Economics 101 — Fall 2011International TradeProblem Set 3November 15, 2010Due: Tue, November 29, before 12:30pmInstructor: Marc-Andreas MuendlerE-mail: [email protected] Import Tariffs and Export Promotion in aSmall Open Economy’s General EquilibriumA small open economy produces cars and grows food with some unspecifiednumber of factors of production. The opportunity costs of car production interms of food change with the production pattern but are lower than those ofits trading partners.• Draw a production possibility frontier that is consistent with the aboveassumptions.• Depict an initial world trade equilibrium and the consumption possibilitiesof the small open economy, consistent with the above assumptions.• Suppose the small open economy imposes a tariff on its imports. Howdo the country’s Terms of Trade change? How does the domestic priceratio change? How will the small open economy’s production patternchange? How will the small open economy’s consumption and trade pat-tern change? How is welfare affected?• Suppose the small open economy promotes its exports with a cost subsidyto exporters. How do the country’s Terms of Trade change? How doesthe domestic price ratio change? How will the small open economy’s pro-duction pattern change? How will the small open economy’s consumptionand trade pattern change? How is welfare affected? Is there a differenceto the import tariff?2 Import Tariffs and Export Promotion in WorldGeneral Equilibrium with a Large CountryA large economy produces cars and grows food with some unspecified numberof factors of production. The opportunity costs of car production in terms offood change with the production pattern but are lower than those of its tradingpartners.• Draw a production possibility frontier that is consistent with the aboveassumptions.• Depict an initial world trade equilibrium and the consumption possibilitiesof the large country, consistent with the above assumptions.1• Suppose the large country imposes a tariff on its imports. How do thecountry’s Terms of Trade change? How does the domestic price ratiochange? How will the large country’s production pattern change? Howwill the large country’s consumption and trade pattern change? How iswelfare affected?• Suppose the large country promotes its exports with a cost subsidy toproducers. How do the country’s Terms of Trade change? How does thedomestic price ratio change? How will the country’s production patternchange? How will its consumption and trade pattern change? How iswelfare affected? Is there a difference to the import tariff?3 Import Tariff in Partial EquilibriumHome’s demand and supply for cars are given by: D = 130 − 30 · P and S =10 + 30 · P , while Foreign’s demand and supply for cars are: D∗= 60 − 30 · Pand S∗= 40 + 30 · P (P is thousands of US$).• Determine the autarky equilibrium, and calculate domestic price for eachcountry. Illustrate your answer with suitable graphs.• Derive Home’s import demand schedule and Foreign’s export supply sched-ule. Calculate and depict the world price when both countries trade, andshow the traded quantities.• Home imposes a tariff of τ = .4 per car. Calculate and depict the pricethat Home consumers pay. Show domestic consumption, production andthe trade volume.• Show graphically how the tariff affects Home welfare. Distinguish Homeconsumer surplus, producer surplus and government revenues.• Did the tariff improve efficiency? Show the net efficiency gain or lossgraphically.4 Export Promotion in Partial EquilibriumConsider the two countries from question 3 again. Home has a tariff of τ = .4per car in place.The Foreign government decides to grant an export subsidy of τ = .4 perexported car.• How does this subsidy affect Home welfare?• Show the changes to surpluses and tax revenues for Foreign.25 Political Economy of TradeAs opposed to the findings of Magee (1980) for the tariff reforms in U.S. Congressin 1973, Baldwin and Magee (2000) identify the following contributions andvoting patterns in 1993 and 1994.Congressional votesFor NAFTA 1993 For GATT 1994Actual votes 229 283Predicted by model 229 290Absence of labor contributions +62 +56Absence of business contributions −34 −33Absence of any contributions +27 +33Baldwin and Magee (2000)• Is this evidence for or against the Stolper-Samuelson theorem?• Is Heckscher-Ohlin trade theory supported? If not, what would votingpatterns have to look like?• Is the Specific Factors model (Ricardo-Viner trade theory) supported? Ifnot, what would voting patterns have to look like?• Discuss in what regards the results of Baldwin and Magee (2000) stand incontrast to those of Magee (1980).6 Negotiations for Free Trade AgreementsThe U.S. Congress recently ratified three trade agreements after many yearsof negotiations with the respective foreign governments and deliberations inCongress: one agreement with Colombia, one with Panama, and one with SouthKorea. Pick any one of the three trade agreements.• State two trade issues that held up negotiations of the trade agreement,one for the foreign government and one for the U.S. government.• Evaluate motivations for the foreign government’s negotiation positionusing trade theory and related economic arguments.• Evaluate motivations for the U.S. negotiation position using trade theoryand related economic arguments.• For the U.S. negotiation position, pick two main domestic interest groupsand their motivation to influence the negotiations.Limit your statements to four