Question:

Consider the following HO Model:

Suppose Japan is relatively abundant in K (capital) compared to Canada, and the production of beef is relatively labor-intensive compared to the production of autos. In the initial equilibrium, Canada and Japan had free trade. Use free trade as the benchmark for comparison for all the trade policies to be examined below. Also, there are only these two countries in the world, and both are large countries.

Canada is considering whether to impose a quota on its imports

Now suppose Canada is aware that Japan may retaliate on the quota and restrict Japanese imports from Canada. In order to smooth out the trade friction that could arise from the Canadian quota, suppose Canada is now considering whether to compensate Japan by transferring the quota revenue to Japan, while maintaining the same import quantity restriction under a quota. This trade policy is often called a "Voluntary" Export Restraint (VER) imposed by Japan at the request of Canada. Use the appropriate diagram to briefly explain how the implementation of the VER (compared to free trade) would affect

(a) World welfare (Hint. Use world export supply and import demand)

(b) Canada's welfare.

(c) Japan's welfare.

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