ARE 138 hw 3

ARE 138 hw 3 - Jeff Phang ARE 138 HW#3 1(15 Imagine the...

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Jeff Phang ARE 138 HW #3 1. (15) Imagine the United States, Mexico, and Canada are considering forming a free trade area (as occurred in pre-NAFTA days.) You are assigned to calculate the potential effects of this agreement on prices and welfare. D US = 1,000 – 100 P US MC US = \$6.00 MC MX = \$4.50 MC CAN = \$6.50 MC ROW = \$4.00 a-i) Prior to any trade agreement, US has a 20% tariff on all imports. Where does the US obtain its broccoli?: The US would obtain its broccoli from the rest of the world (ROW). What is the US Price?: The US price would be at a cost of P ROW * tariff (\$4.00)(1.2) = \$4.8. How much is consumed? At Pw = \$4.8 D US = 1,000 – 100 P US D US = 1,000 – 100 (4.8) = 520 units of broccoli. Find US consumer surplus, government surplus and total welfare. CS = ½ (P max – P * ) * Q P max = 10 P* = 4.8 Q = 520 CS = ½ (10 – 4.8) * 520 = 1352 G = tariff revenue * quantity G = .2(4.00) * 520 = 416 Total Welfare = CS + G Total Welfare = (1352) + (416) = 1768 a-ii) Now assume that the free trade area is formed, and imports from Mexico and Canada no longer are subject to a tariff. ROW imports still are charged a 20% tariff. Now where does the US obtain its broccoli, and what is the US price? The US will now obtain its broccoli from Mexico at a cost of \$4.50. How much is consumed? At P MX = \$4.50 D US = 1,000 – 100 P US D US = 1,000 – 100 (4.50) = 550 units of broccoli. Find US consumer surplus, government surplus and total welfare. CS = ½ (P max – P * ) * Q P max = 10 P* = 4.5

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Q = 550 CS = ½ (10 – 4.5) * 550 = 1512.5 G = tariff revenue * quantity G = 0 * 550 = 0 Total Welfare = CS + G Total Welfare = (1512.5) + (0) = 1512.5 a- iii)What is the net effect of the free trade area on CS, GS (govn. surplus) and total welfare in the US? Net effect on CS = CS w/ FT – CS w/o FT (1512.5) – (1352)= +160.5 increase in CS Net effect on G = G w/FT – G w/o FT (0) – (416) = -416 decrease in government revenues Net effect on total welfare = TW w/FT - TW w/o FT (1512.5) – (1768) = -225.5 decrease in total welfare. Is this trade-creating, or trade-diverting? This is an example of trade diversion. Before the FTA, the United States was importing from the rest of the world (the most efficient producer) at a cost of \$4 plus a tariff of \$0.80 per unit totaling \$4.80. After the FTA, the United States imported from Mexico tariff free at a cost of \$4.50. Since the cost of importing from Mexico w/o a tariff is less than the cost of importing from the rest of the world w/a tariff, this is an example of diversion. b) Now let Mexican demand for corn: D mx = 90,000 - 10,000 P mx Corn can be produced at a constant marginal cost of: \$4.70 in the US, \$5.00 in Mexico, \$4.80 in Canada, and \$6.00 in the rest-of-world (ROW) region. D mx = 90,000 - 10,000 P mx MC US = \$4.70 + \$0.40 MC MX = \$5.00 MC CAN = \$4.80 + \$0.40 MC ROW = \$6.00 + \$0.40 b-i) Prior to any trade agreement, suppose Mexico maintains a \$.40 specific tariff on all imports. Where does Mexico obtain its corn? Mexico would obtain its corn from its own producers. What is the Mexican price? It would purchase at a MC MX = \$5.00 with no tariff since there is no trade.
How much is consumed?

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