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5] [26 points total] Trade creation and diversion Consider a country that is a small open economy and that imports copper. Currently, the country imposes
5] [26 points total] Trade creation and diversion Consider a country that is a small open economy and that imports copper. Currently, the country imposes a 100% tariff on all copper imports. With the tariff, the country could import copper at $100 from Indonesia, or for $120 from Chile. 3] Illustrate equilibrium in the domestic copper market using a supply and demand diagram. Show copper imports. Where do the imports come from? b] Now suppose the government enters a free trade agreement with Chile, but not with Indonesia. Show the new equilibrium. Make sure to indicate the quantity of imports. Where do the imports come from? c] Using the supply and demand diagram [or diagrams] illustrate the change in consumer surplus, the change in producer surplus and the change in government revenue associated with entering the new free trade agreement. d] On net, is the importing country better or worse off [in the copper market] after entering the free trade agreement? e] Suppose the costs were reversed, so that the Chilean price was initially $100 and the Indonesian $120. Would that change your conclusion regarding the welfare effect of the free trade area? Explain briey
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