hw01 - Homework #1: Answers 1. With reference to the home...

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C F . E F M X Figure 2.3 Homework #1: Answers 1. With reference to the home country’s trade triangle illustrated in figure 2.3, suppose the world relative price of clothing stays at the slope shown by the line CED . How would the home country’s volume of imports and exports be altered if: a. a fire destroyed 10% of the clothing endowment? (3 points) or The figure illustrates that both imports and exports are smaller and, thus, the trade triangle is smaller.
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b. a bumper harvest expanded food production by 10%? (3 points) The trade triangle is again smaller. This time because the country’s endowment of the importable good rose. Thus, in both cases, the country’s endowment approaches the country’s preferred consumption bundle at the given prices. 2. Referring to the previous exercise, if a fire destroys quantity GE of clothing in Figure 2.3, will the home country cease to trade if the world relative price of clothing is shown (again) by the slope of the line CED ? (3 points) As the diagram illustrates, expoliting homotheticity, there is still positive trade. For trade to be extinguished, the endowment of C would have to fall to point H . At that point, the endowment contains the same proportion of F to C that the country chooses to consume at given prices.
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3. In a pair of diagrams such as Figures 2.3 and 2.4, illustrate the mutual gains from trade if: a. tastes are similar between countries but endowments differ (3 points); and This diagram illustrates how two countries with the same tastes, but different endowments can trade to mutual gain. Note that, in this case, the countries will end up consuming more similar bundles of goods than they would in autarky. If preferences are homothetic, they will consume Food and Clothing in the same proportions. Can you explain why? b. tastes are different but endowments are the same. (3 points) Note that in this case, the countries end up consuming more different bundles of goods than that (identical) bundle with which they were each endowed. Although the curves are somewhat dubiously drawn (espeicall the one with an intersecting pair) the diagram shows
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balance trade, which is an essential property of equilibrium. 4. In Figure 2.5, a positively sloped curve is drawn to show the foreign supply of exports of food rising as the price of food rises. How can this response be reconciled with the chapter’s assumption that each nation’s production of commodities is fixed with respect to price? (3 points) Recall that excess supply (i.e. export supply) is defined as and that ( 29 E F D S F = - , demand is itself a decreasing function of price (as well as an increasing function of income). Thus, as the relative price of food rises, and assuming that income effects are small in the neighborhood of the equilibrium, consumer demand falls. Combined with the fixed quantity of the food endowment, this implies an upward sloping export supply curve (at least until the income effect kicks in).
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This note was uploaded on 02/16/2012 for the course ECON 464 taught by Professor Maria during the Spring '08 term at Wisconsin.

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hw01 - Homework #1: Answers 1. With reference to the home...

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