Q1. Patria is a small open economy that trades with Povaria and Eurasia. At $5 per unit, it can produce and consume 50 units and 130 units respectively when it trades with Povaria. Patria can produce and consume 60 and 120 units respectively when it trades with Eurasia for an incremental cost of $6 per unit.

A $2 per unit tax on gadgets from Povaria increases production to 70 units but reduces consumption from 130 units to 110 units. A nondiscriminatory tax was also imposed on Eurasia. Patria subsequently signs a bilateral trade agreement with Povaria.

(a) Is the union trade-creating or trade diverting? Why?

(b) Compare the monetized production and consumption effects of the trade agreement.

(c) What is the net loss in tariff?

(d) Could net gains be realized in the immediate period? Why?

(e) Under what conditions could this union be dynamically beneficial?

Q2 Suppose instead that Patria signs a trade agreement with Povaria when Patria could produce and consume, at $5 per unit, 50 and 130 units of gadgets respectively. Further imagine that the same amount of nondiscriminatory per unit tariff ($2) is imposed on Povaria and Eurasia. Patria could produce and consume, at $6 per unit, 60 and 120 units of gadgets respectively when it freely trades with Povaria. The nondiscriminatory tax on Eurasia increases production by 10 units but decreases its national consumption by 10 units. Subsequently Patria decides to sign a free trade agreement with Povaria.

(a) Is the union trade-creating or trade diverting? Why?

(b) Compare the monetized production and consumption effects of the trade agreement.

(c) Are the monetized production and consumption gains greater than the net loss in tariff?