1 Suppose there are two countries, Home (H) and Foreign (F), and two goods, bread (b) and cheese (c), both produced only using labour. Unit labour costs are constant and given by q = 1 and D a= 2 in Home, and a= 2 and a= 2 in Foreign. Both countries have the same labour force L. Bread and cheese are used to make sandwiches: one sandwich re- quires two units of bread and one unit of cheese. Consumers in both countries have the same preferences and derive strictly positive util- ity from consuming sandwiches, but do not value consuming bread without cheese, or cheese without bread. There is free international trade of goods at prices pb and pc. Normalise the price for bread to Pb Pb = 1. a) Show that in the free trade world market equilibrium pc = 2. De- termine the production, imports and exports and wages in each country in equilibrium. How many sandwiches will be produced, and how many will be consumed in each country? b) Home considers introducing a trade tariff of 0.1 per unit of im- ported good. The revenue from the tariff is to be used for infrastructure investment by the government. Derive the prices, production and trade flows in the new trade equilibrium. How many sandwiches will be consumed in each country? c) Home considers an import quota instead of a tariff, capping import of goods at 0.12 units. Derive the production and trade flows in the new trade equilibrium. How many sandwiches will be consumed in each country? Is the import quota or the tariff a better policy for Home?
1 Suppose there are two countries, Home (H) and Foreign (F), and two goods, bread (b) and cheese (c), both produced only using labour. Unit labour costs are constant and given by q = 1 and D a= 2 in Home, and a= 2 and a= 2 in Foreign. Both countries have the same labour force L. Bread and cheese are used to make sandwiches: one sandwich re- quires two units of bread and one unit of cheese. Consumers in both countries have the same preferences and derive strictly positive util- ity from consuming sandwiches, but do not value consuming bread without cheese, or cheese without bread. There is free international trade of goods at prices pb and pc. Normalise the price for bread to Pb Pb = 1. a) Show that in the free trade world market equilibrium pc = 2. De- termine the production, imports and exports and wages in each country in equilibrium. How many sandwiches will be produced, and how many will be consumed in each country? b) Home considers introducing a trade tariff of 0.1 per unit of im- ported good. The revenue from the tariff is to be used for infrastructure investment by the government. Derive the prices, production and trade flows in the new trade equilibrium. How many sandwiches will be consumed in each country? c) Home considers an import quota instead of a tariff, capping import of goods at 0.12 units. Derive the production and trade flows in the new trade equilibrium. How many sandwiches will be consumed in each country? Is the import quota or the tariff a better policy for Home?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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1b
Transcribed Image Text:1 Suppose there are two countries, Home (H) and Foreign (F), and
two goods, bread (b) and cheese (c), both produced only using
labour. Unit labour costs are constant and given by q = 1 and
D
a= 2 in Home, and a= 2 and a= 2 in Foreign. Both
countries have the same labour force L.
Bread and cheese are used to make sandwiches: one sandwich re-
quires two units of bread and one unit of cheese. Consumers in both
countries have the same preferences and derive strictly positive util-
ity from consuming sandwiches, but do not value consuming bread
without cheese, or cheese without bread. There is free international
trade of goods at prices pb and pc. Normalise the price for bread to
Pb
Pb = 1.
a) Show that in the free trade world market equilibrium pc = 2. De-
termine the production, imports and exports and wages in each
country in equilibrium. How many sandwiches will be produced,
and how many will be consumed in each country?
b) Home considers introducing a trade tariff of 0.1 per unit of im-
ported good. The revenue from the tariff is to be used for
infrastructure investment by the government. Derive the prices,
production and trade flows in the new trade equilibrium. How many
sandwiches will be consumed in each country?
c) Home considers an import quota instead of a tariff, capping
import of goods at 0.12 units. Derive the production and trade
flows in the new trade equilibrium. How many sandwiches will
be consumed in each country? Is the import quota or the tariff
a better policy for Home?
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