Chapter 2

The Gains from Trade

Suggested Answers to Textbook Questions

1. (a) The endowment in Figure

2.5 shifts towards the vertical axis by 10 percent. The country can then

trade along a line parallel to CED (as the world prices have not changed). This should lead to the result that both imports and exports decline (i.e., the trade triangle will be smaller).

(b) An analysis similar to the one above should reveal that both imports and exports decrease.

2. This situation will not lead to a lack of trade. It will be analogous to the endowment being at point G

in Figure 2.5.

3. (a) tastes similar across countries, transformation schedules differ

E represents the home endowment, and E' the foreign endowment. The countries share common

tastes, represented by the common indifference curve, labeled y' y'. The autarky price ratios for

the home and foreign country are given by AEB and A'E'B' respectively. The countries can trade at world prices represented by the dotted line CEFE'D. Along this line in the region EFE' both

countries will gain from trade. The home country will be importing clothing and exporting food.

(b) transformation curves are the same across countries, tastes differ

4. (a) Consider that consumption of a given good is equal to production minus exports. In autarky,

exports are zero, and thus production equals consumption. If a good is exported with trade and

production cannot change, then there must be less available for domestic consumption.

(b) Consumption is production minus exports. If production rises more than exports as a result of

trade, then consumption must rise also.

(c) see figure 2.7