HW1 Solution Key
UCDavis, 160a, Spring 2008
Introductory Issues
Prof. Farshid Mojaver
DIRECTIONS: As in the popular TV game show, you are given an answer to a question and you must
respond with the question. For example, if the answer is, "a tax on imports", then the correct question is,
"What is a tariff?"
1.
of micro- or macro-economics, the one whose methods are mostly applied in an international trade theory
course.
Microeconomics
2.
of micro- or macro-economics, the one whose methods are mostly applied in an international finance theory
course.
Macroeconomics
3.
term of French origin used to describe a total absence of government regulation.
Laissez faire
4.
term used to describe a situation in which a country does not trade with any other country.
Autarky
5.
the two types of economic efficiency.
Producer Efficiency and Consumer Efficiency
6.
term given to the principle of redistribution between winners and losers.
Compensation
7.
name of the economist who once remarked, "In the long-run, we are all dead!"
John Maynard Keynes
8.
term used to describe policies which raise domestic welfare while reducing welfare in the rest of the world.
Beggar-thy-neighbor
9.
name given to a policy that shifts profits away from foreign firms towards the domestic economy.
Protectionism
10. the premier controversy in international trade policy analysis.
Free trade versus protectionism
Some Trade Terminology
1- What does autarky mean?
No trade
2- What is a “laissez faire” policy with respect to trade?
Hands off – no restrictive trade policy – free trade
3- Is export promotion considered to be a “laissez faire” policy? If not then what is
it?
No! Export promotion is intended to protect export industries. This is done
through various regulations and government interventions.
1- In the trade spectrum show autarky, free trade, export promotion, and a move
toward protectionism/trade liberalization.
Export
promotion
No trade
2- What is protectionism? What is being protected and against what?
Protectionism protects domestic industries against foreign competition via various
regulations and government interventions in the market.
3- What is trade liberalization? What is being liberalized?
A movement in the direction of free trade occurs when regulations on trade are
removed. Since the elimination of trade policies will generally increase the
amount of international trade, it is referred to as trade liberalization.
Pure Exchange Model
Consider two farmers, one with an endowment of 5 pounds of peaches, the other with an endowment of
five pounds of cherries. Suppose these two farmers meet daily and make a mutually agreeable exchange of
2 pounds of peaches for 3 pounds of cherries.
a. Write down an expression for the terms of trade. Explain how the terms of trade relates to the dollar
prices of the two goods.
TOT = 3 lb cherries /2lb peaches = ($/lb peaches)/($/lb cherries) = Pcherries/Ppeaches=3/2
(At this point it is immaterial to write ToT as Ppeaches/Pcherries or Pcherries/Ppeaches)
b.
Consider the following shocks (or changes). Explain how each of these shocks may influence the terms
of trade between the farmers. Assume that each farmer's sole interest is to maximize her own utility.
1. The cherry farmer arrives at the market with 5 extra pounds of cherries.
TOT↑ (here defined as lb peaches/ lb cherries) because of the increase in supply
of cherries
2. The peach farmer has just finished reading a book titled "How to Influence
People."
TOT↑ because the peach seller can increase demand for his peach
3. Damp weather causes mold to grow on 40% of the peaches.
TOT↑ because supply of peaches goes down
4. News reports indicate that cherry consumption can reduce the risk of cancer.
TOT↓ because demand for cherries goes down
Ricardian Model
Problem 1: Use the information in the table to answer the following questions.
Beer
Pizza
Italian labor productivity
6 bottles/hour
6 pizzas/hour
German labor productivity
5 bottles/hour
3 pizzas/hour
a. Which country has the absolute advantage in beer? ... in pizza? Explain why.
Opportunity cost in each country
Beer (in terms of Pizza)
Pizza (in terms of Beer)
Italy
6 /6 =1
6/6=1
Germany
3/5
5/3
OC of Beer production is lower in Gemany (Germany is relatively more productive in
Beer) thus Germany has comparative advantage in Beer.
b. Explain why Italy's comparative advantage good is the one it can produce "most best", while Germany's
comparative advantage good is the one it can produce "least-worse".
Italy is more productive than Germany in booth sectors however its productivity
advantage in Beer is greater thus its most best is Beer. Italy is less productive in both
sectors compared to Germany however its productivity disadvantage in Pizza is less. That
is the least-worse industry in Italy.
c. What autarky price ratios (PB/PP) would prevail in each country? Explain.
Autarky price-ratios is equal to the opportunity cost in each country
Thus (PB/PP) = 1 in Italy and 3/5 in Germany
d. Explain how price differences signal the expansion and export of a country's comparative advantage
goods and the contraction and import of a country's comparative disadvantaged goods.
People can make profit by arbitrage – buying low and selling high. One can start with a
bottle of German bear. Sell it for 5/3 pizza in Italy. With that much Pizza you can buy 1
and 2/3 of bear in Germany so you have made 2/3 of bear profit.
e. What does the model suggest will happen to employment levels in the export and import industries? In
the model what happens to the overall level of unemployment in the economy after a country moves to free
trade? Explain briefly.
In Germany employment in Beer (its export sector) goes up, and it goes down in Pizza.
The opposite happens in Italy. That is employment in Pizza (its export sector) goes up
and in Beer goes down.
Assuming free and costless movement of labor there will be no unemployment.