Discussion Session 8
International Trade
• Suppose that the United States has 200 million units of labor
and Mexico has 100 million units, and that the production of
corn and strawberries per unit of labor for the 2 countries is
as follows:
Mexico
Unites States
Corn
1 kg
2 kgs
Strawberries
3 pints
3 pints
Production Possibility Frontiers
• PPF is a figure representing the tradeoffs in production given fixed
resources.
• Draw the PPFs for the two countries if there is no trade.
Trade – Comparative Advantage
• Suppose that the United States has 200 million units of labor
and Mexico has 100 million units, and that the production of
corn and strawberries per unit of labor for the 2 countries is
as follows:
Mexico
Unites States
Corn
1 kg
2 kgs
Strawberries
3 pints
3 pints
Trade – Comparative Advantage
• Which country has a comparative advantage in corn production? In
strawberries production? Why?
• Comparative advantage refers to the ability of one country to produce
at a lower opportunity cost.
• The US has to give up 1.5 pints of strawberries to produce 1 kg of
corn, while Mexico has to give up 3 pints of strawberries to produce 1
kg of corn. The US has comparative advantage in corn production.
• Mexico has comparative advantage in strawberry production
Trade – PPF with trade
• Suppose the free trade price is 1 kg of corn for 2 pints of strawberries.
Draw a diagram indicating the production possibilities frontier with
and without trade
Fiscal Policy
• Suppose the economy is currently above the potential GDP and the
government wants to pursue discretionary fiscal policy to cool off the
economy. Show this situation using an AD-IA diagram.
Monetary Policy
• Suppose the economy is currently above the potential GDP and the
government wants to pursue monetary policy to cool off the
economy. Show this situation using AD-IA diagram.
Review 1- SAM
• The government has stated that it wants to increase consumption as
a share of GDP. To accomplish this goal, it is considering a new policy
which would remove export incentives and thereby reduce net
exports as a share of GDP.
• Use the spending allocation model (SAM) to show the long-run
effects of the new policy on the spending shares on GDP.
• Show your results graphically using all four graphs and explain in
words including the role of the real interest rate.
Review 2 – AD-IA
• Use the aggregate demand-inflation adjustment (ADIA) model to
show the short-run and long-run effects of the policy on real GDP,
inflation, the real interest rate, and the levels of consumption,
investment, net exports, and government spending.
• Show your results graphically and explain in words. In addition,
please fill out the table below or replicate it on your exam paper.
Y
C
I
X
G
π
R
SR
LR
Review 3- Microeconomics
• Suppose MegaAirways (a monopolist) charges two types of fares for
air travel, business class and economy class. The marginal (and
average) cost of a business class ticket is $150 (constant at all
quantities) while the marginal (and average) cost of an economy class
ticket is $50 (also constant at all quantities).
• Business class travelers have a demand curve given by: Q1 = 550−P1
• While economy class travelers have a demand curve given by: Q2 =
700−2P2
• If the demand curve is P=a+bQ, then the marginal revenue curve is
MR=a+2bQ.
• How many business class and economy class tickets will MegaAirways
offer? What will be the price of business class and economy class
tickets?
• Show graphically the market for business/economy class tickets.
Denote the profit maximizing quantity and price. Indicate on your
graph the deadweight loss and MegaAirways’ profit, if any.
• If MegaAirways could not distinguish between these two types of
customers and only offered one type of ticket, do you think they
would be able to earn more profits, or would this diminish their
profits? Explain.
•Good luck!