Question

The nation of Textilia does not allow imports of clothing. In its equilibrium without trade, a T-shirt costs $20, and the equilibrium quantity is 3 million T- shirts. One day, after reading Adam Smith’s the Wealth of Nations while on vacation, the president decides to open the Textilian market to international trade. The market price of a T shirt falls to the world price of $16. The number of T shirts consumed in Textilia rises to 4 million, while the number of t shirts produced declines to 1 million.

1. Illustrate the situation just described in a graph. Graph showing all numbers
2. Calculate the change in consumer surplus, producer surplus, and total surplus that results from opening up trade. Area of triangle is ½ X base X height

Answer 1

As per the information, the graph would be as follows:-

a)

в с р

b) Change in CS = The CS will increase by area B+C+D

= 3 million*(20-16) + 0.5*(4m-3m)*(20-16)

= 12 million+2 million

= 14 milion

Change in PS = The PS will decrease by area B

= 1 m*(20-16) + 0.5*(3 m-1 m)*(20-16)

= 4 million+4 million

= 8 million

Change in TS = The TS will increase by area D+C

= 0.5*(4M-3M)*(20-16) + 0.5*(3M-1M)*(20-16)

= 2 million + 4 million

= 6 million