Question

Suppose that the assumptions of the Standard Trade Model apply. Consider three countries: X, Y and Z. Consider two goods: A and B. X and Y export A and import B. Z exports B and imports A. Moreover, suppose that country Y (which is a large country) experiences economic growth in its import sector.

Explain in detail, using any relevant diagrams, what is the effect of this growth on the welfare of X

Answer 1

Ricardian, specific factors and the Hecksher-Ohlin models as special cases. In the question it is given that there are three countries- X, Y and Z. Y is a large country experiencing economic growth and its imports sector. There are two commodities A and B. The trade among X, Y and Z happen as in the following table:

Country	Good A	Good B
X	Export	Import
Y	Export	Import
Z	Import	Export

Suppose good A be food and the good B be cloth. Country x and set, we will considered together as foreign countries and Y as the home country. The equilibrium coma relative price trade and associated trade flows of the home country is given in the following diagram:

Cuados Quantity of Food

In the diagram, axis shows the quantity of food and y axis shows the quantity of cloth. Black line VV1 is indifference curve and Red line is the production possibility curve PP.E is point of equilibrium. Country Y is producing QF quantity of food where it requires only the quantity for its consumption. So the remaining food DFQF the country will export country Y is producing

Country Y is producing to QC quantity of cloth but its demand is is DC quantity, so the additional quantity required for the country Y will be imported from outside.

What is given in the question that other country Y is experiencing economic growth and import sector. The immediate impact of this will be on the PPC of the country. PPC will shift outward as shown in the following diagram-

Quantity of cloth. SHIFT IN PPC QF OF, Quantity of food

This leads to productivity improvement of factor accumulation in the country, It will further lead to economic growth.

The terms of trade is the difference between value of export and import. When the country export food and relative price of food increases, the country benefit from terms of trade. A higher relative price for export means that the country can afford to buy more imports. An increase in the terms of trade increases a country's welfare. On the other hand Country X can be a less competent country as compared with country Y. Country Y will be producing more quantity of Good B in better quality, hence pooling a relative advantage over price.

Since, being a large country, even there will be an improvement in the home country(Y) 's terms of trade, I will be deteriorating terms of trade in the rest of the world that is in countries X and Z. Now there is a possibility increased foreign investment from rest of the world in county Y.