Answers to Text Questions and Problems in Chapter 15

Answers to Text Questions and Problems in Chapter 15 Answers to Review Questions 1. Prior to and during World War Two, Canada s leading trade partners were the United Kingdom and the United States. Today, Canada s major trade partners are the United States, Japan, China, and the United Kingdom. 2. False. Even though a country may have an absolute advantage in every sector, there are likely to be sectors in which the neighbouring advantage has a comparative advantage, that is, in which the neighbouring country is relatively more efficient (i.e., relatively less inefficient) than the first country. If the home country exports goods in which it has a comparative advantage, and imports goods in which its neighbour has a comparative advantage, its consumption possibilities will be improved. 3. See Figure 15.8 (with automobiles replacing wine). The tariff raises the domestic price of automobiles to the world price plus the tariff. Facing a higher domestic price for cars, domestic producers supply more cars and domestic consumers demand fewer cars. Imports, the difference between the domestic quantities demanded and supplied, decline. Consumers are hurt by the tariff, as they must pay more for cars, while domestic producers (who receive a higher price for their output) are helped. The government benefits by collecting tariff revenue. Overall, though, the tariff is inefficient; the costs to consumers exceed the benefits to producers and the government. 4. See Figure 15.9 (with automobiles replacing wine). If the quota allows fewer imports than would occur under free trade, then the domestic price will be higher than the world price. Consumers face a higher price and are thus worse off; domestic producers, who receive a higher price for their output, are better off. Unlike the case of a tariff, with a quota the government collects no revenue; those revenues flow instead to holders of import licences, who can buy cars at the world price and re-sell them at the higher domestic price. 5. A free trade area requires rules of origin to prevent goods from entering the free trade area through the member country with the lowest external tariff and, from there, moving without hindrance to the member countries with higher external tariffs. 6. The application of countervailing duties on Canadian exports of softwood lumber to the United States helped the U.S. lumber industry and harmed the Canadian lumber industry. As well, Americans constructing new homes were losers due to the higher cost of lumber they were forced to pay. 7. In the figure below, a fall in net exports lowers autonomous expenditures and equilibrium output, thereby eliminating the expansionary gap. PAE Y* Y=PAE PAE = 970 + 0.8Y PAE = 960 + 0.8Y

4800 4850 Y Answers to Problems 1a. A foreign worker can produce 500 shoes at $10 each or one robot at $5000. As there are no other costs, foreign workers earn $5000 per year in either industry. b. The opportunity cost of a robot in Canada is 1000/10 = 100 pairs of shoes, while the opportunity cost of a robot abroad is 500 pairs of shoes. Canada therefore has a comparative advantage in robots; it will export robots and import shoes. c. Canada specializes in robots. Each worker can produce 10 robots at $5000 each, so annual income of Canadian workers is $50,000. In terms of goods, after the opening of trade a Canadian worker s annual income will buy $50,000/$5000 = 10 robots or $50,000/$10 = 5000 pairs of shoes. Before the opening to trade, a Canadian worker s income would buy $30,000/$3000 = 10 robots or $30,000/$30 = 1000 pairs of shoes. So buying power in terms of robots is unchanged, but in terms of shoes it has quintupled. Even though they are trading with foreign workers who make 1/10 what they do, Canadian workers are made better off by trade. d. The answer might change if it were costly for workers in the Canadian shoe industry to switch to the robot industry. Canadian shoe workers are much worse off when shoes sell for only $10 instead of $30. The best policy response, however, is not to block trade (which increases consumer buying power in both Canada and abroad) but to provide transition assistance to the shoe workers. 2a. To find the price of a car, set demand equal to supply: 12,000 200P = 7000 + 50P 5000 = 250P P = 20 b. At a world price of 18, domestic demand is 12,000 200(18) = 8400 cars, and domestic supply is 7000 + 50(20) = 8000 cars. The difference, 400 cars, must be imported. Because the world price of cars is lower than the domestic price, domestic consumers will favour the opening to trade and domestic car producers will oppose it. c. Now the domestic price of cars, equal to the world price plus the tariff, is 18 + 1 = 19. Demand is 12,000 200(19) = 8200 and supply is 7000 + 50(19) = 7950. The difference, 250 cars, is imported (so imports have fallen). The tariff raises the domestic price so domestic consumers will oppose it and domestic car producers will support it. The government benefits from the tariff, as it collects 1 unit times 250 cars = 250 units of tariff revenue. d. Suppose the government imposes a quota of 250 imported cars (the same number of imports as in part c). Then supply equals domestic supply + 250, or 7250 + 50P, and demand equals 12,000 200P as before. Setting demand equal to supply, we get 12,000 200P = 7250 + 50P 4750 = 250P P = 19 So the domestic price is the same as with the tariff (part c) and, therefore, so are domestic production and demand. Imports are also the same, at 250, by assumption. So the quota produces the same results in the domestic market. The only difference with the tariff is that the government does not collect the tariff revenue; these extra profits go instead to the holders of the import licences. 3a. The world price of cars is 16. With free trade, the domestic price will also equal 16. Domestic demand will be 12,000 200(16), or 8800 cars, and domestic supply will be 7000 + 50(16), or 7800 cars. The difference, 1000 cars, will be imported.

b. The foreign companies are asked to limit their exports to 500 cars. Total supply to the domestic market is thus equal to the domestic supply plus 500, or 7500 + 50P. Demand remains at 12,000 200P. Setting demand equal to supply, we can find the domestic equilibrium price after the imposition of VERs: 12,000 200P = 7500 + 50P 4500 = 250P P = 18 Thus the domestic price of cars rises from 16 to 18. Domestic supply of cars is 7000 + 50(18) = 7900, and domestic demand for cars is 12,000 200(18) = 8400. The difference, 500 cars, is imported, consistent with the assumed level of voluntary export restrictions by foreign producers. c. Foreign car companies now receive 18 rather than 16 for their cars. Their production costs are 15, so their profit is 3 units per car times 500 cars sold, or 1500. Before the VER, their profit was 1 unit per car for each of 1000 cars, or 1000. So the VER actually raises the total profits (as well as the profit per car) of foreign producers. Sample Homework Assignment 1. Suppose that, in the country of Omicron, demand for shoes is given by D = 20,000 500P and supply by domestic shoe producers is given by S = 500P. a. If Omicron were a closed economy, what would be the equilibrium price and quantity of shoes? b. Suppose that Omicron opens to trade and that the world price of shoes is 10 per pair. Find the domestic quantity demanded and quantity supplied, and the quantity of imports or exports. c. A tariff is imposed on imported shoes equal to 5 per pair. What happens to the domestic quantity demanded and quantity supplied, and to the quantity of imports or exports? 2. Suppose that the country Mu has a comparative advantage in textile production, while its trading partner Xi has a comparative advantage in producing agricultural products. If Mu begins trading with Xi, determine whether each of the following groups will win or lose. a. Consumers in Mu who buy agricultural products from Xi. b. Consumers in Mu who buy textiles made in Mu that are now exported to Xi. c. Producers in Mu who sell textiles to Xi. d. Producers in Mu who compete with agricultural products imported from Xi. Multiple Choice Quiz 1. Which of the following countries has the highest ratio of trade to GDP? a. Japan. b. Canada. c. The United States. d. Australia. e. United Kingdom. 2. Which of the following countries is Canada s biggest trading partner? a. United Kingdom. b. France. c. Japan. d. China. e. The United States. 3. By the late 1990s, the average tariff rate in Canada was a. over 30 percent.

b. 25 percent. c. 22 percent. d. 10 percent. e. less than 1 percent. 4. The idea that we can enjoy more goods and services when each country specializes in the production of what it does best is the principle of a. increasing opportunity cost. b. comparative advantage. c. aggregate demand. d. diminishing returns. e. specialization. 5. An economy that trades with other countries has which kind of economy? a. Import. b. Export. c. Closed. d. Open. e. Trade. 6. A situation in which a country is economically self-sufficient is called a. oligarchy. b. autarky. c. isolation. d. independence. e. free trade. 7. The price at which a good or service is traded on international markets is called the a. equilibrium price. b. international price. c. global price. d. aggregate price. e. world price. 8. Which of the following groups wins from trade? a. Consumers of imported goods. b. Consumers of exported goods. c. Producers of imported goods. d. Workers. e. Investors. 9. Which of the following groups loses from trade? a. Consumers of imported goods. b. Producers of exported goods. c. Producers of imported goods. d. Workers. e. Investors. 10. A legal limit on the quantity of a good that may be imported is called a a. tariff.

b. quota. c. tax. d. restriction. e. protection. Problems/Short Answer 1. Suppose that, in the country of Delta, demand for DVD players is given by D = 10,000 100P and supply by domestic DVD player producers is given by S = 100P. a. If Delta were a closed economy, what would be the equilibrium price and quantity of DVD players? b. Suppose that Delta opens to trade and that the world price of DVD players is 30. Find the domestic quantity demanded and quantity supplied, and the quantity of imports or exports. c. Suppose instead that the world price of DVD players is 60. Find the domestic quantity demanded and quantity supplied, and the quantity of imports or exports. 2. Consider again the country of Delta. Use the demand and supply curves from question 1, and assume that the world price is 30. a. A tariff is imposed on imported DVD players equal to 10. What happens to the domestic quantity demanded and quantity supplied, and to the quantity of imports or exports? b. Which groups in Delta are helped by the tariff, and which are hurt? Answer Key to Extra Questions in Instructor s Manual Sample Homework Assignment 1a. The equilibrium price would be 20 and the equilibrium quantity would be 10,000. b. The domestic quantity demanded is 15,000 and the domestic quantity supplied is 5000, so imports are equal to 10,000 pairs. c. The new domestic price is 15, so the domestic quantity demanded is now 12,500 and the domestic quantity supplied is now 7500. Imports have thus fallen to 5000 pairs. 2a. Win. b. Lose. c. Win. d. Lose. Multiple Choice 1. b 2. e 3. e 4. b 5. d 6. b 7. e 8. a 9. c 10. b Problems/Short Answer

1a. The equilibrium price would be 50 and the equilibrium quantity would be 5000. b. The domestic quantity demanded is 7000 and the domestic quantity supplied is 3000, so imports are equal to 4000 pairs. c. The domestic quantity demanded is 4000 and the domestic quantity supplied is 6000, so exports are 2000. 2a. The new domestic price is 40, so the domestic quantity demanded is now 4000 and the domestic quantity supplied is now 6000. Imports have thus fallen to 2000 pairs. b. Producers in Delta are made better off by the tariff, since they can sell more at a higher price. Consumers are worse off; they buy less at a higher price.