Finally, the quantities traded are found by comparing production and consumption. This can be done by adding the trade triangle to the diagram. In autarky , the country must produce what it consumes. Therefore the best that it can do is to consume on the highest indifference curve that it can reach. The figure shows immediately that the level of welfare is lower in autarky than with free trade, and also that a country will export the good whose relative price in autarky is lower than the price that will prevail with trade.
Trade causes the output of the export good to rise and that of the import good to fall.
Effects of a tariff A tariff causes the domestic price of the imported good to be higher than the world price, and thus the domestic relative price of the exported good, X in this case, to be lower. If the country is small , so that the world price remains unchanged with the tariff, then the tariff faces producers with a flatter price line, to which they respond by producing less of good X and more good Y, at a tangency of the transformation curve with this flatter price line. The budget line of the country as a whole is still given by world prices, however, now passing through this new producdtion point, P 1 . To have balanced trade , consumption must be on this line, at a point of tangency between an indifference curve and another domestic price line parallel to that facing producers. The effects of the tariff in the small country include a drop in welfare compared to free trade, and a reduction in the quantities traded.