The United States imports Molson beer from Canada. Assume the United States and Canada share the...
The United States imports Molson beer from Canada. Assume the United States and Canada share the same currency. Further, a bottle of Molson beer costs $2 in Toronto, Canada and $1 in Chicago, Illinois. (a) Assuming no shipping costs or trade barriers, is this price difference sustainable? (b) What market adjustments will ensue in this case, assuming the price differential isn’t sustainable? (c) List two restrictions on trade or additional costs would keep the price difference between Toronto and Chicago?
Homework Answers
a. When price is different in two countries thought they share same currency, there is no trade barriers and there is no shipping cost then this price difference is not sustainable. It is because under free trade situation without any trade restrictions there will be adjustment in price through less demand in higher price area and higher demand lower price area.
b. The market adjustment will take place through export and import of bottle of Molson beer. In Toronto, Canada price is higher i.e $2 and in Chicago, Illinois price of Molson beer is $1. Due to lower price in Chicago the customer of Toronto, Canada will import beer from Chicago. On the other hand due to higher price in Toronto the supplier of beer in Chicago will export beer to Toronto. This export and import will adjust the price and will continue this process untill the price is reached at same level. Because higher import demand will increase the price and higher supply or export will lower the price. This export and will continue till it is reached at equal price in both countries.
c. The two trade restrictions which would keep the price difference between Toronto and Chicago is tariff and quota. Tariff is price restrictions and quota is quantity restrictions. If tariff is imposed by any of the country then price difference will prevail and similarly quantity restrictions can create price difference among these two places. Tariff can impose additional cost on export or import and quantity restrictions can push price difference.
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