Assignment
Part 1: Essay Questions
Notice that unless specifically instructed, you will not be required to use graphs to answer these questions. You may find it helpful though.
International Trade
1. Suppose that two countries (US and Cuba) conform to the assumptions of the Heckscher-Ohlin model and initially do not trade with each other. Only two products are produced-textiles are labor intensive while steel is capital intensive. Cuba has relatively more labor than does the US. Labor and capital are mobile between industries.
A. Explain which products each country should export and why. [That is, do not just say that Cuba has a comparative advantage in good X-you must explain why it has a comparative advantage.]
B. What would be the expected effect of opening trade on wages and returns to capital in Cuba in the long run? Explain.
2. a. For the policies below, note a small country's imposition of the policy will increase (+), decrease (-), or have an unclear effect (?) on the variables listed vertically. (Please note, you do not have to explain; just note the direction of change.) Assume that transfers among domestic citizens have no effect on welfare.
Tariff Export subsidy Import quota Export tax
Domestic price
Domestic consumer surplus
Domestic producer surplus
Government revenue
Net national welfare
If any of the effects are unclear, provide a brief explanation.
b. For each, explain the nature of any deadweight losses in detail, i.e. compare the costs of domestic production and consumer benefits with the reduced or expanded trade.
3. Suppose the assumptions of the Ricardian model apply. Let LA = country A's endowment of labor =100 units; LB = country B's endowment of labor = 100 units. The unit labor coefficients for the two countries for good S and C are:
aLc = 2L/c, aLs = 10L/s; bLc = 10L/c, bLs = 1L/s.
a. What is the opportunity cost for C in each country? Provide specific numbers (i.e. number of S per C).
b. Explain which country has the absolute advantage in each good.
c. Explain which country as the comparative advantage in each good.
d. What is the range of potential relative prices for mutually beneficial trade? Provide specific numbers (i.e. number of C per S).
e. For one particular possible trading price, show the PPF for both countries and the relevant post-trade national income (presuming full specialization).
4. Illustrate and explain how the US (a large country in international oil markets) can benefit from imposing a tariff on petroleum. Which group or groups ultimately pay for the tariff? What are the major drawbacks for a country pursuing this policy? How would consumers of petroleum in Europe be affected by the tariff?
5. Illustrate and explain how a Australia (a large country in the international iron ore markets) can benefit from imposing an export tax on iron. Which group or groups ultimately pay for the export tax? What are the major drawbacks for a country pursuing this policy? How would Chinese steel manufacturers (who buy iron) be affected by the policy?
6. Suppose that a small country imposes an export tax on its exported good called autos, which is a capital intensive good. The other (imported good) is called wheat.
a. Analyze the impact of the export tax on the real returns to labor and capital in both industries in the short run (i.e. when labor and capital are immobile across industries). Be sure to discuss the ability of workers and capital owners in each industry to buy both goods as a consequence of the export tax.
b. Analyze the impact of the export tax on the real returns to labor and capital in both industries in the long run (i.e. when labor and capital are mobile across industries). Be sure to discuss the ability of workers and capital owners in each industry to buy both goods as a consequence of the export tax.
c. Using relative prices, show that the export tax (on autos) and an import tariff (on wheat) will have similar affects on the production of the two goods in this economy.
7. Suppose that Peru (a small country) is considering two possible policies to limit imports of Chinese textiles: a tariff and a quota
a) Using a supply and demand curve graph, analyze the effects of the tariff on Peruvian consumers, producers, and the government. Be sure to include the impact on overall national welfare, assuming that transfers across individuals have no effect on welfare.
b)Redo part a) for the import quota.
c) Explain how foreigners would be affected for both policies.
8. Suppose that the Trump administration has decided to impose a 25 percent tariff on Chinese products. Using supply and demand analysis (though not necessarily graphs) for a single representative product, explain the effect of imposing the tariffs on the U.S. and Chinese economy. Assume that the U.S. is a "large" country.
9. Outline the basic principles of the General Agreement on Trade and Tariffs (now the WTO). What role does multilateralism and the most-favored-nation (MFN) principle play in the GATT? Discuss two situations where GATT rules allow nations to violate the MFN principle.
10. Suppose that a country exports a good called X and imports a good called Y.
a) Analyze the effects on consumers, producers and the government if the country imposes an export tax. Assume that the country is "large" in its export market.
b) Analyze the effects on consumers, producers and the government if the country imposes an import tax. Assume that the country is "large" in its import market.
11. Derive and explain the relationship between a country's government budget deficit, current account and net private savings. If domestic investment rises at the same time government spending increases, how might this be financed? If the U.S. Congress "outlawed" the current account deficit, use the relationship derived above to explain why the U.S. would be forced to increase net government and/or private savings.
13. Suppose that the assumptions of the Heckscher-Ohlin model apply. Suppose that airplanes are capital-intensive and toys are labor-intensive. Labor and capital are mobile across industries but immobile across countries. Furthermore, the capital and labor endowments for the U.S. and Colombia are: KUS = 200K and LUS = 50L; KC = 10K and LC = 25L
a. Explain which country has a lower relative price for capital before trade.
b. Explain which country has a comparative advantage in each good.
c. Explain what will happen to the wage/rental ratios in both countries if they open to trade.
d. Suppose that labor and capital could move across borders instead of allowing trade in goods. To which country would each tend to move? What would happen to the wage-rental ratio in each country?
Part 2: International Finance/Macroeconomics
1. Consider a foreign exchange market between the Mexican peso ($) and the Japanese yen (Y):
a) Illustrate the market equilibrium. Make up a specific equilibrium exchange rate. Be sure to label the graph carefully and completely.
b) On a new graph, label a situation where the Mexicans have an undervalued currency. Are the Mexican running a balance of payments surplus or deficit? Can you say anything about the current account in this situation? Explain.
c) How would the Mexican central bank maintain this exchange rate? Be specific.
2. Suppose that you are told that the interest rates on a US government bond are lower than a comparable German bond (i.e. equal risk and maturity).
a) Assuming that uncovered interest parity holds (so that investors are currently indifferent between the two assets), what would this imply about the market's expectation of the future value of the dollar in the exchange market? Explain.
b) Can you draw any conclusions about the market's expectation about inflation in the US and Germany? Explain.
3. Suppose that an investor is deciding between buying a U.S. bond (which pays out interest in dollars) and a UK bond (which pays out interest in pounds). The U.S. interest rate is 2% while the British interest rate is 3%. The current exchange rate is: $1 = 0.80 pounds. Suppose further that the investor would like to use the forward market to hedge against exchange rate movements. What would the forward rate be to make investors indifferent between these two investments? Would the investor buy a contract for buying dollars or pounds in the forward market?
4. Suppose two countries have fixed exchange rates
a) The first has a balance of payments surplus. What can you surmise about whether the central bank is gaining or losing official reserves? What economic downsides exist for the domestic economy if these surpluses continue? Explain.
b) The second has a balance of payments deficit. What can you surmise about whether the central bank is gaining or losing official reserves? What economic downsides exist for the domestic economy if these deficits continue? Explain.
5. Suppose that the Trump administration is considering large infrastructure projects to increase U.S. economic activity. Assume further that the U.S. maintains flexible exchange rates. Analyze the impact of this policy in:
a) Keynesian short run model
b) Classical long run model
Assume that financial capital is perfectly mobile. Is there a difference in the expectations about the effectiveness of the policy in the two frameworks? Explain.
6. In the immediate aftermath of the Financial Crisis of 2008-9, the U.S. pursued two policies: a) The Federal Reserve purchased large amounts of domestic bonds in what was called "quantitative easing"; b) the Obama administration pushed an economic stimulus plan that focused on increased government spending. The U.S. had flexible exchange rates during this period. Which of these policies would be more likely to be effective according to Keynesian analysis. .
7. Suppose the assumptions of the Keynesian model apply. Exchange rates are flexible. Suppose that commercial banks decide unilaterally to increase the percentage of funds that they hold in their reserves at the central bank, thereby reducing their outstanding loans and the amount in currency in circulation. Analyze the effects of this decision on the exchange change rate and GNP.
8. Explain the conditions necessary for a group of countries to be considered an optimal currency area. What would be the impact if there were a sharp recession in one of the countries? In particular, how might the two economies adjust to lessen the differences in economic conditions across the regions.
9. Suppose that you have been recently hired as an outside economic consultant for a country that has maintained a flexible exchange rate. Suppose further that past economic policies have severely restricted the ability of private individuals from moving financial investment funds into or out of the country.
Suppose that the country has just entered a recession and that two factions within the government have developed competing plans to revive the moribund economy.
The first faction suggests that the central bank should immediately purchase bonds on the open market while simultaneously decreasing domestic income taxes.
The second faction suggests that restrictions on movement of private capital in and out of the country be eliminated. In addition, a government program of investment in infrastructure should be aggressively pursued.
Using Keynesian analysis, explain which, of these two plans is more likely to increase domestic economic activity. (Consider only these two policy plans.)
10. Suppose that you have been recently hired as an outside economic consultant for a country that has maintained a fixed exchange rate. Suppose further that past economic policies have severely restricted the ability of private individuals from moving financial investment funds into or out of the country.
Suppose that the country has just entered a recession and that two factions within the government have developed competing plans to revive the moribund economy.
The first faction suggests that the central bank should immediately purchase bonds on the open market while simultaneously decreasing domestic income taxes.
The second faction suggests that restrictions on movement of private capital in and out of the country be eliminated. In addition, a government program of investment in infrastructure should be aggressively pursued.
Using Keynesian analysis, explain which of these two plans is more likely to increase domestic economic activity. (Consider only these two policy plans.)
11. Suppose that a country that maintains a fixed exchange rate is considering expansionary monetary policy. Analyze the economic effects of this policy using:
a) the Keynesian framework
b) the classical approach
Be sure to make any necessary assumptions explicit.
12. Explain the effects of a devaluation in
a) the Keynesian framework
b) the classical approach
Be sure to make any necessary assumptions explicit
13. Write a brief essay about the major differences between the Keynesian model and the neoclassical approach to international economics. What are the critical assumptions that yield the different results?
14. Outline the most important arguments for and against floating and fixed exchange rates. Which set of arguments do you find more attractive? Explain.
15. Professor Moore saw this sign in the Atlanta airport.
a) What is the implied Euro-dollar exchange rate at the kiosk? How about the UK - Euro exchange rate?
b) Compare these two exchange rate with that you can find on the internet (which is typically the amount that banks would pay for large transactions)?
c) How much profit does the money changer in the airport make if a U.S. tourist sells $100 for pounds and $100 for euros?