INTERNATIONAL TRADE

QUESTION AND PROBLEMS:

7. The country of Puglia produces and consumes two products, pasta (P) and togas (T ),
with increasing marginal opportunity costs of producing more of either product. With no
international trade the relative price of pasta is 4 T/P.
a) Show Puglia’s economy, using a graph with a production-possibility curve and
community indifference curves.
b) Puglia now opens to international trade. With free trade the world relative price of
pasta is 3 T/P. Which product will Puglia export? Which product will it import? On
the same graph that you used for part a, show the free-trade equilibrium for Puglia.

c) Use your graph to explain whether or not Puglia gains from free trade.
 10. In your answer to this question, use a diagram like Figure 4.3 and start from a no-
trade point like S0 with a no-trade price ratio of 2 W/C. Now trade is opened and the country
can trade whatever it wants at an international price ratio of 1 W/C. (In your answers, you
will need to picture additional community indifference curves that exist but are not shown
explicitly in Figure 4.3.)
a) Show that the country can gain from trade even if the country does not change its
production point. (Production stays at point S0.) (Hint: The price line with slope
of 1 will go through point S0 but will not be tangent to the production-possibility
curve.)
b) Show that the country can gain even more from trade if it also adjusts the
production point to its optimal position (given the price ratio of 1).
c) What happens to the volume of trade as the country’s position shifts from that
shown in part a to that shown in part b?