Suppose there are three countries, A, B and C, in the world and A imports automobiles from either a small country B or a large country C. Assume that the free-trade prices of automobiles from countries B and C are PB=$20,000 and PC=$16,000, respectively, and country A initially imposes a 20% tariff on both B and C. Now A is considering forming an FTA with either B or C. (a) Which one of these FTAs would lead to trade diversion? (b) Use a graph of import demand and export supply curves to show the impact of this FTA on country A’s welfare. (c) What would be country A’s net welfare change if country A formed instead an FTA that leads to trade creation? (d) Suppose country B may become more efficient after forming an FTA with country A and thus may be able to lower its price. What is the price cut required such that the FTA between A and B and the FTA between A and C would generate the same welfare gain for country A?
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Q5: Suppose there are three countries, A, B and C, in the world and A imports automobiles from either a small country B or a large country C. Assume that the free-trade prices of automobiles from countries B and C are PB=$20,000 and PC=$16,000, respectively, and country A initially imposes a 20% tariff on both B and C. Now A is considering forming an FTA with either B or C.
(a) Which one of these FTAs would lead to trade diversion?
(b) Use a graph of import demand and export supply
(c) What would be country A’s net welfare change if country A formed instead an FTA that leads to trade creation?
(d) Suppose country B may become more efficient after forming an FTA with country A and thus may be able to lower its
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