# New Trade Theory

2.

New Trade Theory. Consider the Krugman model whose equilibrium could be described by the intersection of PP (pricing rule) and ZZ (zero profit condition) schedules. How would the closed-economy equilibrium change if fixed costs were larger? Use the graph with PP and ZZ schedules, and explain how in the new equilibrium, consumption per capita of a product, supply quantity of a product, price of a product relative to wage, and number of product varieties change. Provide intuition for your results. 3. Again, consider the Krugman model. Suppose two identical countries that were in autarky (initial equilibrium) move to free trade (new equilibrium). Use the graph with PP and ZZ schedules, and explain how in the new equilibrium compared to the initial equilibrium, consumption per capita of a product, supply quantity of a product, price of a product relative to wage, and number of product varieties available to consumers change. Provide intuition for your results.

# New Trade Theory

Tariff Analysis

4. a) Home’s demand and supply curves for sugar are

,

What would the price of sugar be in the absence of trade in Home? Derive Home’s import demand schedule.

b) Now add Foreign whose demand and supply curves are:

,

Derive Foreign’s export supply schedule, and find the price of sugar that would prevail in Foreign in the absence of trade.

c) Now allow Home and Foreign to trade with each other at zero trade costs. Find the equilibrium price and volume of trade under free trade.

d) Home imposes a specific tariff of 0.5 on sugar imports. Determine the effects of the tariff on the following: (i) price of sugar in each country, (ii) quantity of sugar supplied and demanded in in each country, and (iii) volume of trade.

e) Determine the effect of the tariff on (i) Home’s consumer surplus, (ii) Home’s producer surplus, and (iii) Home’s government revenues. Show graphically and calculate the total effect of the tariff on Home’s welfare.