Hellenic Open University: School of Social Sciences

HELLENIC OPEN UNIVERSITY
SCHOOL OF SOCIAL SCIENCES

MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION
Module: Managerial Economics (MBA50)
Academic Year: 2014-15
2nd Written Assignment (WA2)
Please answer all 4 questions

Subject 1: International Trade with Constant Cost (30%)
Assume throughout that Norway and Argentina are the only two countries in the
world, at least for purposes of trade. Also, there are only two goods: rice and cocoa.
The only factor of production is labor. Each Norwegian worker can produce 1 ton of
rice or 3 tons of cocoa in a single growing season, while each Argentinian worker can
produce 2/3 ton of rice or 2/3 ton of cocoa in a single growing season. There are 130
million workers in Norway and 390 million workers in Argentina. Suppose that the
world equilibrium relative price of rice is 3/2. Answer the following questions.
a. Which country has an absolute advantage in rice? In cocoa? Which country
has a comparative advantage in rice? In cocoa? (Mark: 0.6)
b. Draw the consumption possibility frontier in autarky and under free trade.
Which country produces which good or goods under free trade? Is there
complete specialization? Who gains from trade? (Mark: 0.6)
c. If some workers can move, what will be the pattern of immigration, i.e., who
wants to move where? Does your answer depend on the world equilibrium
price? What is the role of absolute advantage in this?
(In answering this question, assume that a worker's productivity is a function
of where that worker works, rather than his or her inherent skill) (Mark: 0.9)
d. Does anyone in these two countries have any reason to object to free
international trade? Do you find this realistic? What assumptions does it
depend on? Do you think these assumptions are crucial for the idea of the
gains from trade? (Mark: 0.9)
Indicative Answer
a. A country has an absolute advantage in the production of a good over
another country, if its workers are more productive in producing that good.
Since 1 > 2/3, Norway has an absolute advantage in rice; also, since 3 > 2/3 ,
Norway has an absolute advantage in the production of cocoa as well. A
country has a comparative advantage in the production of a good over
another country, if its opportunity cost in producing that good is lower than
that of the other country. The opportunity cost of 1 ton of rice in Norway is 3
1

tons of cocoa. The opportunity cost of 1 ton of rice in Argentina is 1 ton of
cocoa. It follows that Argentina has a comparative advantage in rice.
Similarly, since 1/3, which is the opportunity cost of cocoa in Norway, is less
than 1, which is the opportunity cost of cocoa in Argentina, we conclude that
Norway has a comparative advantage in cocoa.
b. The Consumption Possibility Frontiers (CPF) in autarky and under free trade
for each country are given by the blue and red line, respectively, in the
following figures.
Figure 1. Norways Consumption Possibility Frontier
Cocoa
390
130
260
Rice
Figure 2. Argentinas Consumption Possibility Frontier

Cocoa
390
260
260
Rice
2

Norway has a comparative advantage in cocoa and Argentina in rice. Under

free trade, both countries specialize completely. Norway produces and exports
cocoa; it imports rice. Argentina produces and exports rice; it imports cocoa.
Both countries gain from trade; the CPF of both countries expands under free
trade.
c. Consider
Income of a worker in Norway = 3 tons of cocoa x price of cocoa
Similarly,
Income of a worker in Argentina = 2/3 ton of rice x price of rice
Hence, dividing these two equations we get:

3

2
3
3 2
=3
2 3
3
The income of a worker in Norway is three times higher than that of a worker
in Argentina. The movement of labor will be from Argentina to Norway. The
answer to this question does not depend on the equilibrium price. It is critical
for this result that Norway has an absolute advantage in both goods. Thus,
whatever workers in Argentina produce, a Norwegian worker will have the
option of producing the same thing, in which case she will receive a higher
income because of her higher productivity. If she chooses to produce the other
good instead, that must be because it earns her higher income still. Another
way to see this is the following. From the equation above we have

3

2
3
where the relative price of cocoa lies between the two opportunity costs, i.e.,
between 1 and 1/3. No matter what value between these two numbers the
relative price of cocoa takes, it still be the case that

>1

Thus, comparative advantage determines the pattern of trade, while absolute
advantage determines the international distribution of income and the pattern
of immigration.
d. No one in these two countries has any reason to object to free trade. This is
because everybody gains from trade in this world, or at least no one loses from
it. Obviously, this is not realistic, since as we know there are people who
object to free trade. Also, governments are known to take measures in order to
protect certain groups and sectors. The key assumptions, besides competitive
markets, are the existence of one factor without any specialization that can
move without any cost, in fact instantaneously, from one sector to another. In
a Heckscher-Ohlin world, for example, there are two factors of production and
as the country moves from autarky to free trade, the factor that is relatively
scarce loses. Nevertheless, it is still true that the country overall benefits from
trade. The same holds in a world where there are economies of scale and
hence non-competitive markets.
Subject 2: Protectionism (25%)

Consider a small country that trades steel with the rest of the world. The demand and
supply curves for steel in this country are given by:
Supply: Qs = 2P and Demand: Qd = 600 P (where P is the price of steel)
a. Find the equilibrium price and quantity under conditions of autarky. (Mark: 0.1)
Assume that the country decides to trade steel at a given world price of P = 125.
b. Find the amount of imports or exports under the world price (P = 125). (Mark:
0.2)
c. Next, assume that the government wishes to raise 3,750 by imposing a tariff on
steel imports. Find the amount of the tariff that should be imposed per unit of
imports. Moreover, calculate the change in consumer surplus, the change in
producer surplus, and the net effect of such tariff, starting from the free trade
equilibrium. (Mark: 1.5)
d. Finally, assume that the government decides to impose a quota instead of the tariff.
In fact, it intends to auction the quota licenses to raise revenue. Find the import
quota level that is equivalent, i.e., it generates the same revenue, with the amount
of the tariff that you found in (c). (Mark: 0.7)

Indicative Answer
a. To find the equilibrium price and quantity we set Qs = Qd. Therefore, P = 200 and,
by substituting this price to either of the two equations, Q (equilibrium) = 400.
b. At the world price (P = 125), Qs = 250 and Qd = 475; therefore, imports M = Qd
Qs = 225.
c. The domestic price of imports with the introduction of the tariff is given by: Pd =
125 + t. This will be the domestic price if it is less than the autarky price (i.e., if t
75). Note that for t > 75 the tariff is prohibitive; there are no imports, and the
domestic price equals the autarky price of 200, which was found in part (a) above.
Thus, we have: Pd = 125 + t; Qs = 2(125 + t) = 250 + 2t and Qd = 600 (125
+ t) = 475 - t; Hence, M = Qd Qs = 225 3t. Therefore, Tariff Revenue
(yellow area in the graph below): TR = t x M = (225-3t)t = 3,750. Solving this
= 25 and
equation gives two roots:
= 50. Both of these tariffs will generate
the same revenue.

The changes in consumer and producer surplus can be seen in the figure below
and can be calculated as follows:
The Change in Consumer Surplus (blue + pink + yellow + green area):
=
(475 + 475 )
= 475
2
2
If the tariff is
= 25 then
= 11,562.5
If the tariff is
= 50 then
= 22,500
The Change in Producer Surplus (blue area):
(250 + 250 + 2 )
= (250 + )
2
If the tariff is
= 25 then
= 6,875
If the tariff is
= 50 then
= 15,000
The net effect (efficiency loss) is given by (pink area + green area):
5

If the tariff is
= 25 then
= 937.5
If the tariff is
= 50 then
= 3,750
3
2
Alternatively,
If = 25 then
= 11,562.5 + 6,875 + 3,750 = 937.5
If = 50 then
= 22,500 + 15,000 + 3,750 = 3,750
d. From part (b), imports M = 225 - 3t. Thus, if t = 25, M = 225 3 x 25 = 150. A
quota of 150 and a tariff of 25 have the same effects on domestic price,
consumption, production and imports and hence on revenue. Similarly, a quota
level of M = 225 3 x 50 = 75 is equivalent to a tariff t = 50.
P
S
P+t
P = 125
D
250
250+2t
475-t
475
Imports after the tariff

Imports before the tariff

Subject 3: Protectionism (25%)

The demand and supply of a particular good for a small country are given by the
following equations:
Qd = 180 - 30 P and Qs = 20 + 10 P.
Assume that the world equilibrium price is w =2.
a. Suppose that the government provides an export subsidy equal to 2.5 per unit
of output. At the same time it prohibits imports from the rest of the world;
consequently, domestic demand is serviced only by domestic producers. Find
the equilibrium price within the country, the quantity consumed and the
quantity produced. Who benefits and who loses from the export subsidy
(relative to the free trade equilibrium)? Draw a graph to illustrate your results.
What is the net effect of the export subsidy? (Mark: 1.25)
b. Next, suppose that, instead of an export subsidy, the government provides a
production subsidy. How would your answers in part (a) change? Draw a
new graph to illustrate the effects of the production subsidy. (Mark: 1.25)
Indicative Answer
a. Setting Qs = Qd, we find the equilibrium price under autarky to be P = 4. Also,
under free trade the the domestic price will drop down to the world price (P w = 2).
At this price, the quantity supplied domestically will be Qs = 40 and the quantity
consumed Qd = 120. Therefore, the country will import from the rest of the world
a quantity equal to M = Qd Qs = 80.
With the export subsidy, the domestic price changes to 2+2.5 = 4.5. At this price
Qs = 65 and Qd = 45. The country has been converted from an importing to an
exporting one (see the figure below). The exports are X = Qs - Qd = 65-45 = 20.
Compared to the free equilibrium
CS = a+b+e+f+g = - [(45+120) x 2.5]/2 = - 206.25 (consumers loss)
PS = a+b+c= [(40+65) x 2.5]/2 = 131.25 (producers gain)
Budget effect = -(b+c+d+f )= -X x subsidy = -20 x 2.5 = -50 (tax payers loss)
Net effect = 131.25 - 206.25 - 50 = -125 (overall loss)

b. Case 1: Imports are allowed

If instead of an export subsidy, the government provided a production subsidy,
consumers pay the world price P w = 2 and producers receive the price P = 2+2.5 =
4.5. At P=4.5 quantity supplied is Qs = 65. Compared to the free-trade equilibrium:
Consumers do not experience any loss, because they pay the world price (the same
price as before the subsidy).
PS = a+b = [(40+65) x 2.5]/2 = 131.25 (producers gain)
Budget effect = -(a+b+c+d) = 65 x 2.5 = -162.5 (tax payers loss)
Net effect = 131.25-162.5 = -(c+d) = -31.25 (overall loss)

Case 2: Imports are not allowed
If imports are not allowed then this a pure public finance issue: a production subsidy
in a closed economy. In any case the analysis is very similar (see the graph below).
More specifically, after the subsidy: P = 3.375 and Q = 78.75.
= 136.64
= 230.08

= 196.88
= 103.44

5.875
3.375
2
40
78.75
120
Subject 4: Production, international trade and income distribution (20%)

Some politicians in developed countries support the idea of free trade of goods
between countries and at the same time they are against immigration. Discuss the
consistency of these beliefs, differentiating between economic and non-economic
arguments against immigration. (Maximum number of words: 420)
(Note that the question is not about whether one should be for or against immigration
or for or against free trade. It is about whether it makes sense for someone to be in
favor of free trade and against immigration. You should base your answer mainly on
the theory of international trade that you have learned in the class. You may also use
your own judgment but this should be based on well justified arguments. Be specific
and to the point.)
Indicative Answer
In general, when it comes to factor prices, movements of goods and movements of
factors are substitutes for each other (e.g., see the Heckscher-Ohlin model and the
factor price equalization theorem). Since the production of different goods requires
10

different factor intensities, trade changes relative factor demands and thus factor
prices. Thus, the imports of labor-intensive products by a relatively capital-abundant
country tend to equalize prices of these products in the two countries and at the same
time the expansion of the labor-intensive sector increases wages in the relatively
labor-abundant country. On the other hand, contraction of the labor-intensive sector
in the relatively capital-abundant country lowers wages. Thus, product trade alters the
structure of factor demand and equalizes wages between the two countries. Trade
increases world income and redistributes income from labor to capital in the relatively
capital-abundant country and from capital to labor in the relatively labor-abundant
country.
Immigration has the same effects: it causes world income to rise because
national income rises by more in the destination country than it falls in the country of
origin and it also changes relative prices and the distribution of income in both
countries. Labor becomes more abundant and wage falls in the receiving country,
while capital becomes relatively scarce and its return rises. The opposite effect occurs
in the sending country. As a result, the output of the labor-intensive sector rises and
its price falls in the receiving country, with the opposite effects in the sending
country. Thus, labor immigration substitutes for imports in the relatively capitalabundant country.
The economic argument against immigration that is usually articulated by
certain politicians is that it increases labor supply and hence it decreases the price of
labor (wage). However, consider a developed country that is relatively capital
abundant. Free trade will lead to a decrease in the price of goods that are intensive in
labor and hence a decrease in the price of labor. In that respect, it is inconsistent to
support free trade and at the same time be against immigration. On the other hand,
free trade will increase the price of labor in developing countries that are labor
abundant and export labor-intensive goods. This will diminish the incentives of
workers in developing countries to immigrate to developed ones. Hence, for someone
who is against immigration for non-economic reasons, e.g., changes national identity,
crime, cultural reasons, etc., it is consistent to support free trade, since this will
decrease immigration pressure.
11

Assignment guidelines
It is important that the coursework reflects your knowledge rather than it being
simply an accumulation of information.
The assignment should be well structured and easy to read.
The assignment should clearly present all aspects and perspectives of the
subject area, i.e.:
o
efficiently develop all necessary elements
o
refer to actual case studies or statistics if required
o
present reasonable argumentation
o
omit irrelevant material
All questions are compulsory. The assignment, including possible diagrams,
tables, references etc., should not exceed 2500 words. For every additional 300
words there will be a penalty of 0.5 points.
Each question accounts for a percentage of the total mark. This is clearly
marked at the beginning of each question.
The assignment is due on 20 January, 2015. Please note that no
assignment will be acceptable after this date as the electronic submission
system automatically locks at 23:55 on the last day of submission.
You should submit your assignment via http://study.eap.gr using your
username and password.
You may use any of the following file formats:
o
Rich Text Format (*.rtf).
o
Microsoft Word 97-2003 (*.doc).
o
Microsoft Word Open XML (*.docx)
Other document formats or read only file formats such as Portable Document
Format (*.pdf) are not acceptable formats for the submission of your assignment.
Please pay attention to the proper naming of your assignment. The file should be
named as follows: Surname-Initial-WAnumber-YourClass. For example, if
your name is Peter Drucker, you are sending in your 3rd assignment, and you
are in ATH1 Class, then you should name your file as follows: Drucker-P-WA3ATH1. Assignments that fail to comply with this requirement will receive a lower
mark in the presentation grade.
Use Times New Roman font 12, Line Spacing 1.5 or 2 and justify the text.
References: Harvard Style
You are free to choose any relevant academic source.
To facilitate grading do not rewrite the questions. Just answer them in the
order that they are appear above.
Copying is considered cheating and is not acceptable in any form. Copying
large parts or whole paragraphs of text found in any of the sources used
for an assignment (printed books, academic articles, or electronic media of
any kind) is totally unacceptable. It is considered plagiarism and leads to a
severe penalty for the student(s) involved. Students should cite all sources
from which they take data, ideas or words, whether quoted directly or
paraphrased.
Good luck!!
12

Hellenic Open University: School of Social Sciences

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Hellenic Open University: School of Social Sciences

Hochgeladen von

Copyright:

Verfügbare Formate

HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES

Please answer all 4 questions