Question

1. Supply and Demand Illustration of Trade

In January 2019 the cost of aluminum in US dollars is $0.85. Currently, in the global aluminum market, Australia is an exporting country and Germany is an importing country.

a) Treating Germany as a “small” country, illustrate the German supply and demand for aluminum in the absence of trade.

b) If Germany weren’t trading with the world, would Germany pay $0.85 for aluminum, or a price that is either higher or lower than $0.85? Explain why.

c) Now modify your diagram for Germany to show how the opportunity to trade at a global price of $0.85 affects Germany’s consumer and producer surplus (compared with consumer and producer surplus in the absence of trade).

d) Treating Australia as a “large” country, use supply and demand diagrams for Australia and the Rest of the World (ROW) to show how a recession in Australia, which reduces Australia’s demand for Aluminum, will affect the world price for Aluminum?

Answer 1

a) Consider the following graph that illustrates the Germany's demand and supply of aluminium (given that it's importing country)

Being Germany a small importing country, it would have demand curve and supply curve as presented in above graph., in absence of trade.

b) In absence of trade, Qg is the output of aluminium and Pg is the price. Where price (Pg) in germany is less than world price (0.85) because it is small and importing country. Importing country requires import because it is not able to sell aluminium at equal or lower to world price from domestic supply.

c) Now, if Germany becomes open to trade, it will have new price of aluminium which is ).85. because being a small country it will not influence the world price rather will get affected.

Earleir to trade, consumer surplus in Germany was A and producer surplus was B+E. Now when it start trading, then price changes from Pg to 0.85 and domestic supply is OQ. Import is Q2-Q1. Thus total output is OQ2.

Thus the new CS is A+B+C+D. and new producer surplus of domestic suppliers is E only.

Thus because of trade CS increases and PS decreases.

d) Australia being a large and exporting country will have influence over the owlrd price of aluminium. When because of recession the demand decreases then the demand will shift downward causing a new equilibrium. This new equilibrium will cause a lower price to emerge hence reducing the world price from 0.85.