Let’s assume there are only 2 countries that produce 2 good. More specifically, suppose that the United States (US) and the United Kingdom (UK) each have 2 units of productive resources, 1 used to produce Wine, the other Cloth. The US can produce 40 units of Wine with 1 unit of productive resources and 40 units of Cloth with 1 unit of productive resources. The UK can produce 20 units of Wine with 1 unit of productive resources and 10 units of cloth with 1 unit of productive resources. Using this information, please answer the questions below:
*Who has an absolute advantage in the production of Wine? Cloth?
*Who has a comparative advantage in the production of Wine? Cloth?
*Given specialization, what is production before trade? After trade?
*What are the gains from trade?
*What is the “range” of potential exchange rates between US and UK?
P2. Suppose that in Japan, without a tariff 10,000 cars will be sold per year at an equilibrium price of $20,000. With a $5,000 tariff, supply decreases such that 8,000 cars are produced at $22,500 per car.
*Use a supply and demand diagram to graphically illustrate the example above.
*Why is the increase in price less than the tariff?
*Who bears the burden of the tariff?
*What are government revenues from the tariff?
*What is the “dead-weight loss” associated with the tariff – i.e., the lost in Producer Surplus and Consumer Surplus?
P3. Finally, graphically explain the negative effects of quotas. How about subsidies? Label and explain results in detail.
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1. For the US:
- Absolute advantage in Wine production: The US can produce 40 units of Wine with 1 unit of productive resources, while the UK can only produce 20 units of Wine with 1 unit of productive resources.
- Absolute advantage in Cloth production: The US can produce 40 units of Cloth with 1 unit of productive resources, while the UK can only produce 10 units of Cloth with 1 unit of productive resources.
For the UK:
- Absolute advantage in Wine production: The US can produce 40 units of Wine with 1 unit of productive resources, while the UK can only produce 20 units of Wine with 1 unit of productive resources.
- Absolute advantage in Cloth production: The US can produce 40 units of Cloth with 1 unit of productive resources, while the UK can only produce 10 units of Cloth with 1 unit of productive resources.
2. Comparative advantage refers to the ability of a country to produce a given good at a lower opportunity cost compared to another country.
For the US:
- Comparative advantage in Wine production: The opportunity cost of producing 1 unit of Wine is 1 unit of Cloth (40 units of Cloth/40 units of Wine = 1). In comparison, the UK has an opportunity cost of producing 2 units of Cloth for 1 unit of Wine (10 units of Cloth/20 units of Wine = 0.5). Therefore, the US has a comparative advantage in Wine production.
- Comparative advantage in Cloth production: The opportunity cost of producing 1 unit of Cloth is 1 unit of Wine (40 units of Wine/40 units of Cloth = 1). In comparison, the UK has an opportunity cost of producing 0.5 units of Wine for 1 unit of Cloth (20 units of Wine/10 units of Cloth = 2). Therefore, the US has a comparative advantage in Cloth production.
3. Given specialization, before trade, the production is as follows:
- US: Produces 40 units of Wine and 40 units of Cloth.
- UK: Produces 20 units of Wine and 10 units of Cloth.
After trade, the countries can specialize in their comparative advantage goods and trade with each other. The specific allocation will depend on the terms of the trade agreement.
4. The gains from trade refer to the overall benefits that countries can achieve through specialization and trade. In this scenario, the gains from trade can include increased total production, increased consumption possibilities, and potential cost savings.
5. The range of potential exchange rates between the US and UK will depend on various factors, such as relative productivity levels, demand and supply conditions, and market forces. It is difficult to determine the exact range without more specific information.
P2. Unfortunately, there is no specific question provided to answer based on this information.
P3. Graphically, quotas and subsidies have negative effects on the market.
- Quotas: A quota restricts the quantity of a specific good that can be imported or exported. In the market graph, a quota is represented by a horizontal line that limits the quantity traded. The negative effects of quotas include higher prices, reduced consumer surplus, reduced total trade, and potential dead-weight loss.
- Subsidies: A subsidy is a financial support given by the government to a specific industry or producer. In the market graph, a subsidy is represented by a vertical shift in the supply curve, lowering the production cost and price for the subsidized goods. The negative effects of subsidies include distorted market competition, potential overproduction, increased government spending, and potential dead-weight loss.
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