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    Small economy and trade

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    Trade between a large economy and a small inevitably implies that the largest economy capture most of any gain arising from the exchange due to the disparity of economic power between the two nations. Do you agree or disagree? Why or why not?

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    Solution Preview

    This problem should be tackled from the perspective of open economy with the premise of free trade is good for all. It allows for welfare creation for all trading nations. This is the basis for the creation of the World Trade Organization (WTO).

    The notion that a large economy will gain from trade on the expense of a small economy is a fallacy. In fact we can argue on the other way around. A small economy has more to gain from trade. We can take Singapore as a good example on how a small country with seemingly lacking in any production factor endowment is able to take advantage of free trade. The main contributing factor is market expansion by penetrating into the world market. With a bigger market, producers are able to benefit from economies of scale in production and distribution, which they cannot get from their local market.

    The argument for a small economy cannot gain from trade ...

    Solution Summary

    A small open economy is still able to gain from trade despite of not able to influence world prices. This is due to efficient allocation of resources by allocating more resources towards producing products with comparative advantage in factor prices. Eventually, all trading parties are able to gain from trade by having more products to consume at cheaper prices and factors of production are better paid.