Problem Set 3

1.	Suppose the U.S. is a small country in the global heavyweight motorcycle market. Consider the following about the approximate impact of U.S. tariffs imposed in the 1980s in the heavyweight motorcycle market (quantities are in 1000s):
		Free trade $600 tariff U.S. price $3,400 $4,000 Quantity consumed (Qd) 200 150 Quantity produced (Qs) 100 125
	a.	Contrast the free trade and tariff situation in a domestic market supply and demand diagram.
	b.	Use information from the diagram to compute the value of the following effects of the tariff, and indicate where each one shows up in your diagram: (1) Change in consumer surplus, (2) Change in producer surplus, (3) Tariff revenue, and (4) Welfare cost of the tariff
	c.	An economic study estimated that the tariff created 700 jobs in the domestic motorcycle industry. How much did each of these jobs "cost" U.S. consumers? How much did each one cost the economy?

2.	TRADE POLICY EFFECTS: The diagram to the right depicts Spain as a small country in the global wheat market. The global price of wheat is $3 per bushel. For political reasons, legislation in Spain states that domestic wheat farmers must receive a total of $5 per bushel for the wheat they grow.
	a.	Complete the following table contrasting the effects of alternative trade policies in achieving Spain's objective:
		Tariff Import quota VER D consumer surplus       D producer surplus       D government revenue or domestic quota profits       D national welfare
	b.	Rank the policy options of Spain from best to worst.
	c.	What is the quantity of import licenses that Spain issues when it uses quotas instead of tariffs?

3.	TARIFFS VERSUS QUOTAS:
	a.	Use a domestic-market supply and demand diagram to illustrate an initial free trade equilibrium for a small country importer of beef.
	b.	Use your diagram to depict an equivalent tariff and quota on beef.
	c.	Now suppose the demand for beef increases. Depict the consequences in your diagram. Show that, after the increase in demand, the country's welfare loss from protection is larger with the quota than with the tariff.

4.	EXERCISING MARKET POWER IN TRADE. Consider two large-country trading partners, OPEC, which exports oil, and the rest of the world, ROW, which imports oil.
	a.	Use a trade-market supply and demand diagram (with Dm by ROW and Sx by OPEC) to depict a free-trade equilibrium in the world oil market.
	b.	Now suppose that OPEC restricts its oil exports to ROW by imposing an export quota. Use your diagram to depict the consequences of OPEC's export quota. (hint: the export quota makes Sx by OPEC vetical at the quota amount.)
	c.	Indicate in your diagram the changes in welfare for: (1) ROW, (2) OPEC, and (3) the world as a whole, which result from OPEC's export quota.

5.	STRATEGIC TRADE POLICY: Consider the strategic trade policy worksheet from the exercise done in class. For each of your answers, use actual numerical values from the table for support.
	a.	How does the game's pay-off structure illustrate each of the following?
		(1)	"From the perspective of global welfare, free trade is best."
		(2)	"Trade policy can amount to 'exploitative intervention,' i.e., a 'beggar-thy-neighbor' policy" in which one country gains welfare by reducing the welfare of its trading partner.
	b.	Suppose that you are the trading partner of the U.S., and you plan on trading with the U.S. indefinitely. The U.S. announces a policy of initial free trade, followed by a tit-for-tat retaliation strategy. Consider your first two rounds of trade with the U.S. and show that your best option for round one is to choose free trade.