460PS#3 - l-Iconomies 460 Suggested Answers Problem Set 3...

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Unformatted text preview: l-Iconomies 460 Suggested Answers Problem Set 3 Spring 2010 I. The US, China and the Developing \Vorld 1. Given the endowments ol' the table, the US is capital abundant relative to the developing World (DW’). (l-lOUOX-l-(ltfl) > [HOOD/10000) The I-Iecl-tscher—Ohlin theory then predicts that the US will benefit by specializing in and exporting aircraft (the capital-intensive good) and importing clothing (the labor-intensive good). \u/e‘) ~48 tum" In atttarky, the US will have a higher wage/rent ratio titan will DW’. “"1111 intemational trade, so longr as both regions continue to produce both goods, the commodity prices will equalize and this will cause the wage/rent ratios to convert; '. The Stolper-Samuelstm Theorem tells us that the abundant factor in each country “ill gain from moving to free trade: capital in the [TS and labor in 13“". 32, When China enters trade, it introduces a new set ol'l'actor endowments. China is labor- aliundant relative both to the (IS and to UV". Our prediction for [ES-China trade is straightforward, and identical to that in l: the US will export aircraft to China, and China will export clothing to the US. Given that we anticipate that the terms of trade will become more favorable to the US. we anticipate that it will specialize ct-‘cn more in aircrait than it did in question 1. (The terms 01' trade is the ratio of the price ol'clothing to the price ot'aircralt (1‘0'1‘ = HR) in international trade}. The trade with DH" is more complicated to predict, and depends upon 'l‘( )T. ll'this terms of trade is greater than the autarkic. opportunity cost in DW’, then D\\" will export clothing to the [IS in exchange for aircraft. II' this terms of trade is less than the opportunity cost in autarky. then DW' will export aircraft to China and import clothing. 11"1‘0'1‘ is just equal to the antarkic oppt'irtunity cost in D\-\". then DVV will not choose to trade with either country. (This is a distinct possibility, given our answer to 3 below.) DVV will in either case be less specialized in clothing than it was in question 1. See the diagram above for an illustration. 3. Factor migration will lead to factor owners moving to the countries with highest returns: labor moving to the US, and capital moving to China. Given the aggregate endowments and the identical teclmology in the three counuies, we predict that this will continue until the three countries have equal capital/labor ratios. For example, if 5000 capital moved to China from the US and 5000 workers moved to the US from China, all three regions would have capital/labor ratios of 1. In this case, there is no incentive for factors on net to leave or enter DVV: the world economy will settle with a shared opportunity cost just equal to the autarkic opportunity cost in DVV. II. The cost ofU S sugar subsidies. l. The attached diagram from Excel illustrates the equilibrium prices and quantities for three equilibria: the autarkic outcome (or, for a quota of 0), for the outcome with quota, and for the outcome with free trade. The numeric values are: P Q Autarky $3193.33 753.3 Quota of 100 $3060 720 (produced), 820 (consumed) Free trade $360 45 (produced), 2170 (consumed) The differences between quota and free trade: much higher price with a quota, much larger domestic production, much smaller domestic consumption. (The quota outcome is very close to the autarkic outcome, because the quota is very restrictive.) 2. Welfare can be measured from this diagram by calculating the zu‘eas under the demand curve and above the supply curve. In millions of dollars: Autarky Quota Free trade Producer surplus 1.135 1.037 0.004 Consumer surplus 0.567 0.672 4.709 Importer rent 0.270 Total welfare 1.702 1.979 /1-.7 13 In moving from a quota to free trade: Consumers gain 4.037 Producers lose 1.033 Importers lose 0.270 The (liilerence between gains and losses represents the gains from eliminating dcadweight. losses. 3. The ad valorem tariff t'for the government to impose that will have equivalent. impact of this quota: 750 percent. l+t = (3060/360) The importers no longer benefit from the commercial policy, and the amount. that they received under the quota ($270,000) is now collected by the government in tariff revenues. 4. On this question, I did not require calculations for a perfect score - but I did give relatively higher marks on average to those who used the numbers in the problem. The perfect score in this question went to those who answered clearly the following question: Whose welfare do we consider in defining our commercial policy. There are a few possible answers. a. We could choose to value world welfare. In that case, the higher environmental cost in the Amazon matters to us. That alone would convince us to reduce our quota (i.e., make it smaller) so that more production occurs in the Everglades. However, we’ve already documented the deadwcight losses associated with the quota - our calculation should consider the trade-off between improved environment and increased deadweight loss. b. We could choose to value US welfare alone. In that case, the advice is to increase the quota (i.e., allow more foreign sugar into the country). This reduces deadweight losses and reduces US environmental costs. The best answers calculated the “social” welfare by introducing environmental costs into the US and foreign supply curves. It turns out that the social gains from increasing the quota and reducing deadweight loss outweigh the environmental gains by producing more in the US. For the world as a whole, in this example, moving production to the Amazon is welfare-improvin". Grade Distribution 96 - 100 0 91 - 95 7 86 - 90 6 81 - 85 7 76 - 80 1 71 - 75 6 61 - 70 4 0 - 60 1 Missing 8 Total 40 Cm mammq mcamammm o _ woo woo woo boo moo moo woo” moo. moo moon 500 500 Hwoo 300 ”550 Hmoo Hun—c Hmoo Hwoo Non—o Nuoo. wuoo uwoo “poo _ _ +m flb wwo N5? omamaa I II: main: mutt? v18 2:: 9.53 ...
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