Final answer:
Free trade typically increases welfare by allowing countries to specialize, but this depends on the presence of consumption and production externalities. Proper public policy can help maximize the benefits of free trade while addressing any negative externalities.
Step-by-step explanation:
Comparison of autarky and free trade reveals that free trade tends to increase welfare, typically measured by the sum of consumer and producer surplus. Under autarky, a country is limited to its production capabilities and consumer preferences, often leading to higher prices and lower quantities of goods compared to free trade. With free trade, countries can capitalize on their comparative advantage, allowing for a greater variety of goods at lower prices, which increases consumer surplus. Meanwhile, producers can access larger markets, which can increase producer surplus. However, this analysis assumes there are no externalities.
When considering consumption externalities under both autarky and free trade, the welfare analysis may change. Consumption externalities can influence the true cost of consumption, potentially leading to market failure. Similarly, with production externalities, free trade may not lead to a clear welfare improvement if the external costs or benefits are not accounted for.
To maximize the benefits of free trade while mitigating negative externalities, regulations or policies such as taxes, subsidies, or emission standards can be implemented. Public policy can focus on balancing the efficiency gains from free trade with the equitable distribution of benefits and costs, and the protection of the environment and social welfare.