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Unformatted text preview: UNIVERSITY OF SOUTHERN CALIFORNIA
Marshall School of Business
FBE 462 – International Trade & Commercial Policy Answers to Problem Set #4
1. If the world price declines from $100 to $90, the revenue per unit exported declines from
$120 to $110, which is also the new price paid by domestic consumers of the product.
Because of the decline in revenue per unit, domestic quantity produced declines from 190
million to 175 million. Because of the decline in the domestic price, domestic quantity
consumed rises from 50 million to 60 million. Quantity exported declines from 140
million to 115 million. Because of the decline in revenue per unit and the decrease in
quantity produced, domestic producer surplus declines by area ACGE. Because of the
decline in price and the increase in quantity consumed, domestic consumer surplus
increases by area ABFE. Because of the decrease in the quantity exported, the cost to the
government of paying the export subsidy declines from area BCLH to area FGUN. The
production inefficiency changes from area CLK (using the efficiency standard of $100,
the initial world price) to area GUT (using the new efficiency standard of $90, the new
world price). The consumption inefficiency changes from area BJH to area FRN. If the
domestic supply and domestic demand curves are straight lines, the sizes of the
inefficiencies are the same at the new world price as they were at the initial world price
A B C
G F E J H L K initial world price
new world price N R T U Dd
50 60 175 190 Quantity FBE 462 Problem Set #4 Answers 2. a) With free trade, price is P0 and the quantity exported and imported is M0. The export
subsidy “artificially” shifts the export supply curve down to SX’. (The original SX curve
still shows the resource cost of exports, but the foreign exporters are willing to sell at the
lower market prices shown by SX’ because the foreign government also pays them the
export subsidy.) The international market price falls to P1 and the quantity traded
increases to M1. c) The countervailing duty returns the market to P0 and M0. This is good for the world, because the marginal resource cost of the last unit exported (shown by the height of SX at
M0) just equals the marginal benefit of that unit to the buyer (shown by the height of DM
at M0). We return to the economic efficiency of the free-trade outcome. The export
subsidy alone caused a global economic inefficiency equal to triangle ABC, the
inefficiency of too much exporting. In comparison with just the export subsidy, the
countervailing duty can increase the well-being of the importing country, in the same
way that a tariff can increase the well-being of a large country. By imposing the
countervailing duty, the importing country loses triangle ACF and gains rectangle
P1FEPS. The importing country gains if the rectangle is larger than the triangle. 2 FBE 462 Problem Set #4 Answers 3. There are three relevant types of countries—the embargoing countries that otherwise
would import, the non-embargo importing countries, and the target country (say, Iraq).
Before the embargo (free trade), the world price is P0. When the embargo is imposed, the
price in the embargoing countries rises to P2, and the price that Iraq gets for its exports to
the non-embargo countries falls to P1. The cost of the embargo to the embargoing
countries is area a. The loss to Iraq from exporting less at a lower price is area (b + c).
The embargo is more powerful if area (b + c) is larger, and this is larger if Iraq’s export
supply is less elastic, the non-embargo countries’ import demand is less elastic, or the
embargoing countries’ import demand is more elastic. This last condition probably also
makes it easier for embargoing countries to do without Iraq’s products during the
embargo, because area a is probably smaller. 4. Trade embargoes are usually imposed by large countries that are important in the trade of
the target country. An embargo has a better chance to succeed if it is imposed suddenly
rather than gradually, because a sudden interruption of economic flows damages the
target country by a large amount for some time before it can develop alternatives (in
economic terms, for a good that the target imports, its import demand is inelastic in the
short run, and the elasticity of alternative export supplies may be inelastic in the short run
as well). 5) The following condition must be satisfied in order for the dumping to occur:
a) The domestic and foreign markets must be integrated.
b) The producer faces perfect competition in the domestic as well as in the foreign markets.
c) The elasticity of demand is higher in the domestic market than in the foreign market.
d) The elasticity of demand is lower in the domestic market than in the foreign market. 3 FBE 462 Problem Set #4 Answers 6) Suppose the cost of oil in Mexico is $4.00 per barrel, in the U.S. it is $3.00 per barrel.
Suppose Canada has an import tariff of $2.00 per barrel on oil. The price of oil in Canada
d) $9.00. 7) Which one of the following would imply the free mobility of labor and capital among the
a) Free Trade Area
b) Custom Union
c) Common Market
d) WTO participating countries 8) Suppose that Airbus and Boeing are the only two airplane producers in EC and US
respectively. If both Airbus and Boeing produce, then both Airbus and Boeing will lose
$5.00. If one of them produces but the other does not, then the one produces will gain $100
profit and the other will get zero. If none of them produces, then of course, both will get zero.
Assume that Boeing starts producing airplane first. Then
a) Airbus will not enter the market.
b) Airbus will enter the market and drive Boeing out.
c) Both Airbus and Boeing will be in the market to produce airplane.
d) Airbus may or may not enter the market. 9) Use the information in problem 8. Suppose the U.S. provides $25 subsidy to Boeing and EC
provides $25 to Airbus. Then
a) the total real income (welfare) of the world will be $40.
b) the total real income (welfare) of the world will be $125.
c) the total real income (welfare) of the world will be -$10.
d) the total real income (welfare) of the world will be 0. 4 FBE 462 Problem Set #4 Answers 10) In the following diagram, D is the Mexican domestic demand. S(KO) is the supply curve of
Korea and S(US) is the supply curve of US. Suppose that initially there is a $5 tariff imposed
on import. Assume that Mexico does not produce this product. P 15
a 14 b c S(US) d e $10 S(KO)
D A B C a. Suppose that Mexico form a Free Trade Area with US. Will Mexico be better (or worse)
off? By how much?
If Mexico form a FTA with US, Mexican consumer surplus will increase by a+b. But it
will lose tariff revenue by a+c. Thus Mexican will gain: b - c
b. What does this exercise tell you?
Lowering tariff to one country but not to others will not necessarily increase the welfare.
c. Under what circumstances, a nation is more likely to be better off when joining a Free
If b is larger than c, then the country is better off by joining the FTA. If trade creation
(contribute to gains b) is larger than trade diversion (contribute to gains c), then the
country is better off. 5 ...
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This note was uploaded on 02/15/2011 for the course FBE 462 at USC.