Exam on International Economics, NAA119, 7.5 credits, Friday, 5 June 2015.

Transcription

1 MÄLARDALEN UNIVERSITY School of Business, Society and Engineering Spring term 2015, Lars Bohlin and Ask Hedberg Examination time: Exam on International Economics, NAA119, 7.5 credits, Friday, 5 June This is an anonymous exam. Write your identification number on each paper you submit, including the exam covers. Only readable responses can be assessed! Allowed aids: Calculator Remember that jackets, bags, mobile phones and other such items are not allowed at your bench! You must justify your reasoning carefully, both verbally and graphically in your responses! In the Multiple Choice questions should you just give the alternative that you think is the most correct one. If you select the open alternative, you must also write an explanation and/or calculation. For all changes in the exam is the assumption Ceteris Paribus (all other things equal) valid. In general, Q represents quantity and P price. Unless otherwise noted, every actor is assumed to maximize its profit or utility. Responsible teachers: if you have any questions please call between 9.30 and Lars Bohlin, Ask Hedberg, You will be able to get a total of 28 points. (1 point per question if not else specified) Points ECTS F E D C B A Good Luck!

2 Trade theory 1. Answer the questions below based on the following diagram of a country that is in its international trade equilibrium. Figure 1 a) Refer to Figure 1. This country has comparative advantage in 1. X. 2. Y. 3. both X and Y. 4. neither X or Y. b) Refer to Figure 1. This country's exports equal 1. CE units of X. 2. FG units of Y. 3. 0K units of Y. 4. LF units of X. the country exports LK units of Y c) Refer to Figure 1. This country's imports equal 1. CB units of X. 2. GA units of X. 3. CE units of X. 4. KL units of Y.

3 d) Refer to Figure 1. Which of the following is true? 1. This country is completely specialized in the production of Y. 2. The autarky situation could have been in point A. 3. The value of this country's consumption is larger than the value of its production. 4. The country produces at point F and consumes at point A 5. The country produces at point H and consumes at point F. 2. Answer the questions below based upon the following diagram. (Note that Q is measured in thousands.) Figure 2 a) Refer to Figure 2. With free trade, the total value of imports would equal million million million. b) Refer to Figure 2. With the tariff, the government collects revenues of 1. 0,5 million million. 3. 1,5 million million. c) Refer to Figure 2. The deadweight loss of the tariff equals (( )*5/2) + ( )*5/2) =

4 d) Refer to Figure 2. Domestic producers gain because of the tariff e) Refer to Figure 2. A tariff of would be purely protective Consider two countries, A and B, with the following technologies (the numbers represent the number of labour hours it will take to produce a unit of the given good): Countries Goods A B X 4 9 Y 2 3 Suppose that the wage rate in A, W A, equals 9 per hour and the wage rate in B, when measured in Euros, E * W B, equals 5 per hour. a) Define the concepts of absolute and comparative advantage and then explain clearly which country has which in the production of X and of Y. Absolute advantage is the ability of a country to produce a good using fewer productive inputs than is possible anywhere else in the world. Since country A needs 4 hours to produce 1 X and B needs 9, A has an absolute advantage in the production of X. Country A also has an absolute advantage in the production of Y, since 2 hours for 1 Y is less than the 3 hours country B needs. David Ricardo s Law of Comparative Advantage countries should specialize where they have their greatest absolute advantage (if they have absolute advantage in both goods) or in their least absolute disadvantage (if they have absolute advantage in neither good). A country has a comparative advantage over another in producing a particular good if it can produce that good at a lower relative opportunity cost or autarky price, i.e. at a lower relative marginal cost prior to trade. To be able to produce 1 X country A needs to give up (has an opportunity cost) of 2 Y and in country B will 1 X cost 9/3 = 3 Y s, so country A has the comparative advantage in X-production. Since one country never can have CA in both goods country B must have CA in the production of Y: in country A will 1 Y cost 2/4 = 0,5 X and in country B will 1 Y cost 3/9 = 0,33 X, which is lower!

5 b) Calculate the pretrade price in Euros of X and Y in both A and B. Is there a basis for mutual beneficial trade? Why or why not. Pretrade prices: P X A = W A hours X A = 9 4 = 36 P Y A = W A hours Y A = 9 2 = 18 P X B = (E W B ) hours X B = 5 9 = 45 P Y B = ( E W B ) hours Y B = 5 3 = 15 There is a clear basis for mutually beneficial trade. Good X is cheaper in A than in B and vice versa for good Y. c) Suppose that W A rises to 12 per hour. Everything else held constant, what would happen to the trade patterns? Why? P X A = W A hours X A = 12 4 = 48 P Y A = W A hours Y A = 12 2 = 24 P X B = (E W B ) hours X B = 5 9 = 45 P Y B = (E W B ) hours Y B = 5 3 = 15 There is no basis for trade. Given its productivity advantage, A s wages are too high. 4. Consider two countries, U and D, which are able to produce the following amount of the two goods Beer and Nuts: Countries Goods U D Beer Nuts 30 5 If U and D totally specialize in the production which they have comparative advantage in, how much would be produced in the world? Will it lead to an unambiguous improvement in the world? If not, what can U and D do to increase the total welfare compared to the autarky situation? (2p) Sorry! This is a very good example of a poorly written question, I borrowed it from the internet somewhere and didn t think it through properly. There are several ways of answering it depending on how you interpret the given facts. Based on the literature I would expect you to see the numbers as the two maximum production volumes each country can reach, but it could also be that they give the bundle that is produced in autarky. Anyhow, if we make the assumption that the opportunity cost in each country is based on the relationship we will have it that country U has to give away 15 Beer to be able to produce 30 Nuts (1 Nut = 0,5 Beer) or 30 Nuts for 15 Beer (1 Beer = 2 Nuts). In country D does 5 Nuts cost 10 Beer (1 Nut = 2 Beer) or 10 Beer costs 5 Nuts (1 Beer = 0,5 Nut). So the cheapest way of producing 1 Nut will be 0,5 Beer => CA in country U and therefore will country D have CA in producing Beer (0,5 < 2 Nuts). If we assume that the given values were the bundles of goods produced in autarky, i.e. (30, 15) and (5, 10), the total production with total specialization will give the world + 30 Nuts and 15 Beer from U-country and 5 Nuts and + 10 Beer from D-country => Nuts (+30 5 =) +25 and Beer ( =) -5. The world will win 25 Nuts but lose 5 Beer! (You will probably get something similar if you assumed that the values were the maximum production!) So in that sense is it not an unambiguous improvement.

6 Beer But if we look at the opportunity cost in each country for each good will they give us the boundaries of the price of each good that will be acceptable with trade: 0,5 Price Nuts 2 units of Beer 0,5 Price Beer 2 units of Nuts so if they start trading with a price somewhere inside these boundaries both countries will gain from the trade! Assume that the trade prices becomes Price Nuts = Price Beer = 1, so the relative price becomes 1. U-country produces 60 units of Nuts ( ) and D-country produces ( =) 20 units of Beer (total specialization in both countries). This will give D- country a Consumption possibilities frontier (a TOT-line) from 20 Beer to 20 units of Nuts. This will clearly give a higher utility (a higher Consumption Indifference Curve, CIC) in D- country. The U-country specializes in Nuts and produces 60 units and will therefore have a theoretical TOT-line from 60 Nuts to 60 Beer, but it will just be valid up to 20 units of Beer since D-country just have 20 Beer to sell. This TOT will also be outside the original production possibilities frontier and will give U-country a possibility to reach a higher CIC. (I haven t drawn any CIC s in the figures!) If you made the assumption that the values were the maximum production in D you will get a TOT in D-country from 10 Beer to 10 Nuts and in U-country from 30 to 30 (ending at 10 Nuts due to the limitations of D-production), but you will still have situations that can give the countries higher CIC s. 70 Bundles in autarky = (30,15) and (5,10) PPF U PPF D TOT U TOT D TOT U (theory) Nuts

7 Beer Max production = (30,15) and (5,10) PPF U PPF D TOT U TOT D TOT U (theory) Nuts 5. What is the difference between free trade areas and customs unions? Provide examples of each. (2p) Both types of arrangements eliminate barriers between the member countries. In a FTA, countries are free to maintain their own individual barriers to other countries. In a CU, the members also agree to erect a common barrier to nonmember countries. FTA: CU: NAFTA (United States, Canada, Mexico). The EU; Mercosur (Argentina, Brazil, Paraguay, Uruguay)

8 International finance 6. Which of the following cases gives the strongest argument for a common currency a) The group of countries have a lot of transactions with each other and a lot of asymmetric chocks b) The group of countries have a lot of transactions with each other but few asymmetric chocks c) The group of countries have few transactions with each other but a lot of asymmetric chocks d) The group of countries have few transactions with each other and few asymmetric chocks 7. Assume that the relative PPP-hypothesis holds. What would be the impact on the real and nominal exchange rate of the SEK next year if the rate of inflation will be lower in Sweden than in the rest of the world? a) The real exchange rate will be unchanged while the nominal exchange rate will appreciate. b) The real exchange rate will be unchanged while the nominal exchange rate will depreciate. c) Both the real and the nominal exchange rate will appreciate. d) Both the real and the nominal exchange rate will depreciate. 8. We know the following variables from a small open economy. Private Consumption = 500 Domestic Investments = 300 Government Consumption = 200 Government Budget Balance = 25 Private Saving = 220 The Capital Account Balance = 2 GDP = 975 Calculate the following variables: a) The financial account balance b) Net taxes, (Tax revenue less transfers to the households). c) Net export CA = S P + T G I = = 55 FA = CA KA = 55 2 = 53 S G = T G => T = Tax revenue Tr = S G + G = = 225 NX = GDP C I G = = 25

9 9. Assume the interest rate on a maturity of 1 year is 11% in Russia and 1% in the Euro-area. The spot exchange rate of the Russian ruble towards the Euro is 0.02 euro/ruble. a) Calculate the forward exchange rate of the ruble one year ahead as euro per ruble. b) Explain the logic beyond the calculation, why can you use this kind of formula? a) b) Something like: If the expected return to saving should be the same the ruble must loose 10 % of its value to compensate for the 10 % higher interest rate. If the expected rate of return is not the same the spot exchange rate will change 2. Assume that a small open economy with a floating exchange rate that has a large government debt. For the moment the rate of unemployment is above the equilibrium level. a) Suggest a suitable macroeconomic policy (1p) b) Explain the implications of the policy you suggested. Explain the effects on the interest rate, the exchange rate, investments, private consumption, government consumption, export, import, current account, GDP, employment, government budget balance and the rate of inflation. Explain the causalities between the different variables. (4p) a) To reduce unemployment we need an expansionary policy. Since the government debt is large it is not recommended to have an expansionary fiscal policy. Thus you should choose an expansionary monetary policy. b) For the effects of monetary policy see course literature and solutions to exercises.