Question 1: The diagram shows an economy Gamma producing and importing cars in the form of intra-industry trade. The economy is contemplating forming a customs union with one of the two economies, M or N. The supplies of cars before the customs union from the two economies are denoted by %I and SN respectively. Once the customs union is formed, Gamma will import from the member country without any tariff but will impose a tariff of T when imports from the non-member economy.
(a) Prior to the formation of the customs union, explain which economy Gamma should import the cars from. Determine the levels of domestic production, domestic consumption, and imports.
(b) If Gamma forms the customs union with economy N, explain whether the custom union is trade creation or trade diversion. Analyse the net welfare effects of such a customs union with reference to the appropriate areas in the diagram.
(c) If Gamma forms the customs union with economy M, explain whether the custom union is trade citation or trade diversion. Analyse the welfare effects of such a customs union with reference to the appropriate areas in the diagram.
Question 2: The table below shows the balance of payments of two nations, Micro and Macro. Assume that current account comprises only export and import.
Item Micro Macro
Export $100m $300m
Import $250 $50m
Capital Inflow $150m $100m
Capital Outflow $70m $220m
Statistical Discrepancy $5m -$5m
(a) Discuss the current account balance and financial account balance of both nations and explain the term statistical discrepancy.
(b) Calculate the official settlement balance and explain the overall balance of payment position of both nations.