Problem Set 5_Answers


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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 #5 1. (a) The shaded loss area b is now $15 million. Free trade makes the country better off, because the usual gain from trade (area a, equal to $25 million) is larger than the loss from increased pollution ($15 million). (b) If there is no way to reduce pollution per ream of paper produced, then the first-best outcome can be achieved if the government imposes a tax of $0.05 per ream produced domestically. This shifts the domestic supply curve up to (Sd + $0.05). The country should still export paper, but the amount that it should export is less. With the tax, the country will produce 2.15 billion reams domestically at the international price $1.10, so it will export 350 million reams. 2. (a) The governments should determine the social side costs imposed by the pollution on both countries combined, and impose this as a tax per unit of pollution emitted by the cement producers. When the tax is imposed, the cement producers will adopt the lowerpollution technology, if its cost is less than the tax. The price of cement will increase as the tax and the new technology (if adopted) increase the costs recognized by the cement producers. Pollution will decline to its appropriate level (probably not zero) because the higher price reduces quantity demanded, so production declines, as well as because pollution is lower if the new technology is adopted. (b) If the Pugelovian government must fashion a solution on its own, it should consider restricting its imports of cement from Lindertania. This is not the first-best solution. It does not create any incentive to adopt the lower-pollution technology. But it can lower Lindertania’s production, so pollution will be lower. This brings a net gain to Pugelovia if the gains from lower pollution are greater than the usual losses from restricting imports. 3. Two forces are likely to drive toward a deteriorating terms of trade—a decrease in the prices of the primary product exports relative to the prices of the manufactured good imports. First, the global demand for primary products is likely to rise more slowly than the global demand for manufactured goods will rise, as global incomes rise, because primary products have lower income elasticities of demand (Engel’s Law). Second, new synthetic substitutes are likely to be developed for some of the primary products, lowering global demand for the primary products. Two forces are likely to drive toward an improved terms of trade. First, natural limits could restrain global supply of some primary products. Second, slow growth in primary-product productivity is likely to limit FBE 462 Problem Set #5 Answers cost decreases, so primary product prices do not fall as much as (or rise more than) the cost and prices of manufactures that experience more rapid productivity growth. In addition, more rapid quality improvements in manufactured products effectively increase the country’s terms of trade. 4. The reduction in the annualized cost of migration would lead to more migration (the number of migrants would be greater than 20 million). In the new equilibrium, with a smaller gap (c), the wage rate after migration would be greater than $3.20 in the South, and less than $5.00 in the North. Each of the areas of gain and loss (a, b, d, e, and f) would be larger. 5. The migrants don’t gain the full Southern wage markup from $2.00 to $3.20 because some of their extra labor was supplied only at the marginal cost of their own time that rose from $2.00 to $3.20. That’s shown in the figure by the fact that the curve Sr+ Smig leans further out to the right than does the curve Sr. As for the full international wage gain from $2.00 up to $5.00, it is true that the migrants do get paid that full extra $3.00. However, $1.80 of it is not a real gain in their well-being. It’s just compensation for the economic and psychic costs of migrating. 6. This statement is probably false. The migrants do improve their economic well-being. But once they leave they are no longer part of the sending country. The sending country can lose in two ways. First, analysis of the labor-market effects of emigration indicates that, while workers remaining in the sending country gain, employers and others in the sending country lose more, so the net effect on the sending country is a loss. Second, the net fiscal effect of emigration is probably a loss for the sending country. The emigrants have often received education paid for by the government, but the emigrants shift to paying taxes to the receiving-country government once they leave. We should also note one major way that the sending country can gain—emigrants often send back remittances to relatives and friends. The overall effect on the sending country is then unclear, but a loss is likely in many cases. 2 ...
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