Question

(a)  Using the neoclassical production-possibilities frontier/indifference curve approach, build the case that free trade is preferable to autarky for a country.  Then explain how an economist could still say that trade can be beneficial to the country even if trade causes the community indifference curve map to change such that the country appears to lose welfare on the basis of the original autarky income distribution.

(b)  It has often been pointed out in this course that, within a country, a movement to freer trade, while helping some people, can hurt other people.  Thinking over various parts of this course, indicate two groups of people within a country who can have their well-being reduced because of the opening of the country to trade and very briefly explain why their welfare can be reduced.  

Answer 1

A. Autarchy is the situation of no trade.

We take two goods, wine and cloth.

If we see at this diagram, the x axis measures wine and y axis measures cloth.

AB is the production possibilities frontier.

PP is the price line and it intersects the PPF at point E where we see Indifference curve 2.

This point E is the autarchy trade level. At this point OM quantity of cloth and ON quantity of wine is produced.

Now if the nation opens up international trade the price line shifts to AA and we see the nation can domestically produce OM1 cloth and ON1 wine. Domestically more output is produced of wine in which the nation is more efficient.

We obtain the equilibrium at D where the nation exports N1N2 of wine and consumes ON2.

On the other hand, the nation imports M1M2 level of cloth and consumes OM2.

Thus the nation now obtains more of both wine and cloth through international trade.

We also see that at point D, the nation is at a higher indifference curve IC3. This means that trade leads to higher satisfaction for the country than the autarchy point E.

Thus economists say that international is more beneficial for a nation.

B. The group's which can see a negative impact of international trade are -

1. The producers who lose their jobs because the good they produced is available at a cheaper rate in the international market and this drives them out of competition and results in job loss.

2. International trade may lead to greater income inequality as producers in order to compete and reduce the cost of production cut the wages of the workers leading to a reduction in the wage and increase in the inequality of income.