INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 7
1. If a country experiences a recession and the demand for steel falls, why are
economists skeptical of a strategy to impose tariffs on imports of steel in order to
preserve jobs in the steel industry? How are job prospects in other industries affected
by the imposition of tariffs on steel? When the economy recovers and demand for steel
rises, what political problems arise in subsequently adjusting tariffs?
2. “To show solidarity with underpaid workers in poor countries who are exploited in
sweatshops and made to work in unsatisfactory conditions, the European Union
should restrict imports from countries where such conditions are allowed to exist.” How
would E.U. restrictions affect both domestic and foreign workers, and the amount of
trade that occurs?
3. High tariffs are often imposed in the E.U. and the U.S. on imports of labor-intensive
goods such as apparel and footwear. How do those tariffs affect the distribution of
income, according to the Stolper–Samuelson theorem? Why will eliminating a tariff on
clothing have a different effect on income distribution than eliminating a tariff on
airplanes?
4. a. Consider the import market shown below. Confirm that the initial equilibrium price
is e45 and the quantity is 55.
M
d = 100 – P and Ms = –80+ 3P (7.1)
b. Now determine the consequences of imposing a tariff of e20 per unit. Calculate
the gain in the terms of trade, the loss in economic efficiency from the decline in
imports, and the net effect on the importing country. Also, calculate the loss for the
world as a whole (including both the importer and the exporter) from this policy.
c. If the demand curve were to shift inward and become Md = 50 – P, determine the
new equilibrium price and quantity and then impose the same tariff. Explain why the
consequences of the tariff for national efficiency change, while the impact on world
efficiency remains the same.
5. A business projects that its costs from initiating production of a new toy in Country B
will be $120 in the first year, $100 in the second year, and $80 in the third year, after
which the toy will become obsolete. It will face competition from producers in country
A, whose costs will remain $100 for all three years. How does this situation represent
issues that arise in promoting an infant industry, and when is the case for government
intervention most convincing? How should the decision-maker account for the fact that
a dollar earned in three years is worth less than a dollar spent today?
6. India argues that infant-industry protection of its automobile industry is necessary.
What factors support this claim? How would you assess the benefits and the costs
from targeting this industry versus the toy industry?
7. “Russian wages are so low that European producers will require additional protection
to maintain current wages and generous welfare state benefits.” Evaluate the
economic basis for this statement.
8. How can subsidizing exports and accepting a decline in a country’s terms of trade
make a country better off?
9. Suppose two firms, one U.S. and the other French, compete in the satellite launching
market as Cournot duopolists who take the output of their competitor as given in
determining their own capacity. Their profit-maximizing strategies can be represented
by the following reaction functions:
Q
us = .5(A – MCus) – .5 Qf (7.2)
Q
f = .5(A – MCf) – .5 Qus (7.3)
a. Assume that A = 42 represents the non-price determinants of market demand and
marginal costs are MCus = 9, and MCf = 6. Solve for the output of each firm in the
absence of government intervention. If market demand is given by Q = Qus + Qf =
A – P, what price will be set?
b. Consider the effect of a U.S. subsidy of 3 per launch. (Hint: represent this as a
lower U.S. marginal cost.) Solve for the effect on the distribution of launches and
the equilibrium price. Determine how U.S. government expenditures, U.S. profits,
and French profits are affected, and explain what principle underlies these results.
10. Two firms, home and foreign, compete in the export market as Bertrand duopolists,
where each sets its price assuming that the price of the competitor will remain
unchanged. Because the goods they produce are imperfect substitutes, they need not
sell at the same price. Based on the two inverse demand functions,
P
h = a – bXh – c Xf (7.4)
and
P
f = a – bXf – c Xh, (7.5)
the corresponding reaction functions are:
P
h = (ab – ac + b MCh)/2b + (c/2b) Pf (7.6)
P
f = (ab – ac + b MCf)/2b + (c/2b) Ph (7.7)
a. For marginal costs, MC, equal to 12 for both firms, and a = 60, b = 5, and c = 4, find
the equilibrium price each firm will set, and determine the output of each firm.
(Hint: the inverse demand functions can be solved to show:
Xh = [(ab–ac) – bPh + cPf]/(b2 – c2).) (7.8)
b. If the home government were to impose a per unit export tax of 3.36, the home
firm’s sales fall, but its profits plus the government’s tax revenue rise. For the
values shown above, calculate how large this effect is and explain why a tax is
desirable in this situation.
11. “Dumping will be observed most often in imperfectly competitive markets where
above-average profits can be earned.” Explain whether you agree or disagree with this
statement. How does the imposition of anti-dumping duties affect producers in the
importing country? Why may your answer depend upon their market share?
12. Why do you expect a country’s trade policy to be different in a country depending upon
how wealth is distributed in the country? For a labor-scarce country with a very
unequal distribution of income, what is most likely to be in the interest of the median
voter?
13. If large financial contributions by political action committees and other special-interest
groups account for most of a candidate’s campaign financing, what keeps a country’s
trade policy from being highly protectionistic? Why do we not observe a political action
committee representing consumers of cars? Where do you expect the highest trade
barriers to be imposed?
INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 7: Answers
1. Economists are concerned that a tariff on steel will raise the cost of producing
other goods, such as autos and home appliances, where output will fall. Thus, jobs
2. If the EU restricts imports from low-wage countries, domestic unskilled workers
will face less competition and therefore will benefit. There will be less demand
3. High tariffs imposed on labor-intensive goods such as apparel and footwear in
countries where labor is a relatively scarce factor will result in an increase in
labor’s wage and a fall in the returns to capital. If labor income were less than
4. a) From setting 100-P = -80 + 3P, we obtain 180 = 4P and P = 45. If we substitute
b) If the importer imposes a tariff of 20, then 100 – P = -80 + 3(P-20), where we
are treating P as the price faced by consumers. We now have 240 = 4P, P = 60
and M=40. The tariff of 20 has resulted in price to consumers rising by 15 and
5. A business that expects its costs initially to exceed a foreign competitor’s costs but
subsequently to fall below the competitor’s costs may have a comparative
advantage in producing this good. If this calculation is persuasive to banks or
other lenders who might finance the start up costs (which are incurred by selling
6. India may find the claims for infant industry protection more credible in the auto
industry than in the toy industry because there are larger economies of scale in
auto production. The large fixed costs of entering the industry may be difficult to
7. Low Russian wages are a result of low Russian productivity. While some
industries will exhibit lower costs in Russia due to the productivity disadvantage
being lower than its wage advantage, in other industries Russia will not be
8. In a competitive market, subsidizing exports leads to a terms of trade loss and a
decline in welfare. In a non-competitive market, a subsidy may allow a nation’s
9. a. The initial solution where the two reaction curves intersect is Qf = 13 and Qus =
b. If the US offers a subsidy of 3 per launch, the US firm’s reaction function
10. a) For identical marginal costs, the two duopolists will each set price equal to 20
b) When the home country tax is imposed, the home firm raises its price to 22,
and the foreign firm increases its price to 20.80. Their respective outputs are
11. To the extent that firms can price discriminate and set a lower price in the foreign
market where demand is more elastic, those with market power to set prices
(rather than act as price taking perfect competitors) will find this an attractive
strategy. The reciprocal dumping model particularly applies to a setting with
12. A country’s trade policy will depend upon its income distribution if it is a
democracy where the median voter determines the policy adopted. In a capital
abundant country with a highly unequal distribution of income, the median voter will
13. The protection for sale model suggests that policy makers do pay attention to
campaign contributions, but they also pay attention to consumer welfare,
especially for politicians such as a President who generally will be held
responsible for the overall well being of the citizens. Thus, lobbyists cannot buy
