QUESTION 1

The terms of trade argument is regarded as one of the few arguments that explains government intervention when there are no political economy considerations. Describe with your own words what the terms of trade argument says when applied to imports and, separately, when applied to exports.

(15 marks)

QUESTION 2

Suppose Home is a small exporter of wheat. At the world price of $100 per ton, Home exports 20 tons. Now suppose the Home government decides to support its domestic producer with an export subsidy of $40 per ton. Use the following figure to answer these questions. Please explain your answers so that your reasoning is clear.

(a) What is the quantity exported under free trade and with the export subsidy?
(5 marks)

(b) Calculate the effect of the export subsidy on consumer surplus, producer surplus, and government revenue.
(5 marks)

(c) Calculate the overall net effect of the export subsidy on Home welfare.
(5 marks)

cont/…

QUESTION 3

Consider a country that produces two goods, manufacturing goods and agricultural goods, with the use of two factors, capital and labour. Both factors are perfectly mobile between the two producing sectors of the economy. Refer to the Stolper-Samuelson theorem and describe what the income distribution effects of an import tariff are if the country is capital abundant and, separately, if the country is labour abundant?

(15 marks)

QUESTION 3

Explain verbally and diagrammatically the argument that “history matters” – also called “first mover advantage” – in industries with external economies of scale. Link this to the infant industry argument for protection and provide examples of industries that could possibly fall under that category.

(15 marks)