Question 1.Consider two countries (Home and For

08 Jun Question 1.Consider two countries (Home and For

Question
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?