Question Please indicate your answers CLEARLY in the spaces belo

Please indicate your answers CLEARLY in the spaces below. (Note: you may expand the space available in particular answers before printing off each sheet if necessary). The graphs indicated in several of the questions may be put on extra sheets if you wish. Be sure your graphs, and all your work, is CLEARLY READABLE; unreadable responses will be marked down accordingly.

Question 1:

You’re part of a group of economic consultants supporting the government of Sweden. Sweden wants to liberalize trade in the automobile industry and your job is to help the government explore the benefits and costs of trade liberalization. Government analysts have provided you the following data for the domestic auto industry:

Table 1
Price (P) Quantity Demanded (QD) Quantity Supplied (QS)
20 40 0
35 20 25
50 0 50

a) Your first assignment is to examine the domestic market under autarky. Using these data, derive the domestic demand and supply equations for automobiles. (4 Points)
b) To visualize your findings, please graph the demand and supply curves (4 Points)
c) What is the equilibrium quantity of autos sold in the domestic market and at what equilibrium price are they sold (both under autarky)? (4 Points)
d) To systematically examine the impact of opening Sweden’s borders to trade, the autarky equilibrium establishes a benchmark. Indicate the producer and consumer surplus characterizing the autarky equilibrium in your graph.(2 Points)
e) Now calculate consumer surplus, producer surplus, and total welfare. (6 Points)
f) Now you want to establish whether free trade would be beneficial for Sweden. The analysts tell you that the current world market price for autos is 25 Euros (unrealistic, but for the sake of simplicity) and you know that Sweden is a “small country” in automobile industry. At the world market price, what would be the quantity produced and consumed domestically in Sweden? What quantity will be imported? (3 Points)
g) Draw the new consumer and producer surplus in your graph resulting from free trade. (4 Points)
h) Calculate the new producer surplus, consumer surplus and total welfare.(6 Points)
i) What is your assessment of the situation? 1) Who gains from trade, 2) who loses from trade, and 3) do you think free trade of cars would be beneficial for Sweden? (3 Points)
j) Imagine for a moment that Sweden is a large player in the automobile industry. Would Sweden’s participation in the global trade in autos drive world prices up or down? Why (briefly)? What would the world market price be after Sweden opens its borders (as close as you can tell)? (3 Points)

Question 2: [32 points]

For your next consulting assignment, you are employed by the European Trade Commission to examine the consequences of an EU-U.S. free trade agreement for autos. Your analysts have provided you with the demand and supply equations for both regions, as summarized in Table 2. For your analysis, assume that everyone trades in $US.

Table 2
Europe U.S.
Supply QS(EU) = 10 + 10P QS(US) = 20 + 10P
Demand QD(EU) = 50 – 10P QD(US) = 40 – 10P

a) Before the regions open to trade, what are the domestic prices and quantities in Europe and the U.S.? Which country is the importer and which one the exporter?(8 Points)
b) To examine the impact of trade between the two regions, derive the excess demand function for the importing country. (2 Points)
c) Derive the export supply function for the exporting country. (2 Points)
d) Draw a 3-panel-graph, i.e., the European, World and U.S. markets next to each other, given the functions above (as shown in class). (8 Points)
e) If the free trade agreement were to be implemented, what would the world equilibrium market price be and what quantity would be traded?(2 Points)
f) The European Union is reluctant to agree to the free trade agreement due to political pressure from European producers. Therefore, they consider implementing a tariff of $0.50 (US) on every unit imported. Add the tariff to your graph and clearly indicate the total tariff revenues, as well as the quantities produced and consumed in both Europe and the U.S. with the tariff implemented. (6 Points)
g) If the tariff were implemented, what price would European consumers pay? What would U.S. producers receive? (4 Points)

Question 3: [8 points]
The U.S. wants to make progress on this free trade agreement and argues that freer trade is necessary because the effective rate of protection in the European auto industry is actually much higher than the nominal rate of protection. Assume that the nominal tariff rate on autos is 30%. European producers can import automobile engines at a tariff rate of 10%. The value of engines relative to the whole car is 20%.

a) Please calculate the effective rate of protection and evaluate the claim.(4 Points)
b) As a compromise, the EU suggests they would decrease the tariff rate on cars to 25%, while abolishing all import tariffs on auto engines. Would that compromise be beneficial for the U.S.? (4 Points)

Question 4: [21 points]

Your last assignment brings you to work with the government of Sweden on textile markets. Sweden is fully integrated into the textile world market and the world market price for textiles is 0.50 Euro. Your analyst has summarized for you the domestic supply and demand functions for textiles in Sweden:

Table 3
Supply Q = -5 + 20P
Demand Q = 40 – 20P

a) Given the world market price, what quantities of textiles are produced and consumed in Sweden?(4 Points)
b) Calculate the consumer and producer surplus at their initial equilibrium levels. (NOTE: Although not required, it may be helpful to draw a graph).
(4 Points)
c) The government of Sweden plans to implement a tariff of 0.50 Euro on every unit imported. With the tariff implemented, what quantity of textiles would be produced and consumed assuming Sweden is a “small country” in the textile market? (Again, drawing a graph may be helpful). (4 Points)
d) What is the size of consumer surplus, producer surplus and total tariff revenues with the tariff?(6 Points)
e) What is the difference in welfare between the free trade and tariff regimes? Given this quantity, would you recommend that the government of Sweden implement the tariff or not? (3 Points)

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