Comparative Advantage, Tariffs, Quotas, Subsidies Problem Set

Problem 1. 

Let’s assume there are only 2 countries that produce 2 good.  More specifically, suppose that the United States (US) and the United Kingdom (UK) each have 2 units of productive resources, 1 used to produce Wine, the other Cloth.  The US can produce 40 units of Wine with 1 unit of productive resources and 40 units of Cloth with 1 unit of productive resources.  The UK can produce 20 units of Wine with 1 unit of productive resources and 10 units of cloth with 1 unit of productive resources.  Using this information, please answer the questions below:

*Who has an absolute advantage in the production of Wine?  Cloth?

*Who has a comparative advantage in the production of Wine?  Cloth?

*Given specialization, what is production before trade?  After trade?

*What are the gains from trade?

*What is the “range” of potential exchange rates between US and UK?

Problem 2

 Suppose that in Japan, without a tariff 10,000 cars will be sold per year at an equilibrium price of $20,000.  With a $5,000 tariff, supply decreases such that 8,000 cars are produced at $22,500 per car. 

*Use a supply and demand diagram to graphically illustrate the example above.

*Why is the increase in price less than the tariff?

*Who bears the burden of the tariff?

*What are government revenues from the tariff?

*What is the “dead-weight loss” associated with the tariff?

Problem 3

Graphically explain the negative effects of quotas.  How about subsidies?

Problem 4

Each year, consumers in a small country purchase 1 million pounds of sugar at the global price of $1.50 per

pound. Domestic firms produce 500,000 pounds and domestic consumers imports the remainder. Policymakers of the world’s major supplier of sugar begin an export-subsidy program that rewards firms for exporting sugar. This program causes the global price of sugar to drop to $1 per pound. The domestic quantity demanded in the small country climbs to 1.3 million pounds, and the domestic quantity supplied falls to 300,000 pounds.

  1. Draw a diagram of the small-country market for sugar under free trade, and with the export subsidy in place.
  2. Calculate the loss of domestic producer surplus and the increase in domestic consumer surplus.
  3. What is the total value of the subsidy in the small-country market?
  4. Can you identify any deadweight losses?

Problem 5

Consider the following situation for a nation in a small country setting that has an import quota on men’s shirts.

  With quota Free trade
Price $45 $30
Quality purchased 1 million 1.2 million
Domestic quantity supplied 400,000 300,000
Quota 600,000 None
  • Illustrate the effects of the quota in a supply and demand framework.
  • Indicate in your diagram and calculate:
  • The loss of consumer surplus
  • The gain in domestic producer surplus
  • The deadweight losses
  • The quota rent