# Explain in a few words whether the net welfare effect for the country as a whole is positive or negative.

## Consider two countries (Home and Foreign) that can potentially

Consider two countries (Home and Foreign) that can potentially

Question
1.Consider two countries (Home and Foreign) that can

potentially produce 3 different goods

(A, B, C) using only labor with the following labor requirements (hours

required to produce one unit of the good):

A B C

Home 15

10 34

Foreign 5 2

17

Assume free

trade is possible with no transportation or other costs
. If the wage rate in

the Home country is 25% of the wage in the Foreign country… :

which goods

will be produced in the Home country?

Which goods

will be produced in the Foreign country?

Show how you

get the result
.

2.Consider the following information regarding consumers

valuation and cost of

production of

a good
. The first table shows you how much consumers value different units of

the good (the maximum price they would pay for the first unit, for a

second unit, etc
.):

Value 12 11 10 9 8 7

6 5 4 3 2 1

Unit 1 2

3 4 5 6 7

8 9 10 11 12

So the first

unit has a value of 12 (some consumer is willing to pay up to 12 for that

unit), the

second unit has a value of 11, etc
.
. Consumers

will buy all the units that give them a value greater than or equal to the

price they pay: for example, at a price P=10, 3 units will be consumed
.
Consumers surplusis the value they get

minus the price they

pay: for

example, at a price of 10, consumers get a surplus of 2 from the first unit, 1

from the

second unit, 0 from the third unit consumed (we assume that in case of

indifference,

when the surplus of a unit is 0, they still buy it)
.

The second

table shows the marginal cost for domestic firms of producing each

unit (the minimum price at which they would supply the first unit, the

second,

etc
.):

Cost 1 2

3 4 5 6 7

8 9 10 11 12

Unit 1 2

3 4 5 6 7

8 9 10 11 12

So the first

unit has a cost of production of 1 (some producer is willing to supply it at a

price of at

least 1), the second unit has a cost of production of 2, etc
.
. Assuming perfect

competition,

domestic producers will supply all the units they can produce at a cost

lower than or

equal to the price they can get: for example, at a price P=10, 10 units will

be supplied
.
Producers
surplus
is the price they get minus the cost of production: for

example, at a

price of 10, producers get a surplus of 9 from the first unit, 8 from the

second unit,

etc
. (0 from the 10th unit, but we assume that in case of indifference, when

the surplus

of a unit is 0, they still supply it)
.

Suppose the

country is a small open economy (so it does not affect the world price) and

under free

trade any quantity of the good can be imported at a price P0= 3
.

a)

With free

trade at the world price P0= 3,

how many

units will be consumed in the country?

How much will

be domestically produced?

How much will

be imported?

b)

Suppose now

the government imposes a tariff
t= 2 on each imported unit
.

What will be

the price of the good in the country?

How many

units will be consumed?

How much will

be domestically produced? How much will be imported?

c)

The tariff

will generate gains and losses
.

Where do the

gains and losses come from?

Who gains and

who loses?

Explain in a

few words whether the net welfare effect for the country as a whole is positive

or negative
.

d)

Try to

estimate the net aggregate welfare effect in the following way
.

Consider

first the units that were already bought from domestic producers before:

how does the

tariff affects consumers and producers surplus?

what is the

net welfare effect for those units?

Consider next

the units that are still imported:

how does the

tariff affects consumers and government surplus?

what is the

net welfare effect for those units?

Consider

finally the other units that before were imported but now are either bought

from domestic producers or not consumed anymore:

how does the

tariff affects consumers and producers surplus?

what is the

net welfare effect for those units?

So putting

together these three steps, how much is

the net aggregate welfare gain or loss from the tariff?

3
.Consider a

country under a flexible exchange rate system
. The economy is currently

producing at

its
naturallevel of output, corresponding to a situation of equilibrium

in

the labor

market (where the real wage that firms are willing to pay, given their costs

and market power, is equal to the real wage that workers require, given their

alternatives and their bargaining power, to supply the current amount of

labor)
. The authorities are worried, though, about the unemployment rate, which

is relatively high, and are considering possible measures to stimulate the

economy and increase employment
.

Suppose the

central bank adopts a more expansionary monetary policy and consider the

short-run effects of that policy:

a)

What would

happen to interest rates?

How would

that affect the exchange rate?

b) How would

the changes in interest rates and the exchange rate affect the aggregate

demand and

its components (consumption, investment, government purchases, net

exports)?

– How would that affect
employment?

b)

Would the effects discussed above be persistent beyond
the short-run?

In other words,what else would happen in the medium-run
as a consequence of those changes and

How would that affect the state of the economy (in
particular employment)?

d) Consider the same situation of the previous example,
but this time thinking of a

country maintaining a fixed exchange rate with another
major currency (and the country being small enough so that it does not affect
the economy of the other countries).

the effects of monetary

policy differ?

Would an expansionary fiscal policy help in getting the
desired effects on

employment?

e) If we think more in a medium-long run horizon, what
kind of policies could help in

making employment persistently higher?

– Try to suggest at least two or three different types of
measures that would have a permanent positive effect on employment.

– Comment very briefly on how they would affect per
capita real income and what

difference (if any) would it make to have a fixed rather
than a flexible exchange rate.

Consider two countries (Home and Foreign) that can potentially

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