariff and export tax each equal to $2 per physical unit.
(a) Find the new equili
ium prices, trade quantity, and consumption as well as production in each country. (2.5 points)
(b) Calculate CS, PS, GS, and TS for each country. How big are the gains/losses for each country relative to free trade? How does the world's total welfare change? (5 points)
6. Now consider the game where each country has two actions: protection or free trade. Given the wel-fare outcomes you derived above and assuming that each government wants to maximize total surplus in its country, find the Nash equili
ium of this game. Make sure you clearly draw the two by two game first with proper outcome numbers from your calculations above. What policy lesson do we get from this practice? (4 points)