Problem set 4

Friday, March 30, 2012

Problem Set 4

The fundamentals of trade policy

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

Contrast the free trade and tariff situation in a domestic-market supply and demand diagram.

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.
Important note: Your answers should be millions of dollars.

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 as a whole?

Suppose that the government had instituted a quota policy instead. What is the quantity of import licenses that the government would issue to achieve the same price and quantity effects as the tariff?

2.	Consider China as a small-country importer. From 1992 to 1997, China reduced its (weighted average) tariff rate on imports from 40.9 percent to 28.9 percent. Illustrate the change in China's national welfare from its tariff reduction in a domestic market diagram for a typical item that China imports.

3.	These questions are based on the course reading, "Japan's change in rice policy could hurt state's exports", (Los Angeles Times, December 18, 1998).
	a.	Illustrate Japan's situation in a Japanese domestic-market supply and demand diagram for rice. Use values from Passage B and Passage C of the article to label (1) the world price of rice, (2) the tariff, (3) the price of rice in Japan including the tariff, (4) consumption, (5) production, and (6) imports. For several of these values, provide approximate estimates based on information reported in the article.
	b.	Consider Passage A from the article. Do you agree? If so, explain why. If not, then what alternatives are there?
	c.	Consider Passage D from the article. Are government trade restrictions necessary for the reasons given by Ms. Hanzaki? Why or why not?

4.	Export subsidies: Use a trade-market supply and demand analysis to illustrate the consequences of an export subsidy implemented by a large-country exporter. Be sure to indicate the resulting prices buyers pay in the exporting country and in the importing country.

Efficient policymaking in global markets

Use the domestic-market diagram to the right to complete the table below (PB = Price Buyers pay; PS = Price domestic Sellers receive; QC = Quantity Consumped; QP = Quantity Produced domestically, and QM = Quantity iMported

Policy	PB	PS	QC	QP	QM
No policy
$2 import tariff
$2 consumption tax
$2 consumption subsidy
$2 production tax
$2 production subsidy

6.	The following question draws on information from an article published in the March 10, 2007, edition of the Los Angeles Times, "Ethanol still a long way off in U.S." Assume that the U.S. is a small-country importer of ethanol. You may use diagrams to help you explain your answers, but diagrams are not required. You can receive full credit with careful explanations.
	a.	According to the article, "Bush wants Americans to produce and use ethanol, a fuel made from the alcohols refined from plant material." What policy option(s) would you recommend as best suited to promote the goals that Bush hopes to achieve? Explain the reasoning behind your recommendation(s).
	b.	Which goal do you think is more worthwhile from a global perspective, more U.S. production or or more U.S. consumption of ethanol? Why?
	c.	For each of the following policies described in the article, indicate whether you think the policy promotes what Bush wanted Americans to do, and support your answer with a domestic market supply and demand diagram for ethanol
			(1)	"The U.S. ... grants ... a subsidy of 51 cents a gallon to companies that make ... ethanol."
			(2)	"[T]he U.S. government imposes a 54-cent-a-gallon tariff on ethanol imported from Brazil."

7.	The U.S. is a small-country importer of firearms. Suppose that you are a member of the U.S. International Trade Commission and that you must recommend a policy for the firearms industry. Consider separately each alternative goal below, recommend a "first-best" policy (from the perspective of national welfare) and briefly explain your recommendation (diagrams are optional):
	a.	For national security purposes, it is deemed desirable to increase domestic firearms production by, say, 20 percent (the amount in each case is just suggestive--don't worry about it).
	b.	For national security purposes, it is deemed desirable to reduce dependency on imported firearms by 20 percent.
	c.	For public safety purposes, it is deemed desirable to decrease domestic firearms consumption by 20 percent.

8.	These questions concern the online course readings:
		Taylor (1999). Is free international trade harmful to the environment (1999) <http://faculty.oxy.edu/whitney/xaccess/ec311/iic_env_uw.htm> Smith (2000). Little by little, breathing easier in Mexico City <http://faculty.oxy.edu/whitney/xaccess/ec311/iic_envt_lat_2000.htm>
	a.	Would you expect Taylor to be surprised by the change in environmental quality in Mexico City in recent years? Why or why not?
	b.	How would Taylor likely link (1) Nafta, (2) economic growth in Mexico, and (3) environmental quality in Mexico?

9.	Suppose the diagram to the right shows the market for refined gasoline. The production of refined gasoline causes local air pollution which accounts for the gap between PMC and SMC illustrated in the diagram.
	a.	Suppose the country does efficiently enforce environmental quality regulations. Indicate its free-trade quantities produced, consumed and imported.
	b.	Some have argued that free trade encourages countries to relax their environmental standards. Suppose this country does eliminate its environmental regulations. Indicate the impact on the country's quantities produced, consumed and imported.
	c.	Indicate in the diagram any changes in (1) consumer surplus, (2) producer surplus, (3) environmental damages and (4) national welfare which result from eliminating its environmental regulations.
	d.	From a national welfare perspective, does the country gain by reducing its environmental regulations under free trade? Explain briefly.

10.	Use a trade-market supply and demand diagram to illustrate the consequences of an import tariff implemented by a large-country importer.
	a.	In your diagram, indicate the impact of the import tariff on:
		(1)	the exporter's gains from trade;
		(2)	the importer's gains from trade before taking into account the impact on government revenue; and
		(3)	government revenue of the importing country.
	b.	Decide whether each of the following rises, falls, remains the same, or changes in an uncertain direction when a large country imposes a tariff, and be sure it is clear how you decided:
		(1)	national welfare of the exporting country;
		(2)	national welfare of the importing country; and
		(3)	global welfare.

11.	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 vertical 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.

12.	For years, the European Union (EU) has favored banana imports from its former colonies by using trade policy to block imports of bananas grown in Ecuador and Central America and distributed by U.S. fruit companies such as Chiquita Brands and Dole. The EU has defended its policy as a form of foreign aid to its former colonies.
	a.	Use a trade market diagram to illustrate an equilibrium in which the EU is a large-country importer of bananas, but imports only from its former colonies.
	b.	In a number of trade dispute settlement hearings in the 1990s, the WTO sided with the U.S. and and its banana exporting allies in ruling that the EU's discriminatory barriers violate international trade agreements. In your diagram from part a, illustrate the consequences of free trade in bananas, with imports from Ecuador and Central America no longer restricted by the EU and therefore becoming an extra source of import supply
	c.	Indicate in your diagram:
		(1)	The total change in the EU's gains from trade.
		(2)	The total change in the former colonies' gains from trade.
		(3)	The net change in the EU's gains from trade if the EU increases foreign aid to its former colonies by the amount you indicated in part (2) in order to offset their losses from the trade liberalization..
	d.	In implementing the WTO ruling, could all the parties involved in the dispute end up at least as well off as they were before the ruling? Explain briefly.

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