1.Consider two countries (Home and Foreign) that can
potentially produce 3 different goods
(A, B, C) using only labor with the following labor requirements (hours
required to produce one unit of the good):
A B C
Home 15
10 34
Foreign 5 2
17
Assume free
trade is possible with no transportation or other costs. If the wage rate in
the Home country is 25% of the wage in the Foreign country… :
which goods
will be produced in the Home country?
Which goods
will be produced in the Foreign country?
Show how you
get the result.
2.Consider the following information regarding consumers
valuation and cost of
production of
a good. The first table shows you how much consumers value different units of
the good (the maximum price they would pay for the first unit, for a
second unit, etc.):
Value 12 11 10 9 8 7
6 5 4 3 2 1
Unit 1 2
3 4 5 6 7
8 9 10 11 12
So the first
unit has a value of 12 (some consumer is willing to pay up to 12 for that
unit), the
second unit has a value of 11, etc.. Consumers
will buy all the units that give them a value greater than or equal to the
price they pay: for example, at a price P=10, 3 units will be consumed. Consumers surplusis the value they get
minus the price they
pay: for
example, at a price of 10, consumers get a surplus of 2 from the first unit, 1
from the
second unit, 0 from the third unit consumed (we assume that in case of
indifference,
when the surplus of a unit is 0, they still buy it).
The second
table shows the marginal cost for domestic firms of producing each
additional
unit (the minimum price at which they would supply the first unit, the
second,
etc.):
Cost 1 2
3 4 5 6 7
8 9 10 11 12
Unit 1 2
3 4 5 6 7
8 9 10 11 12
So the first
unit has a cost of production of 1 (some producer is willing to supply it at a
price of at
least 1), the second unit has a cost of production of 2, etc.. Assuming perfect
competition,
domestic producers will supply all the units they can produce at a cost
lower than or
equal to the price they can get: for example, at a price P=10, 10 units will
be supplied. Producers
surplusis the price they get minus the cost of production: for
example, at a
price of 10, producers get a surplus of 9 from the first unit, 8 from the
second unit,
etc. (0 from the 10th unit, but we assume that in case of indifference, when
the surplus
of a unit is 0, they still supply it).
Suppose the
country is a small open economy (so it does not affect the world price) and
under free
trade any quantity of the good can be imported at a price P0= 3.
a)
With free
trade at the world price P0= 3,
how many
units will be consumed in the country?
How much will
be domestically produced?
How much will
be imported?
b)
Suppose now
the government imposes a tariff t= 2 on each imported unit.
What will be
the price of the good in the country?
How many
units will be consumed?
How much will
be domestically produced? How much will be imported?
c)
The tariff
will generate gains and losses.
Where do the
gains and losses come from?
Who gains and
who loses?
Explain in a
few words whether the net welfare effect for the country as a whole is positive
or negative.
d)
Try to
estimate the net aggregate welfare effect in the following way.
Consider
first the units that were already bought from domestic producers before:
how does the
tariff affects consumers and producers surplus?
what is the
net welfare effect for those units?
Consider next
the units that are still imported:
how does the
tariff affects consumers and government surplus?
what is the
net welfare effect for those units?
Consider
finally the other units that before were imported but now are either bought
from domestic producers or not consumed anymore:
how does the
tariff affects consumers and producers surplus?
what is the
net welfare effect for those units?
So putting
together these three steps, how much is
the net aggregate welfare gain or loss from the tariff?
3.Consider a
country under a flexible exchange rate system. The economy is currently
producing at
its naturallevel of output, corresponding to a situation of equilibrium
in
the labor
market (where the real wage that firms are willing to pay, given their costs
and market power, is equal to the real wage that workers require, given their
alternatives and their bargaining power, to supply the current amount of
labor). The authorities are worried, though, about the unemployment rate, which
is relatively high, and are considering possible measures to stimulate the
economy and increase employment.
Suppose the
central bank adopts a more expansionary monetary policy and consider the
short-run effects of that policy:
a)
What would
happen to interest rates?
How would
that affect the exchange rate?
b) How would
the changes in interest rates and the exchange rate affect the aggregate
demand and
its components (consumption, investment, government purchases, net
exports)?
– How would that affect
employment?
b)
Would the effects discussed above be persistent beyond
the short-run?
In other words,what else would happen in the medium-run
as a consequence of those changes and
How would that affect the state of the economy (in
particular employment)?
d) Consider the same situation of the previous example,
but this time thinking of a
country maintaining a fixed exchange rate with another
major currency (and the country being small enough so that it does not affect
the economy of the other countries).
How would the answers to the same questions (a-b-c) about
the effects of monetary
policy differ?
Would an expansionary fiscal policy help in getting the
desired effects on
employment?
e) If we think more in a medium-long run horizon, what
kind of policies could help in
making employment persistently higher?
– Try to suggest at least two or three different types of
measures that would have a permanent positive effect on employment.
– Comment very briefly on how they would affect per
capita real income and what
difference (if any) would it make to have a fixed rather
than a flexible exchange rate.
