Download UNIT 5 Assigment Marco 201

1
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
Macroeconomics--ECN 201
Assignment for Unit 5
Chapters 16-19, Taylor Text 3rd edition
Remember to explain your responses thoroughly. Be careful most of the questions have
several parts. Be sure to answer the
complete question.
1. Suppose there are two countries, identical except for the fact that the central bank of
one country lets interest rates rise sharply when inflation rises and the other country
lets interest rates rise less when inflation rises. Draw the aggregate demand/inflation
curve for each country. What are the benefits and the drawbacks of each country’s
policy?
The benefit to Country A is that by raising interest rates
sharply, the end result will be a lower rate of inflation. The
draw back to Country A’s policy is that it would mean a deeper
drop in real GDP as compared to potential GDP. For Country B,
the opposite is true, because Country B raises interests rates
more slowly, the positive will be that real GDP does not drop as
much as it would in Country A, the drawback is that the inflation
rate will not lowered as much. One of the major goals of
economic policy to keep real GDP close to potential GDP,
therefore when the Fed makes changes to the interest rates, it
usually does son incrementally, not only for the reason of
keeping real GDP close potential GDP, but they usually want to
error on the side of caution, meaning that they don’t want to
make a drastic change to the interest rates because it can have
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
2
drastic changes on the economy. The problem is not that the Fed
does not understand theory behind their decisions, the problem is
that they do not always have perfect information, therefore it is
better to make smaller wrong decision, than a larger wrong
decision.
2. Transport costs relative to the value of most products have been falling throughout the
history of world trade. How has this affected the validity of purchasing power parity?
Suppose many countries impose trade taxes on goods going in or out of the country.
How will this affect purchasing power parity?
The decrease in transportation costs have only served to
strengthen the validity of purchasing power parity, because the
purchasing power parity assumes that transportation costs are
negligible.
If countries impose trade taxes, then the validity of the
purchasing power parity is decreased, because transportation
costs would increase.
A great example of this can be
illustrated from my dealings with Mexican customs on the MexicoUS border. Food items, which could be brought from the United
States into Mexico, were priced about the same when you take into
consideration the exchange rate. A case of coke was about $5.00
US dollars in Calexico (the US border town) and was about $50
pesos in the Mexican border city of Mexicali. At the time the
exchange rate was about 10 pesos per US dollar. However items on
which could not be brought across the border due to taxes imposed
on them were much more expensive in Mexico relatively speaking.
For instance a stereo that cost $300 US dollars in the United
States may cost almost $4000 pesos in Mexico. The reason, there
was about an $800 peso tax on the import. However; a great
example of this, and also how imposing trade barriers hurts a
country is the price of gasoline was so much more expensive in
Mexico than in the US. Not only did you have to convert Mexican
pesos to US dollars, you also had to convert liters to gallons,
when is said and done, a gallon of gas costing $1.75 in the US,
across the border it might be has high a $2.75 on the Mexican
side. So who loses on this? The Mexican government, and the
Mexican people, the Mexican government loses because it loses the
revenue from gas not sold in Mexico when people cross into the US
to fill up their cars. Also the Mexican people who do not have
border-crossing visas lose, because they continue to pay higher
prices for gasoline.
3. Why would a European country want to drop out of the fixed exchange rate system?
Why might the country want to join the fixed exchange rate system?
3
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
A European that is in a fixed exchange rate system may want to
drop out of the system if it is experiencing a downturn in its
own economy, but the other countries are experiencing
inflationary times.
A country may want to join a fixed exchange rate system if it
does not want the exchange rate to change, which affects net
exports.
4. Why is the identity that investment plus net exports equals savings important for
understanding the flow of capital around the world?
S=I+X. That formula is very important fact in macroeconomics
when speaking of the flow of capital around the world. It also
simplifies following statement. If a country does not trade with
anyone, then net exports are removed from the equation and
Savings will equal investment. Why the big deal about the net
exports and the flow of capital around the world; because, it is
from net exports that the flow of capital around the world is
determined.
The general rule is that advanced countries invest
in less developed countries. It is very common that poor
countries have net exports less than zero, investment is lower
than savings, and with imports higher than exports, economic
growth would be very difficult. With that in mind, many poor
countries depend on foreign investment as a source of capital
with which to foster economic growth. Another reason to take
notice of the fact that investments plus net exports equal
savings is advanced countries supply capital in the terms of
investment to poor countries, however; at issues, is, are the
advanced countries saving enough money in order to invest in the
poor countries in the future and thus continue to spread the flow
of capital around the world. The truth of the matter is that
that national savings rate has been decreasing. Since 1970 the
national savings rate has decreased from 25% to 23% in 1990.
Only countries that have large trade surpluses are the net
suppliers of savings to the rest of the world, and the United
States is not one of those countries that is a net supplier of
savings, in fact, the United States is a net user rather than a
net supplier of savings.
5. Plot on a scatter diagram the data for the Asian countries that appear below. Does
there appear to be a catch-up line in the scatter diagrams?
Country
Thailand
Pakistan
Philippines
China
Per Capita Real GDP
in 1995 dollars
(1984 U.S. dollars)
360
210
380
110
Average Annual Rate
of Growth from
from 1965 to 1985
percentage (%)
4.0
2.4
1.9
5.1
4
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
Malaysia
Indonesia
330
190
4.3
4.6
There does not appear to be any real catch up line. If there was
a catch up line, we would expect to see the points of the scatter
form a more distinguishable pattern where as there is an increase
in the per capita REAL GDP followed by a decrease in the average
annual rate of growth, and is this instance that does not appear
to take place. It appears as if there isolated instances where
this holds true such as the Philippines where it has a high per
capita real GDP and a low average rate of growth. This also
holds true for China were its per capita real GDP is low but its
rate of growth is higher compared to the rest of the countries.
Countries like Thailand and Malaysia represented by points A and
E, have both a high per capita real GDP and a high average rate
of growth, therefore they don’t reflect the trend line one would
expect.
6. What is the difference between absolute and comparative advantage?
The difference between absolute and comparative advantage, is
can best be defined by stating that an absolute advantage occurs
when one entity is more efficient at producing a product. A
5
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
comparative advantage occurs when one entity can produce one good
with better efficiency than another entity. When comparing two
entities it is possible that entity “A” produces two products
more efficiently than entity “B”. However, due the opportunity
cost in A, it is entity “B” will have a comparative advantage
over entity “A”. In other words, it is possible for an entity to
have an absolute advantage all of the goods being compared, but
it will only have a comparative advantage in one or more, but not
all of them. If you take two goods, good 1 and good 2, produced
by two entities, entity A and entity B, and entity A has an
absolute advantage in both good 1 and good 2, entity B will still
have a comparative advantage in one of the goods, and entity A
will have a comparative advantage in the other, but neither will
have a comparative advantage in both.
7. Suppose the production of wheat and strawberries per unit of labor in the U.S. and
Mexico is as follows:
Wheat
Strawberries
Mexico
1 bushel
3 pints
U.S.
2 bushels
3 pints
A. Which country has a comparative advantage in wheat production?
The US has a comparative advantage in wheat production
Why?
The reason why the US has a comparative advantage in wheat production is because
since both of produce the same amount of strawberries, then it makes more since for the
US to use its resources to produce wheat. Mexico on the other hand as a comparative
advantage in the production of strawberries because to be able of the opportunity cost
involved in removing labor unit resources from strawberry production to wheat
production. The opportunity cost of Mexico to produce 2 bushels of wheat is 3 pints of
strawberries, therefore, it Mexico has a comparative advantage in strawberry production.
B. With free trade between the U.S. and Mexico, is it possible that 1 bushel of wheat
will trade for 1 pint of strawberries?
Yes,
Why or why not?
When we look at how free trade affects relative price when can that it will trade for a 1:1
ratio
MEXICO
UNITED STATES
RP prior to rade
1 Unit wheat per
3 units strawberries
2 units wheat per
3 units strawbeeries
RP range after trade
Between .33 and 1.5
Between .33 and 1.5
RP assumption
1
1
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
6
C. Suppose the free trade price is 1 bushel of wheat for 2 pints of strawberries. Draw a
diagram indicating the production possibilities curve with and without trade if the
U.S. has 200 million units of labor. What is the maximum amount of wheat the U.S.
can produce?
The maximum amount of wheat the US can produce is 400 million bushels of wheat; that
will not change because of trade. This is true because the US has the comparative
advantage in the production of wheat.
8. The following relationship between price, cost per unit, and the number of firms
describes an industry in a single country.
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Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
Number of firms
1
2
3
4
5
6
7
8
9
10
Cost per Unit ($)
10
20
30
40
50
60
70
80
90
100
Price ($)
90
80
70
60
50
46
43
40
38
36
a. Graph (1) the relationship between cost per unit and number of firms, and (2) the
relationship between price and number of firms. Why does one slope up and the
other slope down?
The cost per unit increases and slopes
up as more firms enter the market because with more firms in the
market, each firm produces less market share of the good and if
the size of the market remains constant, this means that the
production of the product is not as cost efficient as if it had a
larger share of the market, this therefore raises the cost per
unit.
The price in the market slopes down or decreases as the number of
the firms entering the market increases, because as more firms
enter the market, the more competitive the market becomes and the
lower the price is.
b. Find the long-run equilibrium price and the number of firms.
The long run equilibrium price and long run equilibrium number of
8
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
firms in the market occurs where the cost per unit curve and the
price in the market intersect with one another. In this case the
equilibrium price is $50 and the equilibrium number of firms in
the market is 5.
c. Now suppose the country opens its borders to trade with other countries; as a result,
the relationship between cost per unit and the number of firms becomes as follows:
Number of firms
1
2
3
4
5
6
7
8
9
10
Cost per Unit ($)
5
10
15
20
25
30
35
40
45
50
Find the long-run equilibrium price and number of firms.
The long run equilibrium price is $40 and the long run
equilibrium number of firms is 8.
D. What are the gains from expanding the market through the reduction in trade
barriers?
The gains in trade from a reduction in the trade barriers are a
reduction in the price per unit by $10, and more variety from
having more firms in the market.
9. Use a supply and demand diagram to show what happens to the price and quantity of
sugar in the U.S. when the quotas on sugar are removed.
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
9
Point A demonstrates the amount paid by US consumers.
Point B represents the amount received by foreign producers
Point C represents the quota on sugar being removed.
Then the
quota is removed, natural market forces are allowed to take
control, what happens thereafter is the export supply curve and
the import demand curve intersect one another to establish an
equilibrium price that is lower than the price of sugar when
there was a quota on it. The price falls because at point A, the
demand is greater than supply. The aqua blue line intersecting
point a represents the artificial export supply curve imposed by
the quota. As the quota is moved the supply curve will shift to
the right and interest the demand curve at a lower level
(indicated by point C).
10. Has Poland or china had an easier time with the transition from central planning?
Why do you think this is the case?
If comparing the affects felt by the average citizen in both
countries, China has had an easier time transitioning to from
central planning. Two major factors for this are, once, Poland
implemented a shock therapy approach to converting to a market
style economy. Changes were made quickly and swiftly, therefore,
the effects were felt more quickly, and some of the effects were
very painful for the average Polish citizen. Poland at the time
of the transition from centrally planned economy to a market
economy had inflation of above 400%. High inflation is not at
all conducive to a stable economy. Just as Paul Volker made a
serious effort to decrease inflation in the 1980s in order to get
Name: Bryon D Gaskin.
Course Econ 201 Macroeconomics
Text Principles of Macroeconomics
Instructor Steve Scheer
December 6, 2002
Unit 5
10
the US economy back on track, one of the side effects of this is
a drop in GDP, which leads to higher levels of unemployment..
The same held true for Poland, when Poland made efforts to
control inflation, the unemployment rate jumped. However painful
these effects were, nevertheless, they were very effective.
Poland’s inflation rate between 1989 and 1990 of 420% had dropped
to 25% in 1992. China had an easier time than Poland because the
changes took place over a much longer period of time, allowing
for firms to find other avenues of venture, and employees other
types of employment. A huge factor in China’s transition that
did not happen in Poland is that with China’s sheer size and
abundant labor force, China had the ability to export many of its
products in the foreign market; as a result, China’s exports grew
faster than real GDP. Regardless of which style is taken, both
Poland using a shock therapy style transition, and China using
more gradual type transition, the end result has been similar,
the economies of both are starting to make headway in a positive
direction.