Adjustment costs associated with the movement from an autarky equilibrium to a free trade equilibrium can be represented by an economy where the autarky combination of goods is temporarily not affordable. True False
The correct answer and explanation is:
Correct Answer: True
Explanation:
Adjustment costs refer to the short-term economic disruptions that occur when a country transitions from an autarky equilibrium (no trade) to a free trade equilibrium (open to international trade). These costs are an important aspect of international trade theory because, while trade leads to long-term gains, the transition can cause temporary dislocations.
When an economy is in autarky, it produces and consumes goods based on its own production possibilities and demand preferences. The prices of goods reflect only domestic supply and demand. Once the economy opens to trade, it begins to specialize according to comparative advantage. This results in some sectors expanding while others contract. The movement of resources, such as labor and capital, from declining sectors to growing ones is not immediate or costless. Workers may lose jobs, require retraining, or relocate. Capital may become temporarily idle or need to be reallocated.
During this transition period, the economy may face a situation where the previous autarky combination of goods becomes unaffordable at world prices. This is because opening up to trade changes relative prices. For example, a good that was relatively cheap domestically might become more expensive if it is costly in the global market. Consequently, consumers and producers must adjust their behavior, and these adjustments often involve real economic costs.
The economy eventually reaches a new equilibrium where trade improves overall welfare through greater efficiency and access to a wider range of goods. However, the adjustment process itself can lead to short-term welfare losses for specific groups, and it can cause the autarky consumption bundle to be temporarily out of reach. This justifies the statement as true, because it highlights the reality that moving toward free trade can impose transitional economic burdens before the long-term benefits are fully realized.