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Economics and Society (WUCB162/DSSC108) Tutorial Solutions Week 5 Tutorial Solutions Week 5 International Trade 1. Have you ever considered trying to become self sufficient, producing for yourself all the things that you need and want? What would be the benefits of this attempt? What would be the drawbacks? You may be self-reliant, but you’ll never be efficient! 2. What are some goods in which you think the United States has an absolute advantage in production? What about low wage countries such as Thailand and Pakistan? What about tropical countries such as Costa Rica and Cuba? What about Australia? USA: Aircraft, automobiles, technology and development of software, beef and some agricultural goods Thailand and Pakistan: Rice, shoes and textiles. Costa Rica and Cuba: Agriculture (especially tropical fruit), sugar, coffee, and tobacco. What about Australia? Iron ore, gold and other minerals, coal, natural gas, beef, lamb, and some agricultural goods 3. Suppose that the US government places trade restrictions on imports of French wine into the US. What will be the effect of these restrictions on: a) US consumers of wine b) US producers of wine c) French producers of wine d) US farmers producing agricultural goods for export, and e) the US as a whole a) U.S. consumers of wine lose b) U.S. producers of wine gain c) French producers of wine lose d) U.S. farmers lose (more resources going into domestic wine production and France may retaliate and limit goods that they import from US (i.e. US exports) e) U.S. as a whole loses with reduced effiency from misallocation of resources (increased local production) 4. What are some of the problems of international trade that are faced by developing countries? What suggestions would you have for the government of developing country as it plans its trade strategy? 5. Draw a graph of the market for a primary commodity, such as cocoa beans, assuming that the demand is inelastic – think about what this means for the slope of the demand curve. Now think about supply – what happens to equilibrium when supply fluctuates from year to year because of the weather? Now repeat the exercise for a processed good from the commodity, such as chocolate – this product does not have inelastic demand, so think about what this means for the slope of the demand curve. Shift the supply curve around to again see what happens to equilibrium and compare the price fluctuation between the two. What does this example demonstrate about developing country commodity exports for which demand is generally inelastic? What is the effect of processing a commodity such as cocoa beans into a product such as chocolate? 7. 10.Developing countries’ problems with trade include: - lack of diversity in exports - price instability as commodity exports that face inelastic demand tend to experience price instability. - overreliance on imports - declining terms of trade - exploitation (environmental, local workers, etc) It may be helpful to assess and consider whether new products should be encouraged for production, as further processing will benefit the country and create employment (processed goods usually have less likelihood of inelastic demand), but these countries should pay attention to comparative advantage. Comparative advantage is likely to exist where raw commodities can be further processed. 11.Shift the supply curve backwards and forward. Now repeat the process, but drawing the demand curve much flatter. Price fluctuation will be less in the second case. This suggests that developing countries should try to process their primary product commodities in an effort to make demand more elastic, as well as create more employment. For example, cocoa beans are a relatively more inelastic commodity, and instead could be used as an input to produce chocolate which is a relatively more elastic processed good. Multiple Choice Questions 1. One benefit of trade is the improved ______ achieved by specialisation according to comparative advantage. a. equity b. efficiency c. political stability d. government borrowing 2. Which of the following will not suffer from trade restrictions on shoe imports into the U.S.? a. U.S. shoe consumers b. U.S. shoe producers c. U.S. exporters of other products d. the U.S. as a whole 3. U.S. trade restrictions on imports result in: a. a loss of gains from specialisation according to comparative advantage for the United States as a whole. b. a greater opportunity for market power in the United States. c. losses to U.S. exporters. d. All of the above 4. The price of one country’s currency in terms of another country’s currency is: a. the exchange rate. b. the balance of payments. c. the Group of Eight. d. the current account. Multiple Choice Solutions 1. One benefit of trade is the improved ______ achieved by specialisation according to comparative advantage. a. equity b. efficiency c. political stability d. government borrowing 2. Which of the following will not suffer from trade restrictions on shoe imports into the U.S.? a. U.S. shoe consumers b. U.S. shoe producers c. U.S. exporters of other products d. the U.S. as a whole 3. U.S. trade restrictions on imports result in: a. a loss of gains from specialisation according to comparative advantage for the United States as a whole. b. a greater opportunity for market power in the United States. c. losses to U.S. exporters. d. All of the above 4. The price of one country’s currency in terms of another country’s currency is: a. the exchange rate. b. the balance of payments. c. the Group of Eight. d. the current account. Additional In Class Questions 1. Draw a graph of the Australian cotton industry, assuming an open economy (i.e. Australia freely imports cotton) and all cotton is identical. Now draw the effect if the Australian producers of cotton convince the government to place an embargo (which restricts entirely) on the import of cotton. What is the effect (who gains and who loses) on: i. Australian consumers of cotton? ii. Australian producers of cotton? iii. Australian producers of other export products? iv. Australia as a whole? v. Foreign producers of cotton? i. Australian consumers of cotton: lose (higher prices and lower quantity) ii. Australian producers of cotton: gain (higher prices and more production) iii. Australian producers of other export products: lose (more production in cotton industry reduces availability of resources for other industries and possible retaliation by other countries of the Australian exports) iv. Australia as a whole: lose v. Foreign producers of cotton: lose (unable to sell into the Australian market) 2. Draw a graph of the Chinese rice industry, assuming a closed economy (i.e. demand is that it is internally supplied). Assuming that all rice is identical, on your graph show the effect if China begins to freely import rice. Label the new free trade price (PT), quantity demanded (QT), and quantity supplied by Chinese producers of rice (QCP) along the appropriate axes. Who gains and who loses? i. Chinese consumers of rice: gain (lower prices and higher quantity) ii. Chinese producers of rice: lose (lower prices and less production) iii. Chinese producers of other export products: gain (less production in rice industry increases the availability of resources for other industries and allowing rice imports probably means a free trade agreement allowing access to export markets) iv. China as a whole: gain v. Foreign producers of rice: gain (selling into the Chinese market) 3. Assuming only 2 countries of the world (Australia and Japan). Draw a graph of the market for the Australian dollar. (Look up the actual exchange rate for the dollar relative to the yen and identify this value at the equilibrium.) What is the effect on the Australian dollar exchange rate under various scenarios: i. more Japanese tourists coming to Australia? ii. a decrease in the demand for Australian beef from Japanese restaurants? iii. a Japanese company is awarded a contract to build an Australian high speed rail network? i. Increase – Japanese tourists need $AUD ii. Decrease – Japanese consumers do not need as much $AUD as they are not buying as much Australian goods (beef) iii. Decrease – there is an increase in the supply of $AUD to exchange for Yen as Australia needs to pay the Japanese company in Yen 3