Problem Set 1: Trade Policy: Large Country

Homework 7

UCDavis, 160a, Spring 2008 Prof. Farshid Mojaver Problem Set 1: Trade Policy: Large Country Problem 1 On the following page of this problem set there is a three panel graph. In the left hand panel are the demand and supply curves in the Home country for some good Q. In the right hand panel are the demand and supply curves for the Foreign country for the same good. Both Home and Foreign are "large" countries.

A. a. In the middle panel, draw the import demand (MD) and export supply (XS*) curves for Home and Foreign, respectively. Be sure to label the curves. b. Label the equilibrium world price in free trade as PoW, and indicate quantities consumed (QD) and produced (QS) in each country, as well as the quantity of good Q traded (label this Mo).

B. Suppose that Foreign imposes a specific export tax of $t. a. Show the new equilibrium price in Home and in Foreign, plus the new level of good Q traded (label this M1). Also indicate the new quantities produced and consumed in each country. b. Label the areas in the right hand panel. Relative to free trade, what is the i. change in Foreign consumer surplus? ii. change in Foreign producer surplus? iii. change in the Foreign government’s revenue? iv. total change in Foreign’s welfare. Explain why/whether Foreign’s export tax makes Foreign better off. c. Label the areas in the left hand panel. Relative to free trade, what is the i. change in Home consumer surplus? ii. change in Home producer surplus? iii. change in Home government’s revenue? iv. total change in Home welfare? Explain why/whether Foreign’s export tax makes Home worse off. d. Define global welfare as the sum of consumer surpluses, producer surpluses, and government revenues for each country. Using the labeled areas from the graph, what is the effect of the export tax on global welfare? Does the export tax raise/lower/have an ambiguous effect on global welfare?

C. Indicate on the graph above the VER that would be equivalent to Foreign’s export tax t. a. Would Home be better off/worse off/indifferent if Foreign used a VER instead of an export tax? Explain. b. Would Foreign producers be better off/worse off/indifferent if Foreign used a VER instead of an export tax.? Explain.

Problem Set 2: Trade Policy: Export Subsidy, Quota and Monopoly 1. The graph below shows an equilibrium point, B, corresponding to the intersection of Home import demand and Foreign export supply. In this exercise we compare two potential export supply curves: X1* and X2*.

a) Which export supply curve has a higher elasticity of export supply at point B. Interpret the meaning of this difference in words. b) Suppose that the Home country imposes a tariff of t. Show the effect on both export supply curves of the tariff. c) Draw the Home supply and demand diagram for this good beside (to the left of) this graph. Illustrate on your graphs the price seen by Home consumers and price received by Foreign producers. d) What can you say about the relationship between the elasticity of Foreign export supply and the amount of the tariff absorbed by Foreign producers?

2. 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.

3. Extend question 2 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. h) Quota of M in a small country, but with Home monopoly.

4. Ceteris paribus (i.e. all else unchanging), describe the impact of each of the following outcomes of the Hong Kong WTO meeting on world prices and domestic prices of a large country: a) The abolition of agriculture export subsidies b) The reduction of agricultural tariffs c) Duty-free quota-free access for 97% of goods originating in the world’s least developed countries

5. Consider a large country with export subsidies in place for agriculture. Suppose the country changes its policy and decides to cut its subsidies in half. a) Are there gains or losses to the large country, or is it ambiguous? What is the impact on domestic and foreign prices for agriculture? b) Suppose a small food-importing country elsewhere reciprocates by lowering its tariffs on agriculture by the same amount. Are there gains or losses to the small country, or is it ambiguous? Is there a net overall gain? c) Suppose a large food-importing country elsewhere reciprocates by lowering its tariffs on agricultural goods by the same amount. Are there gains or losses to this large country, or is it ambiguous? Is there a net overall gain?

Problem Set 3: Trade Creation and Diversion, Strategic trade 1. As a result of political and economic liberalization in Eastern Europe, it seems increasingly likely that Eastern European nations such as Poland and Hungary may join the European Union in the near future. Discuss the potential economic costs of such an expansion of the European Union, from the point of view of (1) Western Europe; (2) Eastern Europe; and (3) other nations (like the U.S.).

2. The U.S. Commerce Department has urged that the United States provide special support for high-technology industries. It argues that these industries have the prospects of rapid future growth, provide inputs to many other industries, and generate technology that benefits the whole economy. Furthermore, some U.S. high-technology industries such as aircraft and microelectronics face challenges by government-supported foreign competitors. Which of these arguments might be valid reasons for the United States to have a policy targeting these industries?

3. Does the U.S. military budget help or hurt the strategic position of U.S. high- technology industries? Make the case for either point of view.

4. Suppose that the European Commission asked you to develop a brief on behalf of subsidizing European software development –bearing in mind that the software industry is currently dominated by U.S. firms, notably Microsoft. What arguments would you use? What are the weaknesses in those arguments?

Political Economy You are employed as an economic advisor of a presidential candidate in the Unites States. One of the issues you need to take a stand is the threat of Chinese imports to US manufacturing products. A number of labor unions demand a substantial increase in the import tariff rates on such products. a) What is your advice to the presidential candidate 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?