Question

Explain, noting in your answer which trade theory applies, what would happen to aggregate welfare in Ethiopia, and to the returns (payments) to land, labor and capital as the country moves from the initial to the final situation.

Answer 1

Opening of the economy to free trade leads to increase in overall aggregate welfare in Ethiopia as economy moves from a lower point on the production possibility curve to a higher point on the new PPC. This increases aggregate welfare in Ethiopia. As per the returns are concerned, the returns of the factor used intensively in the production of the export commodity will increase and returns of other factors of production declines. However, overall welfare increases in the economy.