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UW-Madison ECON 101 - Brief Answers for Problem Set

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Professor Scholz Posted: 9-22-09 Economics 101, Brief Answers for Problem Set #4 (version 2!) Due: 9-29-09 1) (Output per unit of Labor) Wine (Gallons) Cloth (Yards) England 12 6 Portugal 8 2 a) When observing this table, Will made the following remark, “I don’t see why England should trade with Portugal, it is better at producing both wine and cloth. England should focus all of its resources on domestic production.” Do you agree with Will? Why or why not? [No, England may have an absolute advantage in producing both goods, but it may benefit from trade through specialization. b) What are the opportunity costs of producing wine in terms of cloth for each country? Which country has an absolute advantage in producing wine? Which country has an absolute advantage in producing cloth? [In England, it takes half a yard of cloth to produce a gallon of wine. In Portugal, it takes a quarter year of cloth to produce a gallon of wine. England has an absolute advantage in producing both wine and cloth.] c) Which country has a comparative advantage in producing wine/cloth? [Wine-Portugal, Cloth, England] d) Assume 1 unit of labor is transferred from wine to cloth in England and 2 units from cloth to wine in Portugal. What is the total net gain from these transfers of labor? [England gains 6 yards of cloth, but loses 12 gallons of wine. Portugal gains 16 gallons of wine, but loses 4 yards of cloth. The total net gain is 16-12=4 gallons of wine and 6-4=2 yards of cloth. e) Under what range of prices (in terms of wine and cloth) would both countries gain from trade? [any price between 4 gallons of wine for 1 yard of cloth, and 2 gallons of wine for 1 yard of cloth.] 2) The Prime Minister of Oceania wants to improve his country’s struggling automobile industry. He plans to do this by implementing strict quotas on the importation of foreign automobiles and verysteep tariffs on the few automobiles imported. In a few years, once the automobile industry has matured, he plans to remove the tariffs, allowing for competition on the world market. He believes his policies will both allow the domestic car industry to grow and generate a great deal of revenue for the government. Do you agree with his hypothesis? Why or why not? [Generally, no. Though the “infant industry” argument may work in theory, it rarely works in practice, since it is likely that the high tariffs on the domestic automobile industry will never be removed due to the influential industry lobby. If the quality of domestic cars is exceptionally low, consumer advocacy groups may place political pressure on the prime minister to open up trade markets before the domestic industry has “matured.” In either case, it is not likely that this policy will be very effective.] 3) United States Cuba Price Quantity Demanded Quantity Supplied Quantity Demanded Quantity Supplied 60 230 180 430 310 70 200 200 420 330 80 170 220 410 360 90 150 240 400 400 100 140 250 390 440 a) From the above table, what will be the equilibrium price and quantity in each country under autarky? [Price 70, Quantity 200 in United States. Price 90, Quantity 200 in Cuba] b) If trade is allowed between the US and Cuba, what will the new equilibrium price and quantity be? How much will each country export/import? [Producers in the US will sell to Cuba, while buyers in Cuba will buy from the US. Equilibrium price will rise to 80, with the US exporting/Cuba Importing 50 units.] c) Suppose Cuba imposes an import quota of 30 units. How will this benefit/hurt producers/consumers? Under this scenario, how many units will Cuba import? [Imports will be reduced from 50 to 30, and price will be closer to the equilibria under autarky. Prices will be higher than autarky in the US and lower than autarky in Cuba.]Producers in Cuba and consumers in the US will benefit from these policies, while producers in the US and consumers in Cuba will be hurt by these policies. 4) Suppose that the US market for portable cassette players is represented by the demand equation P=180-6Q and supply equation P=3Q. a) If no international trade is allowed, what will be the equilibrium price and quantity of cassette players? [Q*=20, P*=60] b) Assume there are no barriers to trade and that the world price of portable cassette players is $30. How many cassette players will be imported/exported? [Set price equal to 30 in the above equations. We have that 25 cassette players will be demanded and 10 will be domestically produced. Therefore, the US will import 15 cassette players.] c) Suppose the US imposes a tariff of $12 per cassette player i) How many will now be imported/exported? [Now, set price equal to 42. 23 units will be demanded and 14 will be domestically produced. Therefore, the US will import 9 cassette players.] ii) What will the change be in consumer surplus? [Under free trade, the consumer surplus is: 1/2(180-30)*25=$1875. With the tariff imposed, the consumer surplus is 1/2(180-42)*23=$1587. Therefore, consumer surplus is reduced by 1875-1587=288. iii) What will be the change in producer surplus? [Under free trade, the producer surplus is: 1/2(30*10)=$150. With the tariff imposed, the producer surplus is 1/2(42*14)=$294. Therefore, producer surplus is increased by 294-150=$144.] iv) How much will the government collect as revenue? [The government will collect 9*12=$108 in revenue.] v) Calculate the deadweight loss. [Deadweight loss: 1/2*(Free-trade price-tariff price)*(Change in quantity demanded)+1/2*((Free-trade price-tariff price)*(Change in quantity supplied)=1/2(12)*2+1/2(12)*4=$36 d) Suppose that instead of a tariff, the US implements an import quota of 9 cassette playersi) How many will now be imported/exported? [The US will import 9 cassette players. ] ii) What will the change be in consumer surplus? [Consumer surplus is reduced by $288] iii) What will the change be in producer surplus? [Producer surplus is increased by $144] iv) Calculate the deadweight loss. [Deadweight loss is $36+$108=$144] v) Is there a difference in your answer for v) in part c and iv) in part d? Explain. [Deadweight loss is higher with a quota in place instead of a tariff since the government does not collect any revenue. 5) Using the assigned readings as sources, explain how it is possible that US expenditures to foreign producers (e.g. outsourcing in the high-tech industry) could eventually


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UW-Madison ECON 101 - Brief Answers for Problem Set

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