1) Country is exporting. When a nation have free trade, it will export the good if price in outer world is higher than domestic price and if price in outer world is lower than domestic world, than nation will import.

It is exporting 45-20 = 25. Because at world price $5 domestic quantity supplied is 45 and domestic quantity demanded is 20. So exports are excess quantity supplied that is not demanded domestically.

2) There will be increase in producer surplus and decrease in consumer surplus but increase in producer surplus will be higher than decrease in consumer surplus. So there will be net gain to society.

Producer surplus is the area below the price line and above the supply curve and consumer surplus is area below the demand curve and above the price line.

Before free trade -

Consumer surplus = 1/2( 7-4)*30 = 1/2*3*30 = 1/2*90 = 45

producer surplus = 1/2( 4-2)*30 = 1/2*2*30 = 1/2*60 = 30

Total surplus = 45 + 30 = 75

After free trade-

Consumer surplus = 1/2( 7-5)*20 = 1/2*2*20 = 1/2 *40 = 20

Producer surplus = 1/2( 5-2)*45 = 1/2* 3 * 45 = 1/2 * 135 = 67.5

Total surplus = 20 + 67.5 = 87.5

Net gain = 87.5 - 75 = 12.5

3) So there is decrease in consumer surplus and increase in producer surplus.

In order to mitigate the losses government should set price ceiling for domestic consumers. Price ceiling is the maximum price that could be charged. If price ceiling of $4 is set for domestically then producers can not sell the good for more than $4. Highest price will be $4. So consumers will not loose from free trade.

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