Econ. 474/575 Exam #2
Study Guide
Midterm format
The content of the exam comes primarily from class lecture. Also, the discussion topics
and readings are fair game, particularly the study questions from each chapter that I have
put on my webpage.
The midterm will be comprised of the following types of questions
a. 30% short answer (approximately 2 or 3 questions worth 10 points each) I
will give you a concept and you will define it and explain its relevance to
Latin America
b. 20% essay (one essay worth 20 points). The essay will focus on the broader
issues and lessons learned from the Latin American experience. Case studies,
chapter questions, and applications of economic theory to a new country are
all possible topics.
c. 50% technical questions based on the economic theory or models and their
application to Latin America.
You will have 2 hours to take the exam. There is a class after ours, so papers will be
collected promptly at the end of the hour. Please bring a watch and time yourselves
according to the number of points. You have roughly 100 minutes to complete the exam,
so if a question is worth 10 points, don’t spend more than 10 minutes on it.
General information
Trade integration
Drug war in Latin America
informal sector: definition, how it is changing, relative size
Concepts and definitions
Levels of economic integration: know definition of EACH and example
Advantages and disadvantages of trade blocks
Trade creation
Trade diversion
Insights from trade theory
Benefits of intraregional trade in Latin America
Trends in 21st century
Trade triangle: rum
Bacardi history and importance of move to U.S.
Functioning intraregional trade blocks in Latin America
DR-CAFTA, CAN, MERCOSUR, NAFTA, CARICOM
Effects of NAFTA in Mexico, U.S.
Informal sector
costs of being informal
costs of being formal
why informal sector is characterized by low productivity
Case studies
Puerto Rican trade integration
Puerto Rican rum industry
Impact of drug war in Colombia, Mexico, Caribbean
Informal sector in Peru
Economic models
Model of trade creation
Model of trade diversion
Consumer and producer surplus calculation and definition
Effectiveness of U.S. drug interventions based on S & D analysis
Three tier analysis of informal sector
Sample problem on Trade Diversion
Consider the domestic price of t-shirts in these countries:
China:
$3
Mexico: $4
U.S.:
$7
Canada: $8
What would be the net effect of the creation of NAFTA (free trade among Mexico, US,
and Canada) on the U.S. market compared to the pre-NAFTA policy of $2 tariff on all
imported t-shirts?
1. Pre-NAFTA
a. Which country do we import t-shirts from?
b. What is the price of t-shirts in the U.S.?
c. How much is produced?
Domestically?
Imported?
d. Show regions of CS, PS, and G Revenue
2. NAFTA
a. Which country do we import t-shirts from?
b. What is the price of t-shirts in the U.S.?
c. How much is produced?
Domestically?
Imported?
d. Show regions of CS, PS, and G Revenue
e. Show regions of net gain and net loss compared to the pre-NAFTA scenario
3. Cheap Chinese t-shirt scenario
Suppose that t-shirts can be produced for $1.50 in China. What would happen to
your answer in part 2 (under NAFTA)?
SOLUTION
1. Pre-NAFTA
NOTE: I only drew the price lines that are relevant to the US. We are not interested
in Canadian and Mexican t-shirts because they are more expensive. We are
interested in buying Chinese t-shirts, but must add the $2 tariff.
a. Which country do we import t-shirts from? China
b. What is the price of t-shirts in the U.S.? $5
c. How much is produced? Qc = total quantity produced
Domestically? Qb
Imported? Qc-Qb = imports
d. Show regions of CS, PS, and G Revenue
CS: triangle with vertical lines
PS: triangle with diagonal lines
G Rev: rectangle labeled GOV
NOTE: In order to calculate these areas, you would need to be given the exact
quantities and know where the Supply and Demand curves intersect the axis. You
would calculate the area of a triangle as ½*(Base*Height) and the area or a rectangle
as (Length*Width). In this example, you can just shade them in.
SUS
$7
Schina + t
$5
GOV
Schina
$3
DUS
Qb
Qc
imports
t-shirts
2. NAFTA
a. Which country do we import t-shirts from? Mexico
b. What is the price of t-shirts in the U.S.? $4
c. How much is produced? Qd = total quantity produced
Domestically? Qa
Imported? Qd-Qa = imports
d. Show regions of CS, PS, and G Revenue
CS: triangle with vertical lines
PS: triangle with diagonal lines
G Rev: NONE since there is no tariff with Mexico
e. Gains and losses compared to pre-NAFTA
Gains: the two little triangles in black were not in the last graph and
now they represent CS
Loss: the highlighted rectangle is a net loss because we have lost the
Gov. revenue from the tariff with China in the last graph. We don’t lose the top section
of the rectangle because it is now CS and is shaded in so we are just trading the preNAFTA Gov. Rev. for new CS. But the bottom part of the rectangle is now a net loss.
Net Effect: if the loss > the gain, then you have a net loss. This is what
is called TRADE DIVERSION through economic integration.
SUS
$7
SChina + t
$5
$4
$3
SMex
SChina
Loss in G
DUS
Qa Qb
Qc
imports
Qd
t-shirts
3. Cheap Chinese t-shirts
a. Which country do we import t-shirts from? China
b. What is the price of t-shirts in the U.S.? $3.50
c. How much is produced? Qtotal = total quantity produced
Domestically? Qdom
Imported? Qtotal-Qdom = imports
d. Show regions of CS, PS, and G Revenue
CS: triangle with vertical lines
PS: triangle with diagonal lines
G Rev: rectangle labeled GOV
Under NAFTA, we would still have this same outcome. We would not be interested
in importing t-shirts duty free from Mexico because they would still be more
expensive ($4) compared to the Chinese t-shirts. So sometimes, trade integration has
NO EFFECT!!!!
SUS
$7
SChina + t
SMex
SChina
$3.50
GOV
$1.50
DUS
Qdom
Qtotal
imports
t-shirts