Problem Set # 1

This problem set is due Wednesday, October 4, 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, Nirvana and Keoaaheo, and that there are only two commodities being produced, Pearls and Jam. Furthermore, assume that 50 days of labor can produce the following amounts in each country:

a) Describe and explain the pattern of Pearl-Jam 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 be as a proportion of country Y's wages).

2. Assume that Mexico was closed to trade with the rest of the world until Spanish explorers arrived in the 15th century. At the time the explorers arrived the Aztecs, the main inhabitants of Mexico, had two main industries, corn and cloth. The production of the former was land intensive, while the production of cloth was labor intensive. When Mexico was opened to trade with Europe, the country began exporting corn and importing cloth despite the protests of Aztec laborers. Explain how the Aztec leader, Emperor Moctezuma, could correctly argue that trade with the Europeans was beneficial, but yet Aztec laborers could be perfectly rational in opposing such trade.

3. Argentina imports copper from Chile. Due to recent labor disruptions in Chile, one of the world's major copper exporters, the world price of copper has risen by 30%. Argentina's Finance Minister, Dr. Patricia Ramírez, has urged her country to abandon trade in copper with Chile 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).

4. Concentrate on the market for Barney action figures between South Korea and the United States. Assume that a Barney action figure is a homogeneous product produced under perfect competition and that there are only two countries in the world, South Korea and the U.S.

a) Assume that South Korea has a comparative advantage in the production of Barney action figures. Show the free-trade equilibrium for Barney action figures 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 U.S.' domestic production and consumption under free trade.

b) Now assume that due to new technology the production costs of Barney action figures in South Korea fall dramatically. Assuming that both countries maintain free trade policies, show the effects of this technological change in South Korea's industry and in the U.S.' 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 Barney action figure imports 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 which 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 the U.S. than in South Korea. Who pays most of the tariff now?