Return to the example of problem 2. Starting from free trade, assume that Foreign offers exporters a subsidy of 0.5 per unit.
Calculate the effects on the price in each country and on welfare, both of individual groups and of the economy as a whole, in both countries.
Now add Foreign, which has a demand curve
D* = 80 - 20P
and a supply curve
S* = 40 + 20P.
a. Derive and graph Foreign's export supply curve and find the price of wheat that would prevail in Foreign in the absence of trade.
b. Now allow Foreign and Home to trade with each other, at zero transportation cost. Find and graph the equilibrium under free trade. What is the world price? What is the volume of trade?