An Economic Integration Problem

Assume two isolated free market island economies of significant size separated by 50 miles of ocean, East Island and West Island. Neither island has any trade relations at all with the rest of the world or each other. Both economies are on the gold standard, with all prices denominated in troy ounces of gold, independent of physical form. Government plays no role in either monetary system. Non-monetary uses of gold are only historical at this point in time, so all demand for gold is monetary demand.

One of the major industries on each island is the production of chicken eggs for sale and consumption.

On East Island, the EIEPA (East Island Egg Producers Association) keeps track of the state of the egg industry by sending out monthly questionaires to both the egg consumers and the egg producers of East Island.

Egg consumers are asked for their estimated egg demand schedule, i.e. the number of dozens of eggs that they would expect to buy at each possible gold ounce market price in the coming month. All of the consumer questionaires are processed to produce an aggregate egg demand schedule, adding up the number of dozens of eggs expected to be purchased at each possible gold ounce market price.

Egg producers are asked for their estimated egg supply schedule, i.e. the number of dozens of eggs that they would expect to bring to market at each possible gold ounce market price in the coming month. All of the producer questionaires are processed to produce an aggregate egg supply schedule, adding up the number of dozens of eggs expected to be supplied at each possible gold ounce market price.

With both the estimated aggregate demand and supply schedules now in hand, they are inspected to find the expected market clearing price for East Island, where the quantity demanded is equal to the quantity supplied.

This procedure has historically produced very good results in predicting the monthly consumption of eggs and the market gold ounce price for a dozen eggs on East Island.

An entirely parallel, but independent procedure is carried out by the WIEPA with equally good, but independent, results on West Island.

One day a sea borne entrepreneur appears and wants to build a 50 mile toll bridge between the two islands, combining both roads and railroads, and effectively integrating the two island economies. This is agreed to and accomplished with minimal difficulty in relatively short order.

As soon as the bridge goes into operation, the EIEPA and the WIEPA decide to merge and combine their files. They take their latest aggregate egg supply and demand schedules and combine them, creating aggregate egg supply and demand schedules for the two islands together, and a prediction for total egg consumption and market gold ounce egg prices for the coming month.

Are the predictions likely to experience the historical expected levels of accuracy?

A new monthly combined questionaire is sent out to all of the egg consumers and egg producers of both islands. Are these new predictions likely to be as accurate as the history of single island questionaires would lead one to expect?

Explain.

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