Exam 2: Practice exam

  1. (12 minutes) Suppose that Taiwan's domestic Council of Economic Advisers (CEA) presents the following ranked list (from best to worst) of policies that Taiwan could use to promote domestic production of minicomputers:
    (1) voluntary export restraint agreements with Taiwan's current foreign suppliers
    (2) quotas on minicomputer imports
    (3) tariffs on minicomputer imports
    (4) a production subsidy for minicomputers
Taiwan wants to minimize the national welfare cost of promoting minicomputer production. Since Taiwan is a small country importer of minicomputers, exporters are unlikely to retaliate against any policy that Taiwan adopts.
    a. You are hired as an economic consultant to Taiwan's Council of Economic Advisers. Would you suggest any modifications to the ranking submitted by the CEA? If so, indicate your ranking, and support your recommendation. If not, indicate why the CEA's ranking is appropriate. Support your answer with a domestic market supply and demand diagram for Taiwan's minicomputers.
    b. A pro-tariff contingent of CEA members has argued that a production subsidy is the worst of the four policies because it requires government expenditures, and Taiwanese can't afford the taxes necessary to finance the subsidy. They argue that a tariff is better because it would increase government revenues instead. How would you respond?

    2. (12 minutes) Suppose you are hired as a trade policy consultant to President Clinton. Indicate and carefully support what policy recommendation, if any, you would make for each of the following (no graphs are necessary for full credit, just careful reasoning):
    a. The Los Angeles Times recently reported that flat-panel display screens (used in products such as laptop computers, instrument panels of cars and aircraft, video telephones, high-definition TVs and hand-held personal communicators) are a "dual-use technology" product: "The screens are prominent features of laptop computers, but they are also being used increasingly in military equipment." Domestic production of flat-panel display screens therefore has likely benefits for U.S. national security purposes, but potential U.S. manufacturers cannot compete with lower-cost flat-panel display screens manufactured in Japan.
    b. U.S. candle-making firms file a complaint about candles imported from China and manufactured with "cheap Chinese labor." Research indicates that candle-making workers are slightly more productive in the U.S. than in China, but, because of far lower wages in China, the cost of making candles is lower in China than in the U.S.
    c. Without safeguards, when fishing companies catch tuna, they kill dolphins which swim with the tuna. To protect endangered dolphins, U.S. policy requires that tuna be caught with dolphin-safe procedures. U.S. tuna fishing companies file a complaint that tuna imported from Mexico is caught without using dolphin-safe procedures. Research indicates that the complaint is true.

    3. (12 minutes) Suppose that Australia is a small country in each of the trade market situations  below. Consider each case separately, use a domestic market diagram for each one, and start out from a situation of free trade in each case. Be sure to illustrate in your diagrams the relevant gains or losses which result from the dumping in each case.
    a. Australia imports apparel. What will happen to Australia's welfare if policies abroad result in apparel being dumped on the world market?
    b. Australia exports wheat. What will happen to Australia's welfare if policies abroad result in wheat being dumped on the world market (assume that Australia can still compete as an exporter at the new global price).
    c. Australia initially exports iron ore. What will happen to Australia's welfare if policies abroad result in iron ore being dumped on the world market at a price low enough to turn Australia into an importer of iron ore?

    4. (12 minutes) TRADE MISCONCEPTIONS: Explain how what we have covered during this part of the course relates to each of the following popular misconceptions about the consequences of trade and trade policy. You may use diagrams where you find them helpful, but you can earn full credit for your answers without diagrams, just a careful explanation.
    a. Despite what the popular press sometimes reports, the economic theory of customs unions indicates that regional trade agreements such as Nafta do not necessarily raise a county's national welfare. Why are the effects uncertain?
    b. Despite studies which consistently find that the U.S. as a whole and U.S. consumers in particular lose welfare as a result of trade protection, opinion surveys often indicate that most Americans favor increased protection. How does the public choice theory of protection help account for this?
    c. The trade policy game we played in class illustrates how a willingness to resort to trade market intervention can actually promote freer trade between countries. What is the reasoning behind this apparent contradiction?

    5. (12 minutes) Methods used by traders to evade U.S. tariffs include the following:

Through "smuggling" maneuvers like these, traders avoid paying tariffs, but they also incur additional costs. Assume that the extra cost is some constant amount in each case (for example, $200 per imported truck). Suppose also that the U.S. is a small-country importer of items like the ones listed above. Does circumvention of tariffs make U.S. welfare rise, fall, remain unchanged or change in an uncertain direction? Use a domestic market supply and demand diagram to support your answer. (Hint: recall the results of customs union theory.)