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There are two countries in the world: A large country and a small country. They both...

There are two countries in the world: A large country and a small country. They both produce computers subject to external economies of scale. The price per computer is smaller in the smaller country in autarky.

Answer the following questions:

a) What happens to the output and price of computers in the smaller country when it opens to trade?

b) Is it possible a country can be worse off if it engages in trade in the presence of economies of scale? Explain.

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Answer #1

a) If the price is lesser in smaller country than large country and they open their gates to trade, consumers from large country will start buying computers from small country (import) because price of computer is less there. It will rise in aggregate demand of computers for small country which cause price to rise from P to P1 and output sold from Y to Y1 of computers in small country.

b)  If trade is dependent upon external economies of scale, factor outside the economy will impact the opeartions. Rise in demand from large country for smaller country will hurt consumers of small country because they have to pay higher price for the same computer and reduce total surplus.

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