Name:_____________
SSI 2007, 160A Final Professor Farshid Mojaver
Problem 1: Ricardian Model [12 points total, 2 pts each part]
Answer the following questions using the information implicit in the following PPF curves for Home and Foreign:
a) Suppose that the number of workers doubles in Home.
(i)What happens to the Home PPF
Shifts out parallel to itself.
(ii)What happens to the no-trade relative price of grain?
Does not change.
b) Suppose that there is technological progress in the grain industry, so that Home can produce more grain with the same amount of labor.
(i)What happens to the Home PPF (show this in the figure above)
Home PPF pivots out: same cloth more grain.
(ii)What happens to the Home opportunity cost of grain production?
Falls
(iii)What happens to the after-trade relative price of grain?
It falls if it is a large country.
(iv)Assuming the country in question is a small country what happens to the ratio of Home-Foreign wage rates? Explain your answer.
W/W* = (MPLG↑ / MPL*C ) x ToT => W/W* rises
Problem 2: Sector Specific Model [12 points total, 8 and 4]
In the specific factors model where labor and land are used to produce Food and labor and capital are used to produce Manufacturing products, suppose that price of manufactured goods falls while the price of agriculture is unchanged (i.e. ΔPM/PM < 0 and ΔPA/PA = 0).
a) Arrange the following terms in descending order:
ΔRT/RT , ΔRK/RK , ΔPA/PA , ΔPM/PM , ΔW/W
ΔRT/RT > 0 = ΔPA/PA ΔW/W ΔPM/PM ΔRK/RK
b) How does the marginal productivity of capital (MPK) change and why?
as PM↓=> LM↓=> K/LM ↑=> MPK↓
Problem 3: Heckscher-Ohlin Model [10 points]
Using a graph show that an in crease in the relative price of capital intensive computer to labor intensive shoe will reduce Wage-Rent ratio, that is: PC/PS↑ W/R↓.
- Higher computer prices leads to higher Computer production (and lower Shoe production):PC/PS↑ QC/QS ↑ RD for (L/K)↓ with fixed RS W/R↓
Problem 4: Outsourcing [9 points total]
Consider an outsourcing model where the Home country has a higher relative wage of skilled labor than the Foreign country (like China) and the costs of capital and trade are uniformly higher than Foreign.
(a)What kind of good will be outsourced from Home country on the value chain? That is, will the Home country outsource skilled labor-intensive or unskilled labor-intensive production activities? Explain.
Home country will outsource high activities on the value chain, i.e. skilled labor-intensive production activities. Because the Home country has a higher relative wage of skilled labor than Foreign country, it is less economical to carry out skilled labor-intensive production domestically.
(b)Suppose that the Home country uniformly increases its tariff level, effectively increasing the cost of importing all goods and services from abroad. How does this affect the “slicing” of the value chain?
This will push the dividing line towards the high ending of the value chain, i.e. the Home country reduces outsourcing skilled labor-intensive production activities.
(c)Draw relative labor supply and demand diagrams for the Home and Foreign countries showing the effect of this change. What happens to the relative wage in each country?
As shown in the figure, a rise in the tariff level in the Home country will result in an increase in the relative demand for skilled labor in both countries, which leads to a higher relative wage of skilled labor in both countries.
Problem 5: Monopolistic Competition [12 points, 6 pts each]
Consider the long-run trade equilibrium in the monopolistic competition model as illustrated below. Consider a situation where the foreign and domestic demand for a particular good decrease. For instance, suppose that this is the market for cars and higher gasoline prices result in lower demand.
a)In the Figure below and show what happens when this change in demand occurs. Specifically, show which curve(s) shift.
As the result of decreased demand, both market and firm demand curve will shift to the left, and the corresponding firm marginal revenue curve will also shift leftward. A typical firm will charge a price P’ and sell Q’. If every firm cuts price to P’, the quantity sold is then Q’’, and all firms make negative profits. Subsequently some firms will quit and the market demand curve as well as the firm demand curve shift back (rightward).
b) If the old equilibrium is at point C, describe where the new long run equilibrium occurs, and what has happened to the number of firms and the price they charge.
Less firms, higher price.
Problem 6: Export Subsidy [6 points]
Suppose the EU, South Korea, Japan, and US have reduced their agricultural export subsidy. Discuss the effects of this reduction on national welfare of
(i) EU, South Korea, Japan, and US,
National welfare increases because of improved efficiency (less efficiency loss) and possible gains in Terms of Trade
(ii) land-rich developing countries
National welfare increases because of improved TOT
(iii) land poor developing countries
National welfare decreases because of increased imported food prices
Problem 7: Preferential Trade Agreements [8 points]
Show that under perfect competition a U.S.-Mexico free trade agreement could be harmful for US and beneficial for Mexico.
Problem 8a: Trade Policy [8 points]
Assuming perfect competition in the Home industry, rank the following in ascending order of Home welfare and justify your answers. If two items are equivalent, indicate as such accordingly.
a)Quota of M in a small country, with quota licenses distributed to non-rent-seeking Home firms.
b)Quota of M in a small country, with quota licenses auctioned.
c)Quota of M in a small country, with the responsibility of implementing the quota given to the exporting country.
d)Quota of M in a small country, with quota licenses distributed to rent-seeking Home firms.
Measured in total national welfare, from lowest to highest: (c) < (d) < (a) = (b).
Case a) and b) have the same welfare effect, where rent is earned by domestic residents without (significant) loss.
Case d) incurs some waste in the process of rent-seeking, which could be as large as the rent. In case c) all rent is earned by foreigners.
Problem 8b: Trade Policy [14 points]
Extend question 8a by also ranking the three tariff scenarios listed in d), e) and f), under perfect competition, and the quota in h) with imperfect competition. Compare each of these to the quotas in a), b), c) and d). If two items cannot be ranked, just indicate that.
a)Quota of M in a small country, with quota licenses distributed to non-rent-seeking Home firms.
b)Quota of M in a small country, with quota licenses auctioned.
c)Quota of M in a small country, with the responsibility of implementing the quota given to the exporting country.
d)Quota of M in a small country, with quota licenses distributed to rent-seeking Home firms.
e)Tariff, t, in a small country corresponding to the quantity of imports M.
f)Tariff, t, in a large country corresponding to the same quantity of imports M.
g)Tariff, t’, in a large country corresponding to the quantity of imports M’>M.
First of all, case e) has the same welfare effect as case a) and b).
Case f) has a higher national welfare than cases a), b) or c) does, because a large country can benefit from the improvement of terms of trade when setting a tariff.
But we cannot say which one of case f) and g) is better, since we have no idea about the export elasticity and thus the optimal tariff.
Neither can we compare case g) and e). As for case h), it incurs an efficiency loss compared to cases a), b) and e), since quota splits the market and now the domestic firm can act as a monopoly firm and thus lead to a dead weight loss.
Summary (ordered by total national welfare):
f) > a) = b) = e) > d) > c)
g) ? f), g) ? e)
a) = b) = e) > h)
Illustration: case e) vs. case f)
Net welfare change in case e): – (b + d)
Net welfare change in case f): e – (b + d)
Problem 9: Political Economy using HO model [9 points]
You are employed as an economic advisor of a presidential candidate. Some interest groups demand a substantial increase in the import tariffs but consumer of course like a reduction in such rates.
a)What would your advice regarding import tariff rates if you were an economic and political advisor Sweden and why?
b)How would your advice change if you were employed by a major party in India given that income distribution is less equal in India and that India imports capital intensive goods?
c)How would your advice change if you were employed by the government of China, where income distribution is more equal but most of the enterprises are state-owned?
Here you goal to maximize the votes that you can get and not necessarily economic efficiency/welfare. In getting peoples vote you consider two factors: median voter and contribution of political lobbyists. The interests of the median voter and the lobbyists are against each other. The question is which side you want to lean.
a)Using the median voter model of Mayer we know that when income distribution is relatively equal like that of US, an increase in tariff would be opposed by the median voter. Empirical studies of Maggi show that the weigh of consumer welfare in the government objective function in US is between 50 to 100 times higher than that of political contributions. So to be popular with the voters your trade policies should represent the interest of consumers 50 to 100 times that of the lobbyists. You do not go with the idea of increasing tariff rates on Chinese imports, except for very special items where you can get a handsome campaign contribution without antagonizing the consumers.
b)In India income distribution is less equal than US. Plus they import capital intensive products. From the median voter model of Mayer we know that an increase in import tariffs would be opposed by the medium voter in India. So just like part (a) you do not support tariff increase on imports except for selected special items.
c)Maggi empirical work shows that the state-owned enterprises have a weight that is 4 to 7 times greater than that given to consumers. In China actually it is not the people that elect you. You want to be popular with the power houses that help you get the premier job. Hence if the state-owned enterprises ask for an increase in import tariff you do it most of the time.