AEM-ECON 2300 Prob Set 2 - Ans Sheet 2010

# AEM-ECON 2300 Prob Set 2 - Ans Sheet 2010 - International...

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International Trade and Finance Professor David Lee AEM/ECON 2300 Spring 2010 Problem Set #2 (Due Thursday, February 25, by 4:00 PM in red drop-box outside Warren Hall 106) For full credit, please show all your work and label your answers clearly. Question 1 You are given the following inverse supply and demand functions for bananas in Costa Rica and Iceland (note: inverse S & D functions are the same as regular S & D functions, only price is on the left-hand side): Costa Rica Iceland Supply P = 0.1Q S P = 30 + 0.1Q S Demand P = 60 - 0.1Q D P = 120 - 0.1Q D a) Determine the equilibrium prices and quantities in each country under autarky. Individually, set each country’s supply and demand equations equal to each other and solve for P & Q. Costa Rica Iceland P eq = 30, Q eq = 300 P eq = 75, Q eq = 450 b) Iceland and Costa Rica have decided to trade. Using the reasoning developed in class, which country will be the importer and which country will be the exporter? Briefly explain your answer in 1-2 sentences. Costa Rica will export bananas because its autarky equilibrium price is lower. Iceland will import bananas because its autarky equilibrium price is higher. c) Calculate the excess supply function and the excess demand function for banana trade between Costa Rica and Iceland. What is the equilibrium price? Show your calculations. Costa Rica Iceland Q S = 10P Q S = 10P – 300 Q D = 600 – 10P Q D = 1200 – 10P ES = Q S – Q D = 20P – 600 ED = Q D – Q S = 1500 – 20P In the international market, ES = ED. Solving, we find that: P = 52.5

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d) Draw a 3-panel graph (as shown in class) illustrating the domestic supply and demand curves for Costa Rica and Iceland as well as excess supply and demand in the international market. Please indicate equilibrium prices and quantities – and the points of intersection with x and y axes – in each panel. e) With free-trade and zero transaction costs, how many bananas will be produced and consumed in Costa Rica? How many bananas will be produced and consumed in Iceland? (Hint: after calculating these numbers, check to make sure that the world quantity demanded equals the world quantity supplied!) Costa Rica Iceland Q S = 10P = 10(52.5) = 525 Q S = 10P – 300 = 10(52.5) – 300 = 225 Q D = 600 – 10P = 600 – 10(52.5) = 75 Q D = 1200 – 10P = 1200 – 10(52.5) = 675 f) Did the total world quantity of bananas increase as a result of trade? If so, why? If not, why not?
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