Simon Fraser University Department of Economics. Econ342: International Trade. Final Examination. Instructor: N. Schmitt

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1 Simon Fraser University Department of Economics Econ342: International Trade Final Examination Fall 2009 Instructor: N. Schmitt Student Last Name: Student First Name: Student ID #: Tutorial #: Tutorial Day/Time: TA s Name: Problem 1 Problem 2 Problem 3 Problem 4 Problem 5 Problem 6 Total:

2 Instructions: Answer ALL questions. The total number of marks for this exam is 100. The total time for this exam is 110 minutes. The exam starts at 12:30 and ends at 2:20pm. Allocate your time accordingly. Write your answers with pens. 1. (16 marks) Suppose Boeing and Airbus are deciding whether to invest in R&D to improve the quality of their medium-capacity planes. Boeing Airbus Invest No Invest Invest 70; ; 80 No Invest 90; ; 80 i. (4) Given the following payoff matrix in millions of dollars, what is (are) the Nash equilibrium (equilibria) of the game? Explain. ii. (4) Fill the table below assuming that the governments of Europe seek to expand Airbus international market share by providing the European aircraft producer with a subsidy of $40 million for R&D. Boeing Invest Airbus Invest No Invest No Invest iii. (4) What is (are) the Nash equilibrium (equilibria) of the game illustrated by (ii)? Explain. iv. (4) Is the subsidy increasing or decreasing European welfare and by how much? Explain your reasoning.

3 2. (15 marks) Suppose Home is a small country buying from a large foreign exporter. The supply and demand curve for Home is illustrated by the following figure, where P W denotes the free-trade world price. Assume that the Foreign government supports its producer with an export subsidy that lowers the world price to P*. We would like to know whether Home should consider levying a countervailing duty that would raise the import price back to P W. i. (3) What is a countervailing duty? Define briefly. ii. (4) If Home without the Foreign export subsidy is the benchmark (case 1), what is the change in Home welfare when Home faces the Foreign export subsidy (case 2)? Make sure to provide total welfare changes and the decomposition with respect to all the relevant components (consumer surplus, producer surplus, cost or revenue of the Home policy).

4 iii. (4) If Home without the Foreign export subsidy is the benchmark (case 1), what is the change in Home welfare when Home faces the Foreign export subsidy and Home imposes a countervailing duty (case 3)? Make sure to provide total welfare changes and the decomposition with respect to all the relevant components (consumer surplus, producer surplus, cost or revenue of the Home policy). iv. (4) Rank Case 1 (Home without the Foreign export subsidy), Case 2 (Home faces the Foreign export subsidy), and Case 3 (Home faces the Foreign export subsidy and Home imposes a countervailing duty) from highest to lowest Home welfare. Be sure to justify your ranking.

5 3. (8 marks) Consider the following graph reflecting the case of a Home country facing a Foreign monopolist. We want to determine the net impact on Home s welfare when it imposes a tariff of $2 on the Foreign monopolist. Price c e d 6 mc+t 4 mc D 7 10 i. (2) The change in consumer surplus is equal to: Quantity ii. (2) The change in producer surplus is equal to: iii. (2) The change in government revenue is equal to: iv. (2) The change in welfare is therefore equal to:

6 4. (17 marks) In this question, we would consider the effect on US welfare, a large country, when a foreign exporter dumps a product in the U.S. market. The US market is given by the left of the following figure. i. (5) Assume the world price is P W = $5. Compute (in $) the level of consumer and producer surplus under free trade. The US consumer surplus under free trade is equal to: The US producer surplus under free trade is equal to: ii. (3) Suppose the US government imposes a tariff in the amount of $4 (i.e., t= $4). What is the new Home price and what is the price received by the foreign exporters? The new Home price is equal to: The price received by the foreign exporters is equal to: iii. (3) Determine the terms of trade impact (in $) of the tariff on the Home country. In terms of the figure above, the terms of trade impact of the tariff on the Home country is equal to:

7 Does this correspond to a gain or to a loss in welfare for the Home country? Explain. iv. (3) Does the overall Home welfare increase or decrease due to the tariff? Compute the total welfare effect of the tariff with respect to free trade. Explain. v. (3) At what amount would the tariff be considered prohibitive? Explain what a prohibitive tariff means and indicate its level. 5. (20 marks) This question is composed of several True/False/Uncertain sub-questions. Each sub-question should be answered separately. Points will be given for explanations only. i. (5) `It is more efficient for the government of a small country to impose an import tariff than a production subsidy to stimulate output because it does not have to pay the producers directly.

8 ii. (5) `The role of the most-favored nation clause is to help eliminating discriminatory treatment in international commerce. Make sure to explain what `the most-favored nation clause means. iii. (5) `If the Foreign export supply is perfectly elastic, then a positive optimal tariff in the Home country should maximize its welfare. iv. (5) `If a country like Canada wants to develop a high tech industry, it should impose a barrier to imports in this industry.

9 6. (24 marks) Suppose that (i) the capital-labor ratio to produce one unit of a car is lower than the capital labor ratio to produce one unit of wheat in both Canada and the US; (ii) the ratio of total capital to total labor available in the US is greater than in Canada; (iii) the tastes for wheat and for car is the same in both countries; (iv) the same technology is available in both countries. i. (5) Draw both the US and the Canadian production possibility curves on the graph below where the quantity of cars is on the horizontal axis and the quantity of wheat is on the vertical axis. Make sure to explain how these two production possibility curves differ. Wheat Cars ii. (5) Which country in isolation (i.e. without trade) will have the lower equilibrium price ratio p car /p wheat? Justify your answer.

10 iii. (5) In which country is the price of capital, r, relative to the price of labor, w, lower without international trade? Justify your answer. iv. (4) What is the pattern of free trade between Canada and the US? Explain. v. (5) Explain precisely how trade causes a reduction in the difference in r and in w between the US and Canada.