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Name:___Solution Key____ SSI 2005, 160A Final Professor Farshid Mojaver Multiple Choice Part (36 points, 18 questions, 2 points each) 1. The existence of positive externalities due to the impossibility of full appropriability A. Supports the conclusions of the Heckscher-Ohlin model. B. Rejects the usefulness of government protectionism. C. Supports the concept that the government should support only high tech industries. D. Provides support for government protectionism. E. None of the above. 2. In the Brander-Spencer model the subsidy raises profits by more than the subsidy because of A. The "multiplier" effect of government expenditures. B. The military-industrial complex. C. The forward and backward linkage effects of certain industries. D. The deterrent effect of the subsidy on foreign competition. E. None of the above. 3. If firms in an industry are generating knowledge that other firms can use without paying for it, this industry is characterized by A. Social costs that exceed private costs. B. Social benefits that exceed private benefits. C. Social costs that exceed social benefits. D. Private benefits that exceed social benefits. E. None of the above. 4. The reason protectionism remains strong in the United States is that A. economists can produce any result they are hired to produce. B. economists cannot persuade the general public that free trade is beneficial. C. economists do not really understand how the real world works. D. the losses associated with protectionism are diffuse, making lobbying by the public impractical. E. None of the above. 5. Of the many arguments in favor of tariffs, the one that has enjoyed significant economic justification has been the A. cheap foreign labor argument. B. infant industry argument. C. even playing field argument. D. balance of payments argument E. domestic living standard argument. 6. The main redistribution effect of a tariff is the transfer of income from A. domestic producers to domestic buyers. B. domestic buyers to domestic producers. C. domestic producers to domestic government. D. domestic government to domestic consumers. E. None of the above. 7. It is argued that high-tech industries typically generate new technologies but cannot fully appropriate the commercial benefits associated with their inventions or discoveries. If this is true then in order to maximize a countries real income, the government should A. B. C. D. E. Tax the high-tech firms. Subsidize the high-tech firms. Protect the high-tech firms. Both B and C None of the above. 8. A problem encountered when implementing an "infant industry" tariff is that A. domestic consumers will purchase the foreign good regardless of the tariff. B. the industry may never "mature". C. most industries require tariff protection when they are mature. D. the tariff may hurt the industry's domestic sales. E. None of the above. 9. In practice, international labor mobility is A. a complete complement to trade flows. B. a partial complement to trade flows. C. a complete substitute for trade flows. D. a partial substitute for trade flows. E. None of the above. 10. Multinational corporations A. increase the transfer of technology between nations. B. make it harder for nations to foster activities of comparative advantage. C. always enjoy political harmony in host countries in which their subsidiaries operate. D. require governmental subsidies in order to conduct worldwide operations. E. None of the above. 11. The shift of labor-intensive assembly operations from the United States to Mexican maqiladora may be best explained in terms of a theory of A. location. B. vertical integration. C. horizontal integration D. internalization. E. None of the above. 12. External economies of scale arise when the cost per unit A. rises as the industry grows larger. B. falls as the industry grows larger. C. falls as the average firm grows larger. D. remains constant. E. None of the above. 13. External economies of scale A. may be associated with a perfectly competitive industry. B. cannot be associated with a perfectly competitive industry. C. tends to result in one huge monopoly. D. tends to result in large profits for each firm. E. None of the above. 14. Internal economies of scale A. may be associated with a perfectly competitive industry. B. cannot be associated with a perfectly competitive industry. C. are associated only with sophisticated products such as aircraft. D. cannot form the basis for international trade . E. None of the above. 15. According to the Heckscher-Ohlin model, the source of comparative advantage is a country's A. B. C. D. E. technology. advertising. human capital. factor endowments. Both A and B. 16. The Leontieff Paradox A. refers to the finding that U.S. exports were more labor intensive than its imports. B. refers to the finding that US. Exports were more capital intensive than its imports. C. refers to the finding that the U.S. produces outside its Edgeworth Box. D. still accurately applies to today's pattern of U.S. international trade. E. refers to the fact that Leontieff - an American economist – had a Russian name. 17. Which of the following statements is the best comparison of the motives for IntraIndustry versus Inter-Industry Trade? A. Intra-Industry trade is driven by comparative advantage, while Inter-Industry trade is not. B. Inter-Industry trade is driven by comparative advantage, while Intra-Industry trade is not. C. Both Intra- and Inter-Industry trade are driven by comparative advantage. 18. Which of the following statements is the best characterization of Terms of Trade Effects from the perspective of the country implementing the following policies? A. Both tariffs and export subsidies will improve the terms of trade for the implementing country. B. Both tariffs and export subsidies will worsen the terms of trade for the implementing country. C. Tariffs will harm, while export subsidies will improve the terms of trade for the implementing country. D. Export subsidies will harm, while tariffs will improve the terms of trade for the implementing country. The Ricardian Model of Trade [12 points, parts 5,6,7&8 2 pts, all the rest 1 point each] 1) Korea has 200 units of labor, while there are 400 units of labor in China. When they produce, the countries have the following unit labor requirements. Shoes Cars Korea 10 5 China 10 20 1-1) Which country has absolute advantage in Shoe production and why? What about car production? Korea has absolute advantage in Cars because her labor productivity in that sector is higher than that of China. No country has absolute advantage in the production of shoes. 1-2) In absence of trade, what is the opportunity cost of Shoes (in terms of Cars) in China and Korea? Korea China OC of Shoes (in terms of Cars) aLS/aLC bLS/bLC 10/5 = 2 10/20 = 0.5 1-3) Which country has comparative advantage in Shoe production? China 1-4) What is the relative price of Shoes in each country before trade? Autarky PS/PC in Korea = 2 Autarky PS/PC in China = 0.5 1-5) Show that the real wages (in terms of goods) after trade is higher in both countries 1-6) Calculate relative wages for Korea to China after trade WKor/WChina = WKor/WChina = (bLS/aLC) PC/PS = 10/5 = 2 1-7) Label the graph below carefully (fill for the question marks) PS/PC aLS/aLC = 2 Korea 1 bLS/bLC = 0.5 Relative Supply Relative Demand China bLC↓→(bLS /bLS)↑ (LChina /bLS)/(LKor/aLC) = (400/10)/(200/5) = 1 1-8) What is the effect of a technological improvement in car production in China? Illustrate your answer in the graph above. See above graph Problem 2 [12 points, 4 points each part] You are employed as an economic advisor of a presidential candidate in the Unites States. One of the issues you need to take a stand is the threat of Chinese imports to US manufacturing products. A number of labor unions demand a substantial increase in the import tariff rates on such products. a) What is your advice to the presidential candidate and why? b) How would your advice change if you were employed by a major party in India given that income distribution is less equal in India and that India imports capital intensive goods? c) How would your advice change if you were employed by the government of China, where income distribution is more equal but most of the enterprises are state-owned? Problem 3 (Trade in Perfectly Competitive Markets) [14 points, a, b , c 2 pts each, d 8 pts] There is a three panel graph below. In the left hand panel are the demand and supply curves in the Home country for some good Q. In the right hand panel are the demand and supply curves for the Foreign country for the same good. Both Home and Foreign are "large" countries. (a) In the middle panel, draw the import demand (MD) and export supply (XS*) curves for Home and Foreign, respectively. Be sure to label the curves. (b) Label the equilibrium world price in free trade as PoW, and indicate quantities consumed (QD) and produced (QS) in each country, as well as the quantity of good Q traded (label this Mo). (c) Suppose that Foreign imposes a specific export tax of $t. Show the new equilibrium price in Home and in Foreign, plus the new level of good Q traded (label this M1). Also indicate the new quantities produced and consumed in each country. (d) Label the areas in the left hand panel. Relative to free trade, i. What is change in Home consumer surplus? (write down the area below) CS = -[ a + b + c + d ] ii. What change in Home producer surplus? iii. PS = a What is the change in the Home government’s revenue? Gov R = 0 iv. What is the total change in Home’s welfare? W = -[ b + c + d ] Problem 4 (Monopolistic Competition) [16 points, 4 points each part] Consider the following monopolistically competitive market. Cost function: C = F + cQ Demand function: Q = S[1/n –b(P- P¯ )] Where C is total cost, c is marginal cost, F is fixed cost, Q is output, S is market size, n is the number of firms, b is sensitivity parameter P is price of the good and P¯ is the average market price charged by competitors. a) Draw a graph for the following PP and CC curves and give an economic interpretation each. PP curve: P = c + 1/(bn) and CC curve: P = c + nF/S AC, P CC Curve PP Curve Number of Firms, n As number of firms increase two opposing happens: on one hand price falls because of more competition. This is illustrated by the PP curve. On the other hand, as firms compete for the same amount of resources to produce more verities, cost of production goes up. This is illustrated by the CC curve. b) Suppose there are two countries (A, B) that have monopolistically competitive industries. The two countries have the same costs of production and demand function given above, where F=32 and c=5, b=1/4. Sales in country A, SA=128 units, Sales in country B, SB=512 units. (i) Find the number of firms and the prices charged by firms in each country if there is no integration. 128 n 0.25 * 32 A 0.5 512 4, n 0.25 * 32 32 P 5 0.25 * 128 A B 0.5 0.5 8 32 6 , P 5 0.25 * 512 B 0.5 5.5 ii) Find the number of firms and the prices charged by firms in each country if there is integration. (round the number of firms if it is not an integer) S S A S B 640 640 n 0.25 * 32 0.5 32 8.9 , P 5 0.25 * 640 0.5 5.44 d) Are there any gains from integration? Explain why or why not? The producers are realizing economies of scale and are able to provide a greater variety at a lower cost and produce more. Consumers consume a greater variety at a lower price. Everyone is better off. There are gains from integration for the world as a whole. But if all the efficient firms are in one country and production shifts away from the country with inefficient firms after integration the producers of this country would obviously lose. 5- A question on Income Distribution [20 points, 2 points each] U.S. is considering levying a 15 percent tariff on Chinese imports. Analyze the effects of this policy in the U.S economy in the following table. You may assume that Chinese exports to U.S. are mostly labor intensive products. So in answering the question consider IMP import competing (labor intensive sector) and EXP export (capital intensive) sectors uses Labor and capital in their production. Consider both US and China as small economies. Use the following notation: + 0 A the variable increases in this step the variable decreases in this state the variable does not change the variable change is ambiguous (i.e. it may rise, it may fall) Impact Short Run Long Run IMP to EXP Price ratio + + + Nominal wage in IMP sector WIMP + + + Nominal wage in EXP sector WEXP 0 + + Nominal rent in IMP sector RIMP + + - Nominal rent in EXP sector REXP 0 - - Real wage in IMP WIMP + A + Real wage in EXP sector WEXP - A - Real rent in IMP sector RIMP + + - capital-labor ratio in IMP production 0 - +