ECO6250 Problem Set 1 - Let’s assume there are only 2 countries

ProblemSet1_ECO6250_

P1. Let’s assume there are only 2 countries that produce 2 good. More specifically, suppose that the United States (US) and the United Kingdom (UK) each have 2 units of productive resources, 1 used to produce Wine, the other Cloth. The US can produce 40 units of Wine with 1 unit of productive resources and 40 units of Cloth with 1 unit of productive resources. The UK can produce 20 units of Wine with 1 unit of productive resources and 10 years of cloth with 1 unit of productive resources. Using this information, please answer the questions below:

First, organize data as:

	Wine	Cloth
US	40	40
UK	20	10

 

*Who has an absolute advantage in the production of Wine? Cloth? US

*Who has a comparative advantage in the production of Wine? Cloth?

The relative price of W in US = 40C/40W = 1C/W

The relative price of C in US = 40W/40C = 1W/C

The relative price of W in UK = 10C/20W = 0.5C/W

The relative price of C in UK = 20W/10C = 2W/C

As you can see, the US should produce Cloth (it only costs US 1W/C), and UK Wine (it only costs UK 0.5C/W).

*Given specialization, what is production before trade? After trade?

Before trade:

	Wine	Cloth	Total
US	40	40	80
UK	20	10	30
	60	50	110

After Trade:

	Wine	Cloth	Total
US	0	80	80
UK	40	0	40
	40	80	120

 

*What are the gains from trade?

10 more units of output.

*What is the “range” of potential exchange rates between US and UK?

Remember, the US will produce C, and UK W. As long as the US receives more than 1 W per C it trades to the UK (since this is the cost of producing C in US), and as long as the UK pays less than 2W/C it receives from the US (since this is the cost of producing C in UK), then trade will take place. Hence, the terms-of-trade will be in the range of 1 W/C to 2W/C.

P2. Suppose that in Japan, without a tariff 10,000 cars will be sold per year at an equilibrium price of $20,000. With a $5,000 tariff, supply decreases such that 8,000 cars are produced at $22,500 per car.

*Use a supply and demand diagram to graphically illustrate the example above. Just let the S curve shift parallel to the left $5,000…

 

*Why is the increase in price less than the tariff?

B/c the burden of the tariff is shared by consumers and producers.

*Who bears the burden of the tariff?

Consumers and producers. Consumers pay more ($22,500) and producers receive less ($17,500).

*What are government revenues from the tariff?

These can be solved as $5,000*8,000=$40,000,000.

*What is the “dead-weight loss” associated with the tariff – i.e., the lost in Producer Surplus and Consumer Surplus?

This is (1/2)(2,000)($2,500)+(1/2)(2,000)($2,500)=5,000,000

P3. Finally, graphically explain the negative effects of quotas. How about subsidies? Label and explain results in detail.

You can find answers to this question in the book and/or online…

 

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