Suppose there are two goods: guns and roses. Also suppose Australia is initially closed to trade. When international trade is opened, Australia chooses to sell guns and buy roses in the world markets.
(i) Which is higher, Australia's autarkic relative price of guns or the world relative price of roses?
(ii) If the world relative price of guns falls, will Australia be better off or worse off? What if the world relative price of guns rises? Explain.
(i) Since Australia chooses to sell guns in the world markets, guns must be relatively less costly in Australia than in the rest of the world. Thus the autarkic relative price of guns must be lower than the world relative price of guns.
(ii) If the world relative price of guns falls, then it will be closer to the autarkic relative price. Thus Australia's gains from trade will be lower, and Australia will be worse off. On the other hand, a rise in the world relative price of guns will allow Australia to gain even more from international trade, because then the world relative price will differ even more from the autarkic relative price.
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