SECTION A

The figure above represents a market that has gone from a situation where international trade
was not allowed (autarky) to one where it can engage in international trade.
T U
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N
M
L
O K
J
H
F
E
C
B
A
D
P
Q
Using the appropriate letters identify the following.
(a) The quantity exported due to the move to open trade
(b) The change in consumers surplus due to the move to open trade
(c) The increase in resource use as due to the move to open trade
(d) The value of exports after the move to open trade
(e) Producers surplus under autarky
(f) Producers surplus after the move to open trade
(g) Resource use under autarky
(h) The change in producers surplus due to the move to open trade
(i) The quantity consumed under autarky
(j) Consumers surplus under autarky
SECTION B
Assume there are three countries that can trade with each other: (1) Kerr’s Empire; (2)
Saskabush and; (3) Riderville. You are an agricultural trade policy economist that works for the
government of Kerr’s Empire (hired for the expertise you have acquired in AREC 356). All three
countries belong to the Galaxy Trade Organization (GTO). Kerr’s Empire and Riderville are
frustrated with the slow pace of negotiations at the GTO and think there may be gains from trade
if they can negotiate a preferential bilateral trade agreement between them. They have not
thought of including Saskabush in their trade agreement because Saskabush thinks it is the most
efficient country and does not need more trade liberalization to be able to compete (Note, their
agricultural trade policy economist failed AREC 356). One key product that would be included
in the proposed trade agreement between Kerr’s Empire and Riderville is hops – which is an
ingredient in beer which is the favourite drink in all three countries. Only Riderville and
Saskabush are serious international competitors.
The government of Kerr’s Empire wants to know whether including hops in the bilateral
trade agreement would be a good idea. The hops growers in Kerr’s Empire are dead against it
and have hired your old AREC 356 professor to be their trade policy economist. You are to
provide the government of Kerr’s Empire with advice on whether hops should be included in the
bilateral trade agreement with Riderville.
Professor Kerr is happy to share some of his data with you. He sends you information on
the hops market in Kerr’s Empire. It is provided below.
Kerr’s Empire Market – Hops
Price/Bushel (bu) Quantity Demanded (bu) Quantity Supplied (bu)
$7.50 0.00 812,500
$7.00 100,000 750,000
$6.50 200,000 687,500
$6.00 300,000 625,000
$5.50 400,000 562,500
$5.00 500,000 500,000
$4.50 600,000 437,500
$4.00 700,000 375,000
$3.50 800,000 312,500
$3.00 900,000 250,000
$2.50 1,000,000 187,000
$2.00 1,100,000 125,000
$1.50 1,200,000 62,500
$1.00 1,300,000 0.00
$0.50 1,400,000
$0.00 1,500,000
By checking the WTO data base you find out that the tariff imposed on imports of hops is
$1.00/bu. Currently (before any trade agreement) this tariff will be collected on imports from
both Saskabush and Riderville.
Hops traders tell you that Riderville can supply all of the hops that Kerr’s Empire could
need at $3.50/bu – the Riderville international supply price. They also tell you that Saskabush
can supply all the hops that Kerr’s Empire could need at 3.00/bu – the Saskabush international
supply price.
You now have enough information to undertake the analysis of including hops in the
bilateral trade agreement with Riderville.
(a) Graph the current market for hops in Kerr’s Empire – i.e. the market before the trade
agreement.
(b) What is the quantity supplied by hops producers in Kerr’s Empire?
(c) What is the quantity demanded in Kerr’s Empire
(d) What quantity of hops is imported into Kerr’s Empire?
(e) How much total revenue does the government of Kerr’s Empire make from the collection
of the tariff
(f) What quantity of hops is imported from Riderville?
Now assume that the bilateral trade agreement with Riderville is negotiated. This means the tariff
will no longer be collected on hops from Riderville but remains on hops from Saskabush.
(g) What quantity of hops will now be imported into Kerr’s Empire?
(h) Calculate the value of the loss in producers surplus in Kerr’s Empire as a result of the
trade agreement (show your calculations).
(i) Calculate the loss in tariff revenue for the government of Kerr’s Empire as a result of the
trade agreement.
(j) Calculate the gain from trade creation that will result from the trade liberalization arising
from the agreement (show your calculations). (Note the gain from trade creation is the
same as the gain in consumer surplus from trade liberalization).
(k) The loss from trade diversion (from efficient Saskabush to inefficient Riderville) is the
sum of the reduction of producers surplus and the loss of tariff revenue by the
government. What is the total value of the trade diversion loss?
(l) A country should only include a product in a trade agreement to remove tariffs if the gain
from trade creation is larger than the loss from trade diversion. What would you advise
the government of Kerr’s Empire regarding whether hops should be included in the
bilateral trade agreement with Riderville? Explain.
(m)Why do you think that hops producers in Kerr’s Empire were so against having hops
included in the trade agreement – and willing to pay Professor Kerr (at a very high price)
to work for them?
SECTION C
Assume that the Klingon Empire and the Federation have been at war and, hence, have
not been trading. The war is now over and the Federation has dispatched the Starship Enterprise
commanded by Jean-Luc Picard to open trade negotiations with the Klingon Empire. The
Klingons are very suspicious about opening their Empire to trade. You, as a well-trained
agricultural trade economist, have been beamed aboard the Enterprise to help with the trade
negotiations. Your assignment is to convince the Klingons to trade by proving to them that they
will gain from opening up trade with the Federation. Lieutenant-Commander Data has all the
production information, labour force statistics, costs of shipment, resource inventories, relative
prices and productivity data for both the Federation and the Klingon Empire at his finger tips. He
can produce reams of data from his computer banks, construct sophisticated computer models of
trade flows and can show unequivocally that trade will be beneficial for the Klingon Empire.
You, Captain Picard and Mr. Data go to the first meeting with the representatives of the Klingon
Empire. Mr. Data shows the Klingons endless graphs, mathematical equations, economic
projections, etc. You observe the Klingons closely, they are not impressed, clearly bored, spend
most of their time laughing, drinking and butting heads. At the end of Mr. Data’s four and a half
hour presentation, the Klingons are drunk and when Captain Picard suggests a trade treaty, the
Klingons growl and swagger out of the meeting. Picard suggests another meeting the next day.
The head of the Klingon delegation reluctantly agrees, but says that another interminable
presentation by Mr. Data is not acceptable and if the meeting goes on for more than 20 minutes
without them being convinced, they will walk out and there will be no trade treaty with the
Federation.
Captain Picard is clearly annoyed with the performance of his team. Mr. Data is
perplexed – he simply does not understand why the Klingons were not impressed with his
evidence. Picard says that you are the trade policy advisor and you had better come up with
something more impressive for tomorrow’s meeting. If not, you will spend the rest of your
Starfleet career lecturing to bored Ferengi undergraduates about the neoclassical trade model on
some forgotten planet at the edge of the galaxy. It is clear that you need to do something and
quickly.
After some thought, you realize that to convince the Klingons you need a much simpler
approach. You remember a history of agribusiness assignment you did in your days at the
Starfleet Academy. Your professor there was fascinated by an early 21st century book by two
economists, Kerr and Perdikis, called the A Guide to the Global Business Environment. He
thought the book was a classic and had a battered copy he carried with him everywhere.
One of your assignments at the academy had been to find out more about the agricultural
economist Kerr. You remember finding visual records of his lectures and his lecture notes in the
computer data banks and that he had some simple proofs of the gains from trade – simple enough
for even Klingons to understand. You ask the computer to pull up the lecture notes – and there it
is – the proof that there will be gains from trade. The proof is present simply in the form of
tableaus (tables). You begin to translate one of Kerr’s examples into something the Klingons can
relate to.
Assume that the Klingon Empire has 50 units of resources and that the Federation has 40
units of resources. In the Klingon Empire, one unit of resources can produce 14 barrels of wine.
One unit of resources can also be used to produce 18 dilithium crystals (used as power for space
ships). In the Federation, one unit of resources can be used to produce 20 dilithium crystals or 20
barrels of wine. If there is no trade, both the Klingon Empire and the Federation must produce
both wine and dilithium crystals. If prior to trade, both the Klingon Empire and the Federation
spend half their resources producing wine and half their resources producing dilithium crystals,
using the tableau method developed in class.
a) Show the pre-trade situation for both the Klingon Empire and the Federation.
If trade is now allowed between the Klingon Empire and the Federation, each country should
specialize in the production of one good.
b) Which good, wine or dilithium crystals, should the Klingon Empire specialize in
producing? Why?
Now you need to prove that both the Federation and the Klingon Empire would gain from trade.
c) Using the tableau method developed in class show the after trade situation for both the
Klingon Empire and the Federation. Do the case where each country totally specializes in the
production of one of the products. (Remember the key part of the proof – that consumers must be
no worse off after trade than they were before trade).
d) Calculate the gains from trade arising from this example.
e) One of the Klingon delegates says this is all fine – he believes your example that both the
Klingon Empire and the Federation will benefit from trade. What he would like, however, would
be for there to be more wine available to drink in the Klingon Empire. What would you tell the
delegate?
Your simple example has sent a powerful message to the Klingon delegation. They are
really impressed and agree to open up trade. Captain Picard is also very impressed and
recommends that you be promoted from trade advisor to trade negotiator. You are very pleased
at the prospect of life as a Federation Trade negotiator – living the good life in Geneva as the
negotiations go on for years.
Before you leave on the next shuttle for Geneva, Mr. Data visits you and tells you he has
been searching his memory banks for old theories of trade. He says he has found references to
two ancient theories of trade – absolute advantage and comparative advantage.
f) Was the example above based on the theory of absolute advantage or the theory of
comparative advantage? Explain.
SECTION D
After your success at the trade negotiations with the Klingon Empire, you are now
resident in Geneva and are one of the Federation representatives at the Galaxy Trade
Organization (GTO). Your first job is to facilitate the opening of trade between two Federation
members – Alpha – 17 and Zeta – 22. The planets have not traded up to this point, but advances
in transportation technology have now reduced the cost of transportation sufficiently that trade
could be conducted profitably. Ferengi traders in both countries have identified profitable
business opportunities from trade being allowed. The delegations from both Alpha – 17 and Zeta
– 22, however, remain unconvinced. The Ferengi, having heard of your success with the
Klingons, have asked the Federation for your services in convincing the delegations from Alpha
– 17 and Zeta – 22 to open up trade. Luckily, this time the economies of Alpha – 17 and Zeta –
22 are really simple. They both produce only two goods – replicators and bio-energy which is
fuel for replicators. Replicators are advanced technology that can be used to produce all the
society’s requirements – food, clothing, pre-fabricated housing, etc. The only thing replicators
cannot make is bio-energy. In Alpha – 17, one unit of resources can produce 10 units of bioenergy. In Zeta – 22, one unit of resources can produce 7 units of bio-energy. On the other hand,
in Zeta – 22, one unit of resources can produce 30 replicators. In Alpha – 17, one unit of
resources can produce 2 replicators. Alpha – 17, however, is a much larger economy than that of
Zeta – 22. Alpha – 17 has 20 units of resources which can be used in production. In contrast,
Zeta – 22 has only 10 units of resources available for production.
After your success in the negotiation with the Klingon Empire, you decide to use the
simple proof of gains from trade based on Professor Kerr’s early 21st century classroom notes.
You find out that both Alpha – 17 and Zeta – 22, in the current no trade situation, each economy
uses half its resources to produce bio-energy and half its resources to produce replicators.
a) Using the Table approach developed on Professor Kerr’s notes, illustrate the no trade
production and consumption in Alpha – 17 and Zeta – 22.
Now assume there is an agreement to open trade between Alpha – 17 and Zeta – 22
b) Should Zeta – 22 specialize in the production of bio-energy or replicators? Why?
c) Assuming that each country completely specializes in the production and export of one
product, show the after trade position of both countries (remember, the bottom line is that no
consumers can be made worse off.
d) Calculate the gains from trade for each country.
e) Is the trade in this example based on comparative or absolute advantage? Explain.
The delegates from both Alpha – 17 and Zeta – 22 are very impressed. Clearly the gains from
trade mean there will be an improvement in the “general good”. The delegates from both
countries agree to a tentative free trade deal