Answer to Question #68487 in Economics for Luna Li

Question

International economics

consider an economy imposing an export subsidy.

a) assume that economy is small so that changes in the terms of trade can be ignored. Explain the effects on trade volume and aggregate domestic welfare.

b) following a), suppose instead that the government provides the subsidy for every unit that the home firms produce. Illustrate the welfare implications of this production subsidy and compare them with the case with the export subsidy.

c) assume that the economy is large and hence terms of trade will be affected. Explain the effects on trade volume and aggregate domestic welfare and compare the social welfare with the case where the country imposes a positive import tariff.

Answer 1

a) If the economy is small, then the trade volume and aggregate domestic welfare will not change significantly.

b) if the government provides the subsidy for every unit that the home firms produce, then the welfare implications of this production subsidy will be higher than comparing with the export subsidy.

c) if the economy is large and hence terms of trade will be affected, then the trade volume and aggregate domestic welfare will be significant and the social welfare will be better then in the case where the country imposes a positive import tariff.