This is an International Trade question.

Problem 4 Consider a model with two countries, Home and Foreign, and two goods, X and Y. The demand curve for each good in each country is given by: D=50P Where D is the quantity demanded and P is the price. The supply curve for Y in Home and for X in Foreign is given by: Q3 = P While the supply curve for X in Home and for Y in Foreign is given by: Q3 = 4 + P Where in each case Q3 stands for the quantity supplied. a. Find the Nash equilibrium tariffs for each country in this model. Display all your calcu- lations. b. Calculate the change in social welfare in each country if we move from Nash equilib- rium tariffs to free trade. Illustrate with a diagram. c. Given your results, would Home and Foreign prefer to negotiate trade policy, or would they prefer to maintain their sovereignty and discretion by leaving each country to set its trade policy on its own? Problem 5 In the previous problem, suppose that we increase the size of Foreign by multiplying the Foreign demand and supply curves all by the same very large number. a. Recalling the discussion of tariffs and small countries in Lecture 7. what will the Nash equilibrium look like now? Answer qualitatively; describe the characteristics of the Nash equilibrium, not the exact value of the taris. No new computation is necessary. 2 b. If we move from the Nash equilibrium to free trade, will social welfare in both coun- tries rise? Why or why not? c. Given your answers above, are small or large countries likely to be more interested in pursuing negotiated free trade