3620MT2KEY_Fall2010 - NAME SIGNATURE STUDENT Department of...

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NAME:________________________________ STUDENT #: ________________ SIGNATURE: __________________________ Department of Economics College of Management and Economics University of Guelph ECON*3620 - International Trade Fall 2010 Instructor: Patrick Martin MIDTERM 2 ANSWER KEY Problem 1. Suppose two countries each produce a labour intensive good, cloth and a land intensive good, corn. Let the foreign country be relatively well endowed with land. Describe the impact of the situations below in parts (c) - (f) on the terms of trade and the welfare of the home and foreign country by filling the blanks below with either INCREASE, DECREASE, or AMBIGUOUS. Assume that comparative advantage is not changed in any of the situations ((c) - (f) below). A Standard Model with two „large‟ countries is assumed. Work/Discussion/Graphs are not required but are required if you want any partial credit a) Which country exports corn? Circle either HOME or FOREIGN (4 pts) b) With trade which country sees a fall in the relative price of cloth compared to autarky? Circle either HOME or FOREIGN (3 pts) c) A tariff is placed on the home country's imports. Import tariffs usually increase the internal relative price of the imported good when compared to the initial terms of trade but not so if the terms of trade increase enough (the Metzler paradox) The increase in the terms of trade in the home country has an ambiguous change in welfare increasing terms of trade but tariffs introduce production and consumption distortions. The smaller the country the more likely welfare falls. The trading partner (the foreign country in this case) suffers a decline in its terms of trade and sees a fall in welfare Terms of trade: Home RISES Foreign FALLS (1 pt each) Welfare: Home AMBIGUOUS Foreign FALLS (1 ½ pts each)
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2 d) There is an increase in productivity in the export sector of the home country This is export biased growth in the home country. The terms of trade fall in the home country (more of the exported good is produced at any given relative price than before the increase in productivity). In the foreign country the terms of trade increase and so welfare rises. The change in welfare in the home country is ambiguous as the outward shift in the PPF may not compensate for the fall in the terms of trade (immizerising growth). Terms of trade: Home FALLS Foreign RISES (1 pt each) Welfare: Home AMBIGUOUS Foreign RISES (1 ½ pts each) e) An export subsidy is removed by the foreign country. Export subsidies usually increase the internal relative price of the exported good when compared to the initial terms of trade but not so if the terms of trade fall enough (the Metzler paradox). Hence the reduction of an export subsidy will increase the terms of trade in the foreign country. This increase in the terms of trade results in an unambiguous rise in welfare as the distortions caused by the subsidy also end. The trading partner (the home country in this case) suffers a decline in its terms of trade and sees a fall in welfare Terms of trade: Home FALLS Foreign RISES (1 pt each) Welfare: Home FALLS Foreign RISES (1 ½ pts each) f) The amount of land
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