Instructions:

Answer the following questions on this test only.That is, do not answer on a separate paper. Do not copy and paste from my notes and/or other sources. This will be considered cheating and you will get an F on the test. I like to see how you answer the question using your own words. Collaborative answers will result in an F for both the helper and the receiver of the help. Type your answers. Submit only one document.

 

1. The table below shows the bushels of corn and bottles wine that Japan and Korea can produce from one day of labor under three different hypothetical situations.

 

Product	Case 1		Case 2		Case 3
	Japan	Korea	Japan	Korea	Japan	Korea
Corn(bushels)	4	2	4	1	4	1
Wine(bottles)	2	1	3	2	2	2

 

4. (4.0pts) Use the table above to show for each case the commodity in which each country has a comparative advantage or disadvantage. Show your work. Answer the question by calculating relative prices.

Answer:

In the first case, Japans has an absolute advantage in producing both corn bushels and wine battles because it can produce more bushels of corn and bottles of wine than Korea can produce. By dividing the amount of each commodity that Japan can produce with the amount of each commodity that Korea can produce, labor is two times productive in the production of both commodities. This has been worked out below.

4/2=2

2/1=2

In Case 2, Japan has an absolute advantage in producing both corn and wine because the bottles of wine and bushels of corns produced in one day in Japan are more than those produced on one day in Korea. From the calculation below, labor is 4 times productive in producing corn in Japan than in Korea. The calculation also shows that labor is 1.5 times more productive in Japan than in Korea in producing wine.

4/1=4

3/2=1.5

Once more, Japan has an absolute advantage in producing corn because it is able to produce more corn in a day than Korea can produce. In particular, labor in Japan is 4 times productive than in Korea as indicated below. However, no country has either an absolute advantage over the other in the production of wine because each country can produce 2 bottles of wine in a day. Therefore, labor has the same labor of productivity in the two countries in production of wine.

4/1=4

2/2=1

 

2. (2.0pts) Indicate in each case whether or not trade is possible. Which commodity each country exports? You must explain your answer.

Answer:

To answer this question, we will need to determine the comparative advantage of one country to the next by calculating the relative cost of one commodity in terms of the other in both countries.

In case 1, the relative cost of the products in the two countries is summarized in the table below.

	Japan	Korea
Pc/Pw	0.5	0.5
Pw/Pc	2	2

 

From this table, producing corn is relatively less expensive in Japan than in China while producing wine cost the same in both countries. Therefore, Japan has a comparative advantage over Korea in producing corn. In the production of wine, neither Japan nor Korea has a comparative advantage. In this case, trade is not possible because Korea doesn’t have a comparative advantage in producing either of the goods. Apparently, Korea will be losing by importing more form Japan and exporting less from the country.

For case 2, the relative cost of the products in the two countries is as indicated in the table below.

	Japan	Korea
Pc/Pw	0.75	2
Pw/Pc	1.33	0.5

 

In this case producing corn is relatively cheaper in Japan than in Korea while producing wine is relatively less expensive in Korea than in Japan. Therefore Japan can export corn because it has a comparative advantage in producing this product. The country can produce corns at a cheap price and thus be able to export them. On the other hand, Korea can export wine because the country has a comparative advantage over Japan in producing this commodity. Apparently, Korea can sell wine at a competitive price than Japan can because producing wine in Korea is relatively cheaper than producing the same commodity in Japan. In this regard, trade is possible for case 2.

The table below indicates the relative cost of producing each of the two commodities in both countries. Form the table, Japan has a comparative advantage in producing corn, but has a comparative disadvantage in producing wine. On the other hand, Korea has a comparative advantage in producing wine, but has a comparative disadvantage in producing corn. These two situations means that trade is possible between the two countries because Japan can export corn while Korea can export wine.

	Japan	Korea
Pc/Pw	0.5	2
Pw/Pc	2	0.5

 

1. Suppose in case 2, Japan exchanges 4 bushels of corn for 4 bottles of wine with Korea.
2. (2.0 pts) How much does Japan gain? Show your work.

Answer:

Japan’s TOT for Corn is 0.5, since when Japan exports 1 bushel of corn it receives 0.5 bottles of wine. Therefore Japan will gain 2 bottles.

1 of corn from Japan =0.5 of wine from Korea

4 of corn from Japan =?

0.5 × 4/1 = 2

Therefore gain from trade will be as follows:

4-2 = 2

Therefore, Japan will gain 2.

2. (2.0 pts) How much does Korea gain? Show your work

Answer

Korrea’s TOT for wine is 1 for 0.5 bushel of corn therefore Korea will gain 4 bushel of corn.

Therefore 4×0.5=2

Korea will also gain 2

 

3. (3.0 pts) What is the range for the terms of trade for corn? What will happen if the TOT for corn is ¾ of wine? Will nations trade and why.

Answer

Range for terms of trade 3/4×4=3

Therefore there will be no trade since no nation will have a comparative advantage.

2. (3.pts) How would you counter the argument that the United States needs to restrict textile imports in order save American jobs?

Answer:

 

Production of textile products in the United States would be at higher labor costs than the exporting country. It would therefore be unnecessary for the United States to argue that importing textiles would lead to job loss.

 

 

 

3. (3.0 pts) With the constant level of world resources, international trade brings about an increase in total world output. Explain why this statement is true.

Answer:

 

This statement is true because under constant level of resources, there is complete specialization. This implies that each country will produce what is capable at the highest level thus optimum output.

 

 

 

 

4. (3.0 pts) Can complete specialization take place under increasing cost opportunity? Explain why.

Answer:

 

Partial specialization will take place under increasing cost opportunity. This is because under increasing cost conditions, a country must sacrifice more and more of one product to produce additional units of another product. In the long run, specialization will occur since under increasing opportunity cost resources are not completely adaptable to alternative uses.

 

 

 

5. (4.0 pts) Assume production takes place under constant opportunity costs. Draw two sets of axes, one for Nation 1 and the other for Nation 2. Draw two identical PPS’s, one for each country. Determine the comparative advantage for each country (nation I and nation II) if taste and preferences are different (i.e., each country has a different set of taste and preferences. Label you graph carefully.

Answer:

 

NATION 1                                                                   NATION 2

 

 

 

 

Maize                                                          Maize

 

 

 

 

 

 

 

 

Machinery                                                                    Machinery

 

 

6. (3.0 pts) What is the basis for trade in the Linder’s trade theory? Who are the major trade partners for the exporting country? Do not put everything you know about the Linder’s theorem and ask me to find the answer.

Answer:

The theory suggests that countries with the same per capita incomes are most likely to engage in international trade. According to Linder countries with the same level of economy and preferences will be major export partners.

 

 

 

 

 

 

 

7. (5.0 pts) Discuss the significance of the assumption of “identical preferences and tastes” in the factor endowment theory. Will the H.O theory collapse if tastes and preferences are different between the two nations? For the latter question, draw a graph to show it graphically. Explain

Answer:

 

The assumption of ‘’ identical preferences and tastes’’ in factor endowment theory implies that the comparative advantage between the two countries is determined by the supply conditions. This is however not the case in HO theory. The HO theorem states that a country will have a comparative advantage in the good whose production is relatively intensive in the factor in which the country is relatively abundant.

 

 

 

8. (2.0 pts) Explain why in intra-industry trade all factors of production will gain.

Answer

When there is intra industry trade, firms produce products that they have comparative advantage in, this allows for specialization and factors of production are used efficiently and thus the net product for any factor of production increases.

 

9. (3.0 pts) Suppose the foreign supply for good X is price elastic. Suppose further that the home country imposes a tariff on good X. Who pays the tariffs? Consumers in the importing country? Producers in the exporting country? Explain carefully.

Answer:

When supply of product exported to another country is price elastic, this means that the supply will reduce if the supplier gets a lower price. Effectively, if the importing country enforces a tariff, the suppliers will raise the price of the product by an amount almost equal to the tariff imposed if they have to continue supplying product X else they will cut down the supplied amounts. If the product is demanded by the consumers, then the supplier will raise the selling price and bear only very little burden of the tariff while transferring the larger portion to the consumers. The consumers in the country where the product is sold will bear the larger portion of the tariff imposed if they have to consume the product.

 

 

 

10. (3.0 pts) How does the elasticity of domestic demand and supply influence the size of the deadweight loss of an import tariff? What will happen to the deadweight loss as the demand and supply become price inelastic?

Answer:

 

Increase in demand elasticity of an imported product reduces the deadweight resulting from a tariff on the product. Therefore, if a product has an elastic demand, then a tariff results in a huge deadweight and if the demand is inelastic, then the deadweight reduces and a tariff only causes a small deadweight loss, this results because for an inelastic demand, changes increase in prices due to a tariff will not result in large changes in quantity consumed and thus there will not be a lot of welfare lost.

 

11. (3.0 pts) Which tends to result in a greater welfare loss for the home economy: (a) an import quota levied by the home government or (b) a voluntary export quota imposed by the foreign government? Elaborate your answer.

Answer:

 

An import quota levied by the home government will have a greater welfare loss for the home economy as opposed to the voluntary quota from foreign government. This is because the home government will charge extra fees for the imported goods. As a result the price for these products will rise beyond the world prices and local consumers will suffer from expensive purchases. There is fall in consumer surplus while the producer surplus is on the rise.

 

12. (4.0 pts) Describe why an import quota is far worse than an equivalent tariff in terms of welfare effect if the demand for the quota-constrained product increases over time. Do your analysis under two scenarios: (1) tariff, (2) quota. Do NOT draw a graph.

Answer:

Import quota is far worse than an equivalent tariff in terms of welfare effect if the demand for the quota constrained products increases over time. For instance, if the government gives free quotas on first come first served basis, the government will collect no revenue. This means that part of the lost consumer surplus is not transferred to the government.  I Assume that two nations trade with each other.  The free trade price is $20 and the volume of trade is 75 units.  Now introduce a $10 transport cost which will reduce the volume of trade to 35 units. Show that in the presence of transport costs, the steeper are the domestic demand and the supply curves for a tradable good, the greater is the burden of transport costs on the home nation. Discuss and show graphically. n addition, the administrative costs involved in administering quotas may be quite high. However, this is not the case in tariffs since they automatically generate revenues. Tariffs also do not limit the level of international competition and hence will have lesser impacts on consumer surplus as compared to quotas that provides the highest limit.

 

13. (4.0 pts) Assume that two nations trade with each other. The free trade price is $20 and the volume of trade is 75 units.  Now introduce a $10 transport cost which will reduce the volume of trade to 35 units. Show that in the presence of transport costs, the steeper are the domestic demand and the supply curves for a tradable good, the greater is the burden of transport costs on the home nation. Discuss and show graphically.

 

Answer

The introduction of the transport cost will have similar effect to tariffs on consumers. The volume of trade will have to fall significantly and consequently there will be loss of consumer surplus as shown by the graph below;

P2=30

 

Price

P1=20

 

 

 

 

Volume of trade          V2=35        V1=75

 

The introduction of transport cost leads to a decline in the volume of trade thus moving from V1 to V2. The price also increases from P1 to P2. The difference between P1 and P2 is brought about by the introduction of transport cost which the local consumers will have to cater.

 

 

14. (4.0 pts) Analyze the economic effect of a subsidy provided by the national government on a particular export commodity in a small Draw a graph. Suppose at the free trade price of $400, the domestic production is 45 units and the domestic consumption is 20 units. A subsidy of $100 is granted to each unit exported. Production increases to 55 units and exports increase to 40 units. Show the welfare effect of such policy (i.e., the loss in CS, the gain in PS, the cost of the subsidy, and the welfare loss).

Answer:                                            S2

S1

 

D1

 

 

P2   D2

P0

P1    S2

Price

S1                                                                                      D2        D1

Quantity

The introduction of subsidy for exports will lead to an increase in the amount of quantity exported. This will consequently lead to gain in producer surplus.  On the other hand, the consumer surplus will be at a loss and hence the overall loss of welfare.

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