Question

Please work on the following question, which is meant to trade creation and trade diversion.

2. The following three countries of the world produce and consume digital cameras. The autarky price of digital cameras for the three is given below.

Country                                                       Autarky price of steel

Belgium (small country)                               $12

U.S.                                                                 $2

Germany                                                        $4

Using relevant graphs, compare the outcomes of Belgium forming a Free Trade Area (FTA) with the U.S. versus with Germany. Assume a per unit tariff of $1.

Answer 1

In the given example, first let's understand what is Autarky and Autarky price before proceeding. Autarky is a characteristic of a country which is closed to exports or imports,which is self sufficient on its own for its need. A country which is Autarky is when it closes it's door for external world and relying on localisation and strictly no to globalisation.

Autarky price is the price of a good in a closed economy.

Now to calculate the Autarky relative price of Digital camera:

With respect to US, Autarky price of Belgium/ US = $12/$2 = $6

With respect to Germany, with the same formula, its $3

When Belgium wanted from form a Free trade area (FTA) with US, it has to think of two scenarios, 1) why imports from US is allowed in the FTA, the consumer will buy products more cheaply via imports but the producers in the country will face stiff competition. Hence they should analysis both the countries and find which product is cheap in Belgium but costly in US, so that the terms of trade can be accordingly framed in such a way that on one product Belgium becomes better off and improve trade so that in other product it can adjust as it would worse it's trade.

Similarly the FTA with Germany should be worked out.

To make the FTA looks reasonable, tariffs are introduced in the agreement. In this case when $1 is introduced as import tariff for importing digital cameras into the country , Belgium can use the money from tariff to give relief to the producers of digital camera in Belgium and also improve the infrastructure so that economics of scale can be used and improve the price in domestic market.