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Suppose the home market for good Y is dominated by a monopolist. Good X is perfectly competitive. The economy is initially in autarky.
1) Draw a PPF diagram consistent with the monopoly setup as described. Let Am be the output/consumption level in the presence of the monopoly. Include an indifference curve and price ratios. Label the IC and Price/ratio IC1 and P1, respectively. You should also put on the graph point A to represent what the autarky output/consumption level might be if the market was perfectly competitive. [Hint: make your drawing large so that you have plenty of space.]
2) Suppose the home market is opened for trade. The home market is small compared to the world market, and does not influence world prices. Add to your PPF graph from above and include the situation in which the world price ratio P2 happens to be exactly the same as the slope of the PPF at point A. Label the new indifference curve and price with the number 2.
3) Now suppose that the world price ratio Px/Py is smaller than the price ratio in part 2. Draw in the price ratio and indifference curve consistent with that situation.
4) Indicate on your graph the different types of "gains from trade" when the economy moves from the situation in part 1 to situation in part 3.
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