Homework 5
UCDavis, 160a, SSII11
Prof. Farshid Mojaver
Economies of Scale and Imperfect Competition
1. Explain how increasing returns to scale in production can be a basis for trade.
2. Why is trade within a country greater than trade between countries?
3. There are some shops in Japan that sell Japanese goods imported from the United States at a
discount over the prices charged by other Japanese shops. How is this possible?
4. Our derivation of the gravity equation from the monopolistic competition model used the
following logic:
(1) Each country produces many products;
(2) Each country demands all of the products that every other country produces;
(3) Thus, large countries demand more imports from other countries.
The gravity equation relationship does not hold in the Heckscher-Ohlin model. Explain how the
logic of the gravity equation breaks down in the Heckscher-Ohlin model: that is, which of the
above statements is no longer true in the Heckscher-Ohlin model?
5. The United States, France, and Italy are among the world’s largest producers. To answer the
following questions, assume that their markets are monopolistically competitive, and use the
gravity equation with B = 93 and n = 1.25.
a. Using the gravity equation, compare the expected level of trade between the United
States and France and between the United States and Italy.
(Note: These numbers are larger than is realistic because we are using the gravity
equation estimated on the United States and Canada state/provincial trade, rather than
the equation estimated on international trade.)
b. The distance between Paris and Rome is 694 miles. Would you expect more French trade
with Italy or with the United States? Explain what variable (i.e., country size or distance)
drives your result.
6. What evidence is there that Canada is better off under the free-trade agreement with the United
States?
7. Consider the long-run trade equilibrium in the monopolistic competition model as illustrated
below. Consider a situation where the foreign and domestic demand for a particular good
increase. For instance, suppose that this is the market for cars and lower gasoline prices generates
higher demand.
a. Redraw the Figure below and show what happens when this change in demand occurs.
Specifically, show which curve(s) shift.
b. If the old equilibrium is at point C, describe where the new long run equilibrium occurs,
and what has happened to the number of firms and the price they charge.
8. Intra-Industry Trade
a. Of two products, rice and paintings, which product do you expect to have a higher index
of intra-industry trade? Why?
a. Access the U. S. TradeStats Express Web site http://tse.export.gov/. Click on “National
Trade Data” then “Global Patterns of U. S. Merchandise Trade.” Under the “Product”
section, change the item to rice (HS 1006) and obtain the export and import values. Do
the same for paintings (HS 9701), and then calculate the intra-industry trade index for
rice and paintings in 2009. Do your calculations confirm your expectation from part (a)?
If your answers did not confirm your expectation, explain.
9. Suppose the Home firm is considering whether to enter the Foreign market. Assume that the
Home firm has the following costs and demand:
Fixed Costs = $140; Marginal Costs = $10/unit; Local Price = $25
Local Quantity = 20; Export Price = $15; Export Quantity = 10
a. Calculate the firm’s total costs from selling only in the local market.
b. What is the firm’s average cost from selling only in the local market?
c. Calculate the firm’s profit from selling only in the local market.
d. Should the Home firm enter the Foreign market? Briefly explain why.
e. Calculate the firm’s profit from selling to both markets.
f. Is the Home firm dumping? Briefly explain.
Questions from ch8
Problem Set 1: WTO
1. Go to: http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm , and find out
how many countries belong to the WTO. Which countries joined most recently?
2. Which of the following actions would be legal under GATT, and which would not?
a. A U.S. tariff of 20 percent against any country that exports more than twice as much to
the United States as it imports in return.
b. A subsidy to U.S. wheat exports, aimed at recapturing some of the markets lost to the
European Union.
c. A U.S. tariff on Canadian lumber exports, not matched by equivalent reductions on other
tariffs.
d. A Canadian tax on lumber exports , agreed to at the demand of the United States to
placate U.S. lumber produces.
e. A program of subsidized research and development in areas related to high-technology
goods such as electronics and semiconductors.
f. Special government assistance for workers who lose their jobs because of imports
competition.
Problem Set 2:Tariffs and Quota
1. Consider a small country applying a tariff, t, to imports of a good.
a. Suppose that the country decides to reduce its tariff to t’. Draw the graphs for the
Home (with domestic supply and demand) and import markets (derived import
demand curve) to illustrate this change. What happens to the quantity of goods
produced at Home and their price? What happens to the quantity of imports?
b. Are there gains or losses to domestic consumer surplus due to the reduction in
tariff? Are there gains or losses to domestic producer surplus due to the reduction
in tariff? How is government revenue affected by the policy change? Illustrate
these on your graphs.
c. What is the overall gain or loss in welfare due to the policy change?
2. Consider a large country applying a tariff, t, to imports of a good.
a. How does the export supply curve in panel (b) compare with that in the small
country case? Explain why these are different.
b. Explain how the tariff affects the price paid by consumers in the importing
country, and the price received by producers in the exporting country. Use graphs
to illustrate how the prices are affected if (i) the export supply curve is very
elastic (flat), or (ii) the export supply curve is inelastic (steep).
3. Consider a large country applying a tariff, t, to imports of a good. How does the size of
the terms-of-trade gain compare with the size of the deadweight loss when (i) the tariff is
very small, and (ii) the tariff is very large? Use graphs to illustrate your answer.
4. Consider the following scenarios:
a. If the foreign export supply is perfectly elastic, what is the optimal tariff Home
should apply to increase welfare? Explain.
b. If the foreign export supply is less than perfectly elastic, what is the formula for
the optimal tariff Home should apply to increase welfare?
c. What happens to Home welfare if it applies a tariff higher than the optimal tariff?
5. Rank the following in ascending order of Home welfare and justify your answers. If
two items are equivalent, indicate this accordingly.
a. Tariff of t in a small country corresponding to the quantity of imports M.
b. Quota with the same imports M in a small country, with quota licenses distributed
to Home firms and no rent seeking.
c. Quota of M in a small country with quota licenses auctioned to Home firms.
d. Quota of M in a small country with the quota given to the exporting firms.
e. Quota of M in a small country with quota licenses distributed to rent-seeking
Home firms.
6. Suppose Home is a small country. Use the graphs below to answer the questions.
a. Calculate Home consumer surplus and producer surplus in the absence of trade.
b. Now suppose that Home engages in trade and faces the world price, P*= $6.
Determine the consumer and producer surplus under free trade. Does Home
benefit from trade? Explain.
c. Concerned about the welfare of the local producers, the Home government
imposes a tariff in the amount of $2 (i.e., t = $2). Determine the net effect of the
tariff on the Home economy.
7. Refer to the graphs in problem 8. Suppose that instead of a tariff, Home applies an
import quota limiting the amount foreign can sell to 2 units.
a. Determine the net effect of import quota on the Home economy if the quota
licenses are allocated to local producers.
b. Calculate the net effect of the import quota on Home’s welfare if the quota rents
are earned by foreign exporters.
c. How do your answers to parts (a) and (b) compare with part (c) of problem 8?