Consider the rest of the world with free trade (production at S1 and consumption at C1),

Description

QUESTION:

Consider the rest of the world with free trade (production at S₁ and consumption at C₁), as shown in the graph on the right in Figure 4.4A. The international relative price of cloth now changes to 1.3 WIC.

a. Using a graph, show the effects of this change in the international relative price on production and consumption in the rest of the world.

b. Is this change in the international relative price improvement or deterioration in the terms of trade of the rest of the world? According to your graph, does the rest of the world gain or lose well-being? Explain.