Short_questions_on_Chapter_5_6___7

Short_questions_on_Chapter_5_6___7 - Chapter 5 1 Assume...

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Chapter 5: 1. Assume that Norway and Sweden trade with each other, with Norway exporting fish to Sweden, and Sweden exporting Volvos (automobiles) to Norway. Illustrate the gains from trade between the two countries using the standard trade model, assuming first that tastes for the goods are the same in both countries, but the production possibilities frontier differ: Norway has a long coast that borders on the north Atlantic, making it relatively more productive in fishing. Sweden has a greater endowment of capital, making it relatively more productive in automobiles. Solution: Welfare in both countries increases as the two countries move from production patterns governed by domestic prices (dashed line) to production patterns governed by world prices (straight line). 5. Japan primarily exports manufactured goods, while importing raw materials such as food and oil. Analyze the impact on Japan’s terms of trade of the following events: a. a war in the Middle East disrupts oil supply. b. Korea develops the ability to produce automobiles that it can sell in Canada and the United States. c.U.S. engineers develop a fusion reactor that replaces fossil fuel electricity plants. d. A harvest failure in Russia. Solution: The terms of trade of Japan, a manufactures ( M ) exporter and a raw materials ( R ) importer, is the world relative price of manufactures in terms of raw materials ( p M / p R ). The terms of trade change can be determined by the shifts in the world relative supply and demand (manufactures relative to raw materials) curves. Note that in the following answers, world
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relative supply (RS) and relative demand (RD) are always M relative to R . We consider all countries to be large, such that changes affect the world relative price. a. Oil supply disruption from the Middle East decreases the supply of raw materials, which increases the world relative supply. The world relative supply curve shifts out, decreasing the world relative price of manufactured goods and deteriorating Japan’s terms of trade. b. Korea’s increased automobile production increases the supply of manufactures, which increases the world RS. The world relative supply curve shifts out, decreasing the world relative price of manufactured goods and deteriorating Japan’s terms of trade. c. U.S. development of a substitute for fossil fuel decreases the demand for raw materials. This increases world RD, and the world relative demand curve shifts out, increasing the world relative price of manufactured goods and improving Japan’s terms of trade. This occurs even if no fusion reactors are installed in Japan since world demand for raw materials falls. d. A harvest failure in Russia decreases the supply of raw materials, which increases the world RS. The world relative supply curve shifts out. Also, Russia’s demand for manufactures decreases, which reduces world demand so that the world relative demand curve shifts in. These forces decrease the world relative price of manufactured goods and deteriorate Japan’s terms of trade.
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