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 units of cloth with 1 unit of productive resources. Using this information, please answer the questions below:
*Who has an absolute advantage in the production of Wine? Cloth?
*Who has a comparative advantage in the production of Wine? Cloth?
*Given specialization, what is production before trade? After trade?
*What are the gains from trade?
*What is the “range” of potential exchange rates between US and UK?
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.
*Why is the increase in price less than the tariff?
*Who bears the burden of the tariff?
*What are government revenues from the tariff?
*What is the “dead-weight loss” associated with the tariff?
Graphically explain the negative effects of quotas. How about subsidies?
Each year, consumers in a small country purchase 1 million pounds of sugar at the global price of $1.50 per
pound. Domestic firms produce 500,000 pounds and domestic consumers imports the remainder. Policymakers of the world’s major supplier of sugar begin an export-subsidy program that rewards firms for exporting sugar. This program causes the global price of sugar to drop to $1 per pound. The domestic quantity demanded in the small country climbs to 1.3 million pounds, and the domestic quantity supplied falls to 300,000 pounds.
- Draw a diagram of the small-country market for sugar under free trade, and with the export subsidy in place.
- Calculate the loss of domestic producer surplus and the increase in domestic consumer surplus.
- What is the total value of the subsidy in the small-country market?
- Can you identify any deadweight losses?
Consider the following situation for a nation in a small country setting that has an import quota on men’s shirts.
|With quota||Free trade|
|Quality purchased||1 million||1.2 million|
|Domestic quantity supplied||400,000||300,000|
- Illustrate the effects of the quota in a supply and demand framework.
- Indicate in your diagram and calculate:
- The loss of consumer surplus
- The gain in domestic producer surplus
- The deadweight losses
- The quota rent