CDAE 272
International Economic
Development
Spring 2008
Class 12
Feb. 21
Last class
3. Economic concepts and methods
Quiz 3
Today:
Result of Quiz 3
3. Economic concepts and methods
4. International trade theories
Next class:
Quiz 4 (Sections 3.5 and 3.6)
4. International trade theories
Readings:
Important date: Problem set 2: due Tuesday, Feb. 26
Result of Quiz 3
N = 40
Range = 4.5 – 10
Average = 8.4
1. Major difference between a normal good and an inferior good:
“Normal good: prices increases when income increases.”
“Normal good = toilet paper, you buy it regardless of the price.”
“Normal good: demand increases when price increases.”
“Normal good: demand increases when price decreases.”
“Normal goods are purchased by people with high income and inferior goods are …”
“Normal good: good with high demand elasticity.”
“Normal good = seafood, inferior good = tuna fish.”
“Normal goods are preferred to inferior goods.”
2. Which of following examples is a good explanation of “consumer surplus”?
(a) Kevin bought a $50 DVD player when it was 20% off, his CS = $10.
(b) Kevin received a $50 DVD player as a birthday gift, his CS = $50.
(c) Kevin was expecting to pay $50 for a DVD player but the price was only
$45 when he bought it, his CS = $5.
(d) Kevin saved $50 to buy a DVD player but the price went up to $60 when he went to
the store, his CS = -10.
Result of Quiz 3
3. Supply and demand in a market
(a) Draw a graph to show the supply and demand functions
(b) Derive P* and Q*
(c) Calculate the CS and PS
(d) Shift in the demand curve due to a change in the price of
another good.
4. Calculate the change in CS due to a change in the price.
3. Economic concepts and methods
3.1.
3.2.
3.3.
3.4.
3.5.
3.6.
3.7.
An overview of an economic system -- How does it work?
Demand and supply
Market equilibrium and price determination
Excess supply and excess demand
Consumer and producer surplus
Impacts of market interventions
International trade & price determination
3.6. Market interventions
3.6.4. Impacts of a sales tax (e.g., $1.5 per unit)
-- Notations:
-- Total price paid by consumers: Pcon
-- Net price received by producers: Pprod
-- Sales tax: t = Pcon - Pprod
-- Total tax revenue: T = t * Q
-- A graphical analysis
-- Consumers: worse off (a decrease in CS)
-- Producers: worse off (a decrease in PS)
-- Government: better off
-- How about the total welfare (CS+PS+T)?
-- A mathematical analysis:
A mathematical analysis of the effects of a sales tax
Demand: Qd = 13 - 1.0 P => Qd = 13 - 1.0 Pcon
Supply: Qs = -2 + 0.5 P => Qs = -2 + 0.5 Pprod
(1) When there is no sales tax, Pcon = Pprod = P
Qd = Qs => 13 - 1.0 P = -2 + 0.5 P => P* = 10 => Q* = 3
CS =
PS =
CS + PS =
(2) When there is a sales tax of $t per unit (e.g., t = 1.5)
t = Pcom - Pprod = 1.5 or Pcom = Pprod + 1.5
Qd = Qs ==> 13 - 1.0 Pcon = -2 + 0.5 Pprod ==>
13 - 1.0 (Pprod + 1.5) = -2 + 0.5 Pprod
==> Pprod = 9 ==> Q = 2.5 Pcon = 10.5
New CS =
New PS =
T=
Changes in CS, PS, T and CS + PS + Tax revenue
Take-home exercise
(Tuesday, Feb. 19)
Suppose a market has the following supply and
demand functions
Demand: Qd = 15 - 1.5 P
Supply: Qs = -1 + 0.5 P
(a) What are the equilibrium quantity (Q*) & price (P*)?
(b) What are the CS and PS at the equilibrium?
(c) If a tax of $0.8 per unit is imposed, what will be the
changes in CS, PS and total welfare (CS+PS+T)?
3.6. Market interventions
3.6.5. Impacts of a price subsidy (e.g., $1.5 per unit)
-- Notations:
-- Total price paid by consumers: Pcon
-- Net price received by producers: Pprod
-- Price subsidy: s = Pprod - Pcon
-- Total subsidy cost = s * Q
-- A graphical analysis
-- Consumers: better off (an increase in CS)
-- Producers: better off (an increase in PS)
-- Government: worse off
-- How about the total welfare (CS+PS+Sub. cost)?
-- A mathematical analysis:
A mathematical analysis of the effects of a price subsidy
Demand: Qd = 13 - 1.0 P => Qd = 13 - 1.0 Pcon
Supply: Qs = -2 + 0.5 P => Qs = -2 + 0.5 Pprod
(1) When there is no subsidy, Pcon = Pprod = P
Qd = Qs => 13 - 1.0 P = -2 + 0.5 P => P* = 10 => Q* = 3
CS =
PS =
CS + PS =
(2) When there is a price subsidy of $t per unit
s = Pprod - Pcon = 1.5 or Pcom = Pprod - 1.5
Qd = Qs ==> 13 - 1.0 Pcon = -2 + 0.5 Pprod ==>
13 - 1.0 (Pprod - 1.5) = -2 + 0.5 Pprod
==> Pprod = 11 ==> Q = 3.5 Pcon = 9.5
New CS =
New PS =
Sub. cost =
Changes in CS, PS, T and (CS + PS + sub. Cost)
Take-home exercise
(Thursday, Feb. 21)
Suppose a market has the following supply and
demand functions
Demand: Qd = 17 - 1.5 P
Supply: Qs = -1 + 0.5 P
(a) What are the equilibrium quantity (Q*) & price (P*)?
(b) What are the CS and PS at the equilibrium?
(c) If a price subsidy of $0.8 per unit is imposed, what
will be the changes in CS, PS and total welfare
(CS + PS + sub. cost)?
Impacts of government interventions
Qs
Qd
Q*
P*
CS
PS
Total
welfare
No intervention
Q*
Q*
Q*
P*
CS
PS
CS+PS
Floor (min.) price (PF)
If PF < P*
If PF > P*
No impact
↑
↓
↓
↑
↓
?
↓
Ceiling (max.) price (Pc)
If PC > P*
If PC < P*
No impact
↓
↑
↓
↓
?
↓
↓
Sales tax ($t/unit)
↓
↓
↓
↑
↓
↓
↓
Price subsidy ($s/unit)
↑
↑
↑
↓
↑
↑
↓
4. International trade theories
4.1.
4.2.
4.3.
4.4.
4.5.
4.6.
4.7.
4.8.
Simple examples: two-person cases
Absolute and comparative advantages
Trade between two countries
The sources of comparative advantage
Other explanations for international trade
Trade between two nations
Measurement of the gains from trade
Exchange rate and its determination
4.1. Simple examples -- two-person cases
Example 1:
Suppose Kevin and Mark have just completed the
data collection and analysis for a group project and
are ready to write the project report that will include
18 pages of text and 10 graphs. Here are the
estimated rates for both Kevin and Mark:
Text
Graphs
Kevin
2 pages/hr.
2 graphs/hr.
Mark
3 pages/hr.
1 graph/hr.
50/50 share with no specialization:
Kevin: 9 pages of text and 5 graphs ==> 7 hrs
Mark: 9 pages of text and 5 graphs ==> 8 hrs
4.1. Simple examples -- two-person cases
With specialization:
For example:
Kevin: 8 graphs & 2 pages of text ==> 5 hrs
Mark: 2 graphs & 16 pages of text ==> 7.3 hrs
OR
Kevin: 10 graphs and no text ==> 5 hrs
Mark: 18 page of text and no graph ==> 6 hrs
In this case, Kevin is more productive in graphs and
Mark is more productive in text. When each person
is more productive in one production, trade and
specialization can benefit both of them.
4.1. Simple examples -- two-person cases
Example 2:
Suppose Ashley and Helen are another group for the
same project (18 pages of text and 10 graphs) with
the following estimated rates:
Ashley
Text
2 pages/hr.
Graphs 1 graph/hr.
Helen
3 pages/hr.
2 graphs/hr.
50/50 share with no specialization:
Ashley: 9 pages of text & 5 graphs ==> 9.5 hrs
Helen: 9 pages of text & 5 graphs ==> 5.5 hrs
Helen is more productive in both text & graphs but Ashley is
less productive in both text & graphs. Can specialization
4.1. Simple examples -- two-person cases
With specialization:
Ashley: 14 pages of text & 2 graphs ==> 9 hrs
Helen: 4 pages of text & 8 graphs ==> 5.33 hrs
OR
Ashley: 18 pages of text & no graph ==> 9 hrs
Helen: 10 graphs and no text ==> 5 hrs
Ashley is less productive in both text and graphs but
is RELATIVELY more productive in preparing text
(Helen is more productive in text & graphs and
RELATIVELY more productive in graphs).
4.1. Simple examples -- two-person cases
What can we conclude from the first two examples:
(1) When each person is more productive in one
activity, specialization and trade can benefit both
of them
(2) When each person is RELATIVELY more
productive in one activity, specialization and
trade can benefit both of them.
What can we conclude from the third example
(David and John) on the next page?
4.1. Simple examples -- two-person cases
Example 3:
Text
Graphs
David
6 pages/hr.
4 graphs/hr.
John
3 pages/hr.
2 graphs/hr.
50/50 share with no specialization:
David: 9 pages of text & 5 graphs ==> 2.75 hrs
John: 9 pages of text & 5 graphs ==> 5.5 hrs
David is more productive in ________________
John is relatively more productive in ___________
Can specialization benefit both David and John?
Why?