This problem set is due Thursday, February 10, at the beginning of the class period. Problem sets done on notebook paper or unstapled will not be accepted. Late problem sets are unacceptable also.

1. Assume that there are only two countries in the world, Morocco and Egypt, and that there are only two commodities being produced, Babouches (traditional leather slippers) and Jellabas (full-length cotton garments). Furthermore, assume that 50 days of labor can produce the following amounts in each country:

a) Describe and explain the pattern of trade.b) Prove that the country with absolute advantage in both commodities has a higher standard of living (Note: A complete answer should include a comparison of wages across countries, that is, how much would the wages in country X as a proportion of country Y's wages be).

2. Assume that Perú was closed to trade with the rest of the world until Francisco Pizarro, a Spanish explorer, arrived in the 16th century. At the time Pizarro arrived, the Incas, the main inhabitants of Perú, had two main industries, sugar and cloth. The production of the former was land intensive, while the production of cloth was labor intensive. When Perú was opened to trade with Europe, the country began exporting sugar and importing cloth despite the protests of Inca laborers. Explain how the Inca leader, Emperor Huáscar, could correctly argue that trade with the Europeans was beneficial, but yet Inca laborers could be perfectly rational in opposing such trade.

3. Concentrate on the market for Red Hot Chili Peppers between Mexico and the United States. Assume that a Chili Pepper is a homogeneous product produced under perfect competition and that there are only two countries in the world, Mexico and the United States.

a) Assume that Mexico has a comparative advantage in the production of chili peppers. Show the free-trade equilibrium for chili peppers using the supply and demand for each country, as well as the export supply and import demand (Hint: You need to draw three diagrams). Show the United States' domestic production and consumption under free trade.

b) Now assume that due to the development of new seeds, which produce pest resistant chili peppers, the production costs in Mexico fall dramatically. Assuming that both countries maintain free trade policies, show the effects of this technological change in Mexico's domestic price, domestic production, domestic consumption, and exports. Also show the effects of this change in the United States' quantity of imports, price of imports, domestic production, and domestic consumption.

c) Starting at the new free-trade equilibrium (in question 3b), assume that the U.S. government wants to cut the imports of Red Hot Chili Peppers to the level they had before the technological change took place (the level in question 3a). Assuming that the domestic elasticities of demand and supply are similar in both countries, show graphically the appropriate tariff that achieves the objective of the U.S. government.

d) Repeat the exercise in part c), but now assume that the demand and supply elasticities are much higher in Mexico than in the United States. Who pays most of the tariff now?

4. Austria imports CVD players from South Korea. Due to recent labor disruptions in South Korea, one of the world's major CVD player exporters, the world price of CVD players has risen by 20%. Austria’s Finance Minister, Dr. Monica Schmitt, has urged her country to abandon trade in CVD players with South Korea so as to avoid the damage that will be done by the deterioration in their terms of trade. Comment and be sure to point out correct as well as incorrect elements of the Finance Minister's proposal (Use a diagram in your answer. You should assume that Austria is a "small country" in the market for CVD players).