INTERNATIONAL TRADE

 INTERNATIONAL TRADE

Ragan Chapters 19 and 20

The Gains from Free Trade

1. Discuss Adam Smith’s theory of Absolute Advantage and David Ricardo’s theory of Comparative Advantage?

Illustrate the gains from trade.

2. Imported good. Example: D = 12 – 2p, S = 2p, pW = 1. (Figure 19-6)

3. Exported good. Example: D = 12 – 2p, S = 2p, pW = 5. (Figure 19-5)

4. Are there any disadvantages from free trade?

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5. Illustrate Two-Country Equilibrium where DA = 18 – p, SA = p – 6, DB = 12 – p, SB = p – 4.

a. Illustrate two-country equilibrium

b. Illustrate the changes in CS, PS and TS

Import Tariffs

6. Supply and Demand are given by D = 12 – 2p and S = 2p. The world price is pW = 1.

a. Illustrate the import market.

b. Compute and illustrate CS, PS and TS.

c. Illustrate the impact of a t = 1 tariff in this market. (Figure 20-1)

d. Compute and illustrate CS, PS, GS and TS.

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Import Quotas

7. Supply and Demand are given by D = 12 – 2p and S = 2p. The world price is pW = 1.

a. Illustrate the import market.

b. Compute and illustrate CS, PS and TS.

c. Illustrate the impact of a Q = 2 quota in this market. (Figure 20-2)

d. Compute and illustrate CS, PS, LS and TS.

Quantity

Price

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Labour Mobility

8. In Canada labour supply is SC = w − 60 and labour demand is DC = 180 – w. In Mexico labour supply is SM = w − 40 and

labour demand is DM = 120 – w.

a. Calculate equilibrium wages and employment in closed economies.

b. Provide a two-country diagram showing the benefits from free trade in labour markets.

c. Explain commuting.

Capital Markets

9. Discuss the benefits of free trade in international capital markets

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Tutorial Questions

1. Domestic Supply and Demand for an internationally traded good are given by S = p – 2 and D = 24 – p. The world price is 5

dollars. Next month the government will introduce an Import Tariff of 3 dollars. Calculate the efficiency loss. Provide a

Supply and Demand Diagram to illustrate this calculation. Explain how the size of the efficiency loss will depend on the

elasticity of supply and demand.

2. Calculate and illustrate the volume of exports under a free trade policy with pw = 60, D = 80 – p and S = p. Explain how the

size of the efficiency gain will depend on the elasticity of supply and demand.

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3. Calculate and illustrate consumer surplus under a free trade policy with pw = 10, D = 60 – p and S = p. Explain how the size

of the efficiency gain will depend on the elasticity of supply and demand.

4. An internationally traded good has a world price of p = 2 dollars. Domestic demand and supply are D = 16 – p and S = p.

Next month an import quota q = 6 will be introduced for domestic producers. Provide a Supply and Demand Diagram to

illustrate this calculation. Explain how the size of the efficiency loss will depend on the elasticity of supply and demand.

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Review Questions

1. A $1 per-litre tariff on all wine imported into Canada will

a. Protect the production of cheaper wines more than expensive wines. ✓

b. Create an incentive to produce better quality wines.

c. Equally protect the production of all Canadian wines.

d. Protect the production of expensive wines more than cheaper wines.

2. The principle of comparative advantage was first formulated in the 18th century by

a. Thomas Malthus.

b. Adam Smith.

c. David Hume.

d. David Ricardo. ✓

3. The imposition of a tariff on an imported good causes consumer surplus to ________ and producer surplus to ________.

a. Decrease; increase ✓

b. Increase; decrease

c. Increase; increase

d. Decrease; decrease

4. A country that engages in no foreign trade is said to be in a situation of

a. Absolute advantage.

b. Autarky. ✓

c. Isolation.

d. Comparative advantage.

5. The existence of any "gains from trade" relies on

a. comparative advantage. ✓

b. absolute advantage.

c. both absolute and comparative advantage.

d. closed economies.

6. Economies of scale and product differentiation can provide an explanation for

a. intra-industry trade. ✓

b. the imposition of trade barriers.

c. countries remaining at their autarkic positions.

d. absolute advantage.

e. countries trading in completely different products.

7. If Canada's index of export prices is 250 and the index of import prices is 200, then the index of the terms of trade is

8. The effect of the imposition of a new tariff is to ________ domestic production of the commodity and ________ the

domestic consumption of the commodity.

c. Decrease; increase

d. Increase; increase

9. A 10 percent tariff on all wines imported into Canada will

a. provide no protection at all to the Canadian wine industry.

b. protect the cheaper wines at the expense of the expensive wines.

c. protect the expensive wines more than the cheaper wines. ✓

d. equally protect the production of all Canadian wines.

10. Efficiency gains from the introduction of free trade in an export market will be largest when

a. Demand is inelastic and supply is elastic

b. Demand is elastic and supply is inelastic

c. Demand is elastic and supply is elastic ✓

d. Demand is inelastic and supply is inelastic

11. Efficiency gains from the introduction of free trade in an import market will be largest when

a. Demand is inelastic and supply is elastic

b. Demand is elastic and supply is inelastic

c. Demand is elastic and supply is elastic ✓

d. Demand is inelastic and supply is inelastic

12. Efficiency losses from the introduction of a quota in an import market will be largest when

a. Demand is inelastic and supply is elastic

b. Demand is elastic and supply is inelastic

c. Demand is elastic and supply is elastic

d. Demand is inelastic and supply is inelastic ✓

13. Efficiency losses from the introduction of a tariff in an import market will be largest when

a. Demand is inelastic and supply is elastic

b. Demand is elastic and supply is inelastic

c. Demand is elastic and supply is elastic ✓

d. Demand is inelastic and supply is inelastic

14. Efficiency gains from the elimination of a tariff in an import market will be largest when

a. Demand is inelastic and supply is elastic

b. Demand is elastic and supply is inelastic

c. Demand is elastic and supply is elastic ✓

d. Demand is inelastic and supply is inelastic

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15. Supply and demand are given D = 200

− 20P and S = 20P

− 40. Currently the government allows a Free Trade policy at a

world price of $3.

a. Provide a labelled Supply and Demand Diagram along with supplementary calculations to assess how the

introduction of an Import Quota of 40 units will affect Consumer Surplus, Producer Surplus, Licensee Surplus and

Total Surplus.

b. On your diagram illustrate how the gains from trade would increase if demand was more elastic. Provide numbers

for A = _______ and B = ________ that would make the demand curve D = A – BP more elastic than D = 200 – 20P.

16. Canadian demand for strawberries is given by D = 16000 – 2000p and the supply by domestic producers is given by S =

2000p – 4000. Canada imports strawberries. The world price is only p = 3. Next month the Minister of Finance will

introduce an import quota of 4,000 units in this market.

a. Provide a labelled Supply and Demand diagram and supporting calculations to assess how this import quota will

affect price and quantity in the strawberry market.

b. Blueberries are a substitute in consumption for strawberries. When analyzing how this quota on strawberries will

affect the well-being of local blueberry producers explain why the price elasticity of demand for strawberries an

important consideration.

17. The demand for oranges in Canada is given by D = 1000 – 100p and supply by domestic producers is S = 200p – 200. The

world price is 2 dollars per orange.

a. Provide a labelled Supply and Demand diagram showing the market for oranges and supporting calculations to

explain why a tariff of 1 dollar would create a welfare loss in this market.

b. A journalist suggests that this tariff will be bad news for Canadian apple growers firstly because apples are a

substitute in consumption for oranges and secondly because the Canadian demand for oranges is very inelastic.

Provide a second supply and demand diagram showing the market for apples. Do you agree with this claim?

18. Supply and Demand for an imported good are given by QD = 30 – 4P and QS = 6 + 2P. Currently Canada allows free trade at

a world price of $2.

a. Trade disputes lead the Canadian government to implement an import quota at Q = 6 units for this good. Provide a

labelled diagram and calculate how introducing an import quota will affect consumer, producer and licensee

surplus in the economy. Label the deadweight (efficiency) loss.

b. Clearly explain which elasticities are most important when trying to predict how much total surplus will decline

when a quota is implemented.

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19. An island economy imports milk. Demand is D = 24 – 2p, Supply is S = 2p and the world price is equal to 1 dollar per litre.

Next month the governor will implement a tariff of 1 per litre on milk imports. Provide a labelled Supply and Demand

Diagram to illustrate and quantify the impact of this tariff.

a. The efficiency loss will be equal to __________. Revenues collected from the tariff will be equal to __________.

Illustrate the efficiency loss and revenues in your diagram.

b. The governor gets greedy. He has asked for your help in recalculating the tariff rate. His goal is to maximize the

revenues that his government will collect from the tariff. The revenue maximizing tariff rate is __________ dollars

per litre. Revenues collected from the tariff will be equal to __________. You do not need to draw this part in your

diagram.

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20. The demand for oranges in Canada is given by D = 100 – 10p and supply by domestic producers is S = 20p – 20. The world

price is 2 dollars per orange.

a. Provide a labelled Supply and Demand diagram showing the volume of imports in the market for oranges at a

world price of 2 dollars.

b. Next month the government will introduce a tariff of 1 dollar in this market. Use the same diagram to show how

this policy will affect the volume of imports, consumer surplus, producer surplus and government surplus.

c. Shade in the Efficiency Loss in from this policy.