Fall 2004
ECONOMICS 3347
J.G. Gonzalez
Problem Set # 2
This problem set is due Thursday, November 4th, at the beginning of the class period.
All text answers must be typed. Unstapled problem sets will not be accepted. Late problem sets
are unacceptable also.
I. You are asked to estimate the welfare cost of a tariff imposed by Denmark on imported
compact flash cards. You are told that imports were K 1,350 million before the tariff and K 825
million (valued at world prices, in other words, without including the tariff revenue) after it was
imposed; the tariff rate is 40 percent (prices are in Danish Krones). You can assume that
Denmark is a small country in the compact flash card market, and that the domestic elasticities of
demand and supply are the same. Estimate the approximate loss in national welfare due to the
tariff.
II. Spain uses € 6.50 worth of imported meat and € 1.50 worth of imported paprika to produce a
kilogram of chorizo whose world price is € 12.00 (prices are in Euro).
1. What is the value added by Spain’s chorizo industry?
2. Suppose that Spain imposes a 25 percent ad-valorem tariff on imports of chorizo. What
happens to the value added by Spain’s chorizo industry? What is the effective rate of protection
provided to Spain’s chorizo producers?
3. Suppose that in addition to the tariff on chorizo imports, Spain imposes tariffs of 20 and 12
percent on imports of meat and paprika, respectively. Calculate the new effective rate of
protection.
4. Recalculate the effective rate of protection, assuming that the nominal tariff rates on meat and
paprika are 50 and 42 percent, respectively.
III. Concentrate on the market for shrimp. Assume that there are only two countries in the
world, the U.S. and Vietnam (assume that both countries are large nations in trade), that shrimp
is a homogeneous good, and that it is produced under perfect competition.
1. Assume that the Vietnam has a comparative advantage in shrimp production. In order to
protect its domestic producers, the U.S. uses a quota that limits the amount of shrimp that can
come into the country. Show the international trade equilibrium under the quota using the supply
and demand for each country, as well as the export supply and import demand (Hint: You need
to draw three diagrams).
2. It was recently reported in the Los Angeles Times that the “American Seafood Distributors
Association” is concerned with the effects of a recent decline in the Vietnamese domestic supply
of shrimp. Use diagrams to show the effects of this decrease in Vietnam’s supply (assume that
the quota is binding even after the changes in supply). What are the effects of this change on the
price of shrimp in the U.S., the price of shrimp in Vietnam, and the revenue going to the holders
of the import quotas in the U.S.? Make sure that you include a diagram in your answer.
3. The Los Angeles Times also reported that the “American Seafood Distributors Association” is
concerned about an increase in the U.S. domestic demand for shrimp. Use diagrams to show the
combined effects of this increase in the U.S. domestic demand and the decrease in the
Vietnamese supply discussed in part 2 (assume that the quota is binding even after the changes in
both curves). What are the effects of this change on the price of shrimp in the U.S., the price of
shrimp in Vietnam, and the revenue going to the holders of the import quotas in the U.S.?
(Please make all comparisons with respect to the equilibrium found in part 2). Make sure
that you include a diagram in your answer.
4. According to Los Angeles Times, the U.S. government responded to these changes by
increasing the amount of shrimp that is allowed to enter the U.S. (i.e., increasing the size of the
quota). Use diagrams to show the effects of this increase in the shrimp quota (assume that the
new quota is still binding). What are the effects of this change on the price of shrimp in the U.S.,
the price of shrimp in Vietnam, and the revenue going to the holders of the import quotas in the
U.S.? (Please make all comparisons with respect to the equilibrium found in part 3). Make
sure that you include a diagram in your answer.
IV. Assume that there are only two countries in the world: Colombia and the European Union
(think of the EU as a single country and assume that both countries are large).
1. Colombia’s demand curve for coffee is:
Qd = 450 - 25P
Its supply curve is:
Qs = 150 + 35P
where: Qd = Quantity Demanded; Qs = Quantity Supplied; and P = Price
(Note: Quantity is given in pounds of coffee per hour, while price is given in
Euro per pound).
Derive and graph Colombia’s export supply schedule. What would the price of coffee be
in the absence of trade?
2. Now add the EU, which has a demand curve:
Qd = 400 - 25P
and a supply curve:
Qs = -50 + 15P
A) Derive and graph the EU import demand curve, and find the price of coffee that would prevail
in the EU in autarky.
B) Now allow Colombia and the EU to trade with each other. Find and graph the equilibrium
under free trade. What is the world price? What is the volume of trade?
3. The “Federación Nacional de Cafeteros de Colombia” convinces the Colombian government
to provide the coffee industry with an export subsidy. The government agrees to give a subsidy
of $4 per pound of coffee exported (Note: All answers to this section should compare the free
trade equilibrium to the subsidy equilibrium).
A) Determine and show graphically the effects of the subsidy on the following: (a) The price of
coffee in each country; (b) the quantity of coffee supplied and demanded in each country; (c) the
volume of trade.
B) Show graphically and calculate numerically the effects of the subsidy on the welfare of each
of the following groups: (a) EU import-competing producers; (b) EU consumers; and (c) the
“nation” of the EU.
C) Show graphically and calculate numerically the effects of the subsidy on the welfare of each
of the following groups: (a) Colombia’s producers; (b) Colombia’s consumers; (c) Colombia’s
government; and (d) the nation of Colombia.
D) Show graphically and calculate numerically the net change in world welfare that resulted from
the granting of the export subsidy by the Colombian government.
4. The “Specialty Coffee Association of Europe” convinces the EU government to impose
countervailing duties (CVDs) on the subsidized imports from Colombia. The government agrees
to impose a CVD of $4 per pound of imported coffee (Note: All answers to this section should
compare the subsidy equilibrium to the CVD equilibrium).
A) Determine and show graphically the effects of the CVD on the following: (a) The price of
coffee in each country; (b) the quantity of coffee supplied and demanded in each country; (c) the
volume of trade.
B) Show graphically and calculate numerically the effects of the CVD on the welfare of each of
the following groups: (a) EU import-competing producers; (b) EU consumers; (c) the EU
“government,” and (d) the “nation” of the EU.
C) Show graphically and calculate numerically the effects of the CVD on the welfare of each of
the following groups: (a) Colombia’s producers; (b) Colombia’s consumers; (c) Colombia’s
government; and (d) the nation of Colombia.
D) Show graphically and calculate numerically the net change in world welfare that resulted from
the imposition of the CVD by the EU government.
5. A) Which is better for Colombia: Free Trade or the Subsidy-CVD combination? Why?
B) Which is better for the EU: Free Trade or the Subsidy-CVD combination? Why?
C) Which is better for the World as a whole: Free Trade or the Subsidy-CVD combination?
Why?
V. Canada and Russia trade two commodities: softwood lumber (L) and flat rolled steel (S).
Their offer curves are given by the following equations (Note: Both softwood lumber and flat
rolled steel are measured in tons per day):
L = 30S2 + 2500S
L = -70S2 + 6000S
(Russia’s offer curve)
(Canada’s offer curve)
a) Determine the free trade equilibrium international price and each country's exports and
imports. Illustrate your results graphically.
b) As a result of lobbying activities by the Canadian Steel Producers Association (L’Association
canadienne des producteurs d’acier), the Canadian Prime Minister, Paul Martin, imposes a quota
of 25 tons of flat rolled steel per day. Determine the quota equilibrium international price, the
domestic price in Canada, the domestic price in Russia, and each country's exports and imports.
Illustrate your results in a new diagram.
c) Is Russia better off or worse off as a result of the imposition of the steel quota? Why? Is
Canada better off or worse off as a result of the imposition of the steel quota? Why?
d) After months of negotiations, Canada decides to eliminate its import quota in exchange for
the imposition of a VER by Russia. Mikhail Fradkov, the Russian Prime Minister, agrees to
restrict Russia’s exports of flat rolled steel to 25 tons per day. Determine the VER equilibrium
international price, the domestic price in Canada, the domestic price in Russia, and each country's
exports and imports. Illustrate your results in a new diagram.
e) Is Russia better off or worse off as a result of the imposition of the steel VER? Why? Is
Canada better off or worse off as a result of the imposition of the steel VER? Why? (For both
nations, please compare the VER equilibrium to the free trade equilibrium)
f) Which policy does Canada prefer, an import quota or a VER? Why? Which policy does
Russia prefer, an import quota or a VER? Why?