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Free Trade Equilibrium

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3. Draw an initial free-trade equilibrium for a small country facing fixed world prices, depicting its production possibilities frontier and relevant indifference curves.

a). Indicate in your diagram the rate of the tariff that would completely wipe out trade between this country and the rest of the world.

b) What happens to production and consumption if legislators are overzealous and the tariff rate is set higher that this rate?

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The prohibitive tariff is judged.

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Solution:

3.

a)
The initial free-trade equilibrium is shown with production at A and consumption at B. Since there exists a difference between the production and consumption, free trade will take place.

The prohibitive tariff would be the tariff that induced domestic prices such ...

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