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

Answer :-

The effect of growth on the welfare of X.

considering three countries : X, Y and Z

Consider two goods : A and B

X and Y export A and Import B .

Since X and Y import B, any impact on ones import impacts the other. Now since the import in country Y increases , the entire demand curve for product B shifts that is the demand for product B increase overall.

Price » Shift in shift in demand - cusue yoriginal desired Cusve → Quantity

As shown in the graph the demand curve shifts for product B , and thus for the same price quantity demand is more, thus the price of product B increases.

Now for country X , the price of product B increases thus the import bill increases and hence the overall fiscal deficit and current account deficit of the country increases. Plus the increase in price leads to higher inflation thus overall the higher demand in country Y has bad impact on the economy of country X.