Quiz 5 Sample Essay Answers

Economics 3563 Holmes Quiz 5 Sample Essay Answers Note: The following are not the only possible correct answers. Also, they are not necessarily 100% complete. In particular, I didn't completely define all the relevant economic terms; you should do so. Keep these answers and use them to study for subsequent quizzes and the final.

Given the hostile response by the Canadians (reported in the article “you’ve stumped us,” https://libproxy.temple.edu/login?url=http://search.ebscohost.com/login.aspx? direct=true&db=aph&AN=6404770&site=ehost-live&scope=site ) to the U.S. imposition of a tariff on lumber imported from Canada, which graph is more appropriate for explaining the effects on various groups of the tariff: the small country graph or the large country graph? Explain why. The large-country graph is more appropriate since in the small-country case, the tariff would have no effect of the price of Canadian lumber; so there would be no reason for them to complain. In the large-country case, the tariff drives down the price of their export good; thus, lowering national income; so they respond negatively. b. Does the quotation “Its government just can’t get a grip in its timber industry, which is too powerful.” suggest that the tariff has an efficiency justification or that it is protectionist? Explain. It suggests protectionism because it indicates that the reason for the restrictions is the political power of the U.S. timber industry and not any national gain that would compensate for the deadweight losses (a national gain is necessary for an efficiency justification).

Using the large country graph for the case of China importing airplanes (be sure to explain how you know--economics, not geometry--your graph shows a large country, and not a small one.), (See graph 1 on the next page. The graph is for a large country (=buys enough that its purchases affect world price) since Sd+w is upward sloping. Thus, increased (decreased) Chinese demand leads to a higher (lower) world price. Explain which domestic groups (of the three: airplane consumers, airplane producers, and government beneficiaries) gain and which lose in China, why, and how much, if a tariff is imposed on airplane imports? The consumers lose the area a+b+c+d because the domestic price rises in response to the effect of the import tariff increase on demand for domestic airplanes. For the same reason, the domestic airplane firms gain area a. The government beneficiaries gain area c+e because of the taxes collected on the imports; however, only area c is collected from domestic consumers. b. The tariff increase would result in two deadweight losses and a terms-of-trade gain to China as a whole (meaning?). Give an economic explanation for why the gain and each loss occurs. In our story, “China as a whole” refers to the sum of the gains minus the losses for each of the three groups in the country. Area b is the deadweight loss (definition?) to China due to producing the additional airplanes domestically at a cost above the world price (= world cost) and d is the deadweight loss due to lost consumer surplus as consumption is reduced, These losses are countered in part by the gain of the part of the tax (e) being borne by foreign sellers due to the world price dropping in response to the tax (= improvement in China’s terms of trade since airplanes are an import AND?).

Using (= label and use the labels in your written answer) a graph and the gains-from-trade story, explain why, and in what specific sense, there is a net gain to the U.S. if it removes a quota on imported sugar? See graph 2 below. Trade barriers reduce the degree of specialization (import-competing production increase; so production for export will also fall) and therefore the gains from specialization by areas b, d, and (maybe) parts of c, depending on who gets the quotas (=?). The U.S. will be able to consume more (or it gains consumer plus producer surplus) if the quota is removed; specifically because it is now importing the sugar that cost more (in other output) to produce than to import (area b) and it is consuming more sugar at a cost less than the benefit of doing so (area d). Explain why this does not mean that everyone in the U.S. gains by removal of the quota (hint: what does “net” refer to?). In particular, using the factor-price-equalization prediction (give the general version and then apply it), explain why U.S. workers in general are worse off with the quota removed. (Assume sugar is an labor-intensive good.) While total U.S. consumer surplus is increased because of the price decrease, other groups will lose (but less than consumers gain; so gains-losses = net gain to the U.S.). In particular, since the U.S. is importing a labor-intensive good, by the factor-proportions story, labor must be scarce in the U.S; so by the factor-price-equalization story, wages in general are higher with the quota.

Graph 1

Graph 2