Question

Assume only two countries in the world, A and B which are producing widgets subject to external economies of scale. In autarky, the cost per widget is higher in country A. Explain what happens to the output and price of widgets in country A when it opens to trade.

Answer 1

When country A opens to foreign trade, it will import widgets from country B which can produce them at a lower cost. These widegets from country B are cheaper as compared to the ones domesticallt produced by country A. As a result, the following points can be noted -

• The net domestic demand for widgets will increase.
• The net price of the widgets in the domestic market will reduce
• The net production of widgets within country A will reduce
• The difference between the domestic production and the domestic consumption demand for widgets will be imported from country B