Additional HL Paper 3 Exercises Altogether With Solutions Final March 19th Copy3

1
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nL aper 3 uant|tat|ve Lxerc|ses
and Worked So|ut|ons

taken from

Workbook for the New I.8. Lconom|cs
(2
nd
ed|t|on)

by 8ryce Mc8r|de

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Authors Introduction

Slnce Lhe fall l have been worklng on a new and lmproved edlLlon of !"#$%""$ '"# ()* +*, -./.
01"2"3415 feaLurlng lmproved lessons and addlLlonal exerclses presenLed wlLh Lhe ald of aLLracLlve
graphlc deslgn.

l expecL Lo compleLe Lhe enLlre revlslon laLer Lhls sprlng (mosL llkely ln Aprll, 2013) buL have declded Lo
release Lhese exerclses and worked soluLlons earller (wlLhouL Lhe beneflL of graphlc deslgn) ln order Lo
asslsL Leachers and sLudenLs faclng Lhe flrsL examlnaLlons under Lhe new syllabus comlng up ln May.

1he quesLlons are arranged ln Lhe order LhaL Lhe expecLaLlons Lhey refer Lo appear ln Lhe syllabus.
SecLlon one feaLures quesLlons arlslng from syllabus secLlons 1.1 and 1.3 (MarkeLs and CovernmenL
lnLervenLlon), secLlon Lwo feaLures quesLlons arlslng from syllabus secLlon 1.3 (1heory of Lhe llrm),
secLlon 3 feaLures quesLlons arlslng from syllabus secLlon 2 (Macroeconomlcs) whlle secLlon 4 feaLures
quesLlons arlslng from syllabus secLlon 3 (lnLernaLlonal Lconomlcs).

l would llke Lo Lhank kaLhryn eyLon for her help ln revlewlng some of Lhe quesLlons and answers and
would encourage anyone flndlng anyLhlng quesLlonable Lo emall me wlLh Lhelr concerns.

1hank you for your conslderaLlon and besL wlshes ln Lhe upcomlng exams.

8ryce Mc8rlde
bryce[brycemcbrlde.com

1ab|e of Contents

AddlLlonal PL aper 3 Lxerclses SecLlon 1 age 3




SecLlon 1 SoluLlons age 30



Add|t|ona| nL aper 3 Lxerc|ses Sect|on 1

3


1. Clven Lhe demand funcLlon Cd = 100 2 and Lhe supply funcLlon Cs = -30 + 4:

a) loL Lhe funcLlons on Lhe grld below and label Lhem. ?ou may flrsL llke Lo calculaLe Lhe
ordered palrs uslng a Lable of values as lndlcaLed below.

rlce Cd = 100 2 Cs = -30 + 4

b) uslng algebra, flnd Lhe equlllbrlum prlce and quanLlLy lmplled by Lhe lnLersecLlon of Lhe Lwo
functions. Check that it agrees with what is suggested by your graph from part a.

4


c) uslng geomeLry (and rememberlng LhaL Lhe area of a Lrlangle ls calculaLed accordlng Lo Lhe
formula A = x b * h) calculaLe Lhe consumer and producer surplus en[oyed aL Lhls equlllbrlum
polnL.

d) uslng algebra, calculaLe Lhe quanLlLy demanded and Lhe quanLlLy supplled aL a prlce of $20.
Would Lhere be excess demand or excess supply aL Lhls prlce and of how many unlLs?

e) !usL by looklng aL Lhe funcLlons expressed algebralcally, how can you Lell how many unlLs
people would wanL Lo buy aL a prlce of zero? Pow can you Lell aL whlch prlce sellers wlll begln Lo
brlng Lhe good Lo markeL?

f) lf buyers suddenly began buylng many more addlLlonal unlLs every Llme Lhe prlce dropped by
$1, how would you expecL Lhe demand funcLlon Lo change? Conversely, lf sellers suddenly
began supplylng many more addlLlonal unlLs every Llme Lhe prlce rose by $1, how would you
expecL Lhe supply funcLlon Lo change? Lxplaln your answers.

3


2. Clven Lhe same llnear demand and supply funcLlons as were used ln quesLlon 1:

a) Apply a $3 per unlL speclflc lndlrecL Lax Lo Lhe good and ploL Lhe resulLanL supply and demand
curves on Lhe grld below:

b) Looklng aL Lhe dlagram, whaL has been Lhe lmpacL of Lhe Lax on Lhe equlllbrlum markeL prlce
and quanLlLy sold as compared Lo Lhe slLuaLlon wlLhouL Lhe Lax looked aL ln quesLlon 1? LsLlmaLe
Lhe new equlllbrlum prlce and quanLlLy Lo Lhe nearesL whole unlL.

c) CalculaLe Lhe consumer and producer surplus assoclaLed wlLh Lhls new posL-Lax equlllbrlum
polnL as well as Lhe revenue galned by Lhe governmenL Lhrough Lhe lmposlLlon of Lhe Lax.
Comparlng Lhe sum of Lhese Lhree amounLs Lo Lhe sum of Lhe consumer and producer surplus
associated with the equilibrium point in question 1 c above, which is greater? What then has
been Lhe lmpacL of Lhe Lax on overall welfare?

6


d) CalculaLe and compare consumer expendlLure and producer revenue before Lhe Lax was
applled Lo consumer expendlLure and producer revenue afLer Lhe Lax was applled. WhaL was Lhe
lmpacL of Lhe Lax on each?

e) Comparlng Lhe lnlLlal equlllbrlum prlce from C1 wlLh Lhe posL-Lax equlllbrlum prlce from parL
b above, how much of the $5 Lax has been borne by consumers? WhaL porLlon Lherefore has
been borne by producers? Lxplaln why Lhe lncldence of Lhe Lax ls dlfferenL for consumers and
producers (or, ln oLher words, why Lhe burden of Lhe Lax has been borne unevenly).

3. Clven Lhe same llnear demand and supply funcLlons as were used ln quesLlon 1:

a) Apply a $3 per unlL speclflc lndlrecL subsldy Lo Lhe good and ploL Lhe resulLanL supply and
demand curves on Lhe grld below:

7


b) Looklng aL Lhe dlagram, whaL has been Lhe lmpacL of Lhe subsldy on Lhe equlllbrlum markeL
prlce and quanLlLy sold as compared Lo Lhe lnlLlal slLuaLlon looked aL ln quesLlon 1?

c) CalculaLe Lhe consumer and producer surplus assoclaLed wlLh Lhls new posL-subsldy
equlllbrlum polnL as well as Lhe money spenL by Lhe governmenL Lo pay for Lhe subsldy.
Compare Lhe sum of Lhe consumer and producer surplus Lo Lhe LoLal welfare assoclaLed wlLh Lhe
equlllbrlum polnL ln question 1 c. What has been Lhe lmpacL of Lhe subsldy on overall welfare?

d) AfLer maklng Lhe necessary calculaLlons, compare consumer expendlLures and producer
revenues before Lhe subsldy was applled Lo consumer expendlLures and producer revenues
afLer Lhe subsldy was applled. WhaL ls Lhe lmpacL of Lhe subsldy on each?

e) Comparlng Lhe lnlLlal equlllbrlum prlce from C1 wlLh Lhe posL-subsldy equlllbrlum prlce from
part b above, how much of Lhe $3 subsldy has been Lransferred Lo consumers? WhaL porLlon
Lherefore has been Lransferred Lo producers? Lxplaln why Lhe lncldence of Lhe subsldy ls
dlfferenL for consumers and producers (or, ln oLher words, why Lhe beneflLs of Lhe subsldy have
been dlsLrlbuLed unevenly).

8


4. Clven Lhe demand funcLlon Cd = 200 30 and Lhe supply funcLlon Cs = -30 + 20:

a) loL Lhe funcLlons on Lhe grld below and label Lhem. ?ou may llke Lo flrsL calculaLe Lhe
ordered palrs uslng a Lable of values as lndlcaLed below.

rlce Cd = 200 30 Cs = -30 + 20

b) uslng algebra, flnd Lhe equlllbrlum prlce and quanLlLy lmplled by Lhe lnLersecLlon of Lhe Lwo
funcLlons. Check LhaL lL agrees with what is suggested by your graph from part a.

9


c) uslng geomeLry (and rememberlng LhaL Lhe area of a Lrlangle ls calculaLed accordlng Lo Lhe
formula A = x b * h) calculaLe Lhe consumer and producer surplus en[oyed aL Lhls equlllbrlum
polnL.

d) lf Lhe governmenL were Lo lmpose a floor prlce of $6, would Lhere be a shorLage or surplus ln
response and of how many unlLs?

e) Compare producer revenue and consumer expendlLure ln Lhls slLuaLlon (Lhe $6 prlce floor)
wlLh producer revenue and consumer expendlLure ln Lhe lnlLlal slLuaLlon wlLhouL Lhe prlce floor.
Conslder only Lhe unlLs LhaL are acLually sold by producers Lo consumers.

f) lf Lhe governmenL were Lo commlL Lo buylng Lhe surplus producLlon aL Lhe prlce Lhey have
mandaLed, how much would Lhey have Lo spend?

g) lf lnsLead Lhe governmenL were Lo lmpose a prlce celllng of $4, would Lhere be a shorLage or a
surplus ln response and of how many unlLs?

10


h) Compare Lhe producer revenue and consumer expendlLure ln Lhls slLuaLlon (Lhe $4 prlce
celllng) wlLh Lhe producer revenue and consumer expendlLure ln Lhe lnlLlal slLuaLlon wlLhouL Lhe
prlce celllng. Conslder only Lhe unlLs LhaL are acLually sold by producers Lo consumers.

l) CalculaLe Lhe consumer and producer surplus en[oyed under Lhe $4 prlce celllng and compare
it to the consumer and producer surplus enjoyed in the initial situation set out in part c. Has
Lhe prlce celllng Lransferred some surplus from producers Lo consumers and lf so, how much?
Pas some welfare slmply been losL? lf so, explaln your answer and calculaLe Lhe exLenL of Lhe
welfare loss. ?ou may wlsh Lo use Lhe grld below Lo draw Lhe demand and supply funcLlons and
Lhe prlce celllng Lo help you answer Lhe quesLlon.

11



1. A monopollsL can supply a producL for $3 per unlL (whlch ls boLh hls marglnal and average cosL)
whlle Lhe demand curve for Lhe producL ls Cd = 10 .

a) CompleLe Lhe Lable below:

rlce $10 $9 $8 $7 $6 $3 $4 $3 $2

Cd = 10

1oLal 8evenue

Marglnal 8evenue

Average 8evenue

b) On the grid below, graph the monopolists marginal and average cost curves along with their
marglnal and average revenue curves

c) Were Lhe flrm noL a monopollsL, Lhe equlllbrlum polnL would be where Lhe marglnal cosL
curve meL Lhe demand curve. ldenLlfy Lhls polnL and label Lhe resulLlng prlce and quanLlLy c
and Cc.

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d) CalculaLe, uslng geomeLry, Lhe producer and consumer surplus aL Lhls equlllbrlum polnL.

e) now flnd Lhe prlce and ouLpuL LhaL a proflL-maxlmlzlng monopollsL would choose and mark
Lhem m and Cm (remember Lhe proflL maxlmlzlng rule produce unLll M8 = MC).

f) CalculaLe, uslng geomeLry, Lhe producer and consumer surplus at the monopolists preferred
equlllbrlum polnL.

g) lrom uslng Lhe calculaLlons and from looklng aL Lhe dlagram, how much surplus was
Lransferred from consumers Lo Lhe monopollsL and how much was slmply losL?

h) ln order Lo llmlL Lhe welfare loss due Lo monopoly, Lhe governmenL decldes Lo regulaLe Lhe
monopollsL and mandaLes a flxed prlce of $4/unlL for Lhe producL. CalculaLe Lhe producer and
consumer surplus aL Lhls new prlce and calculaLe Lhe exLenL of Lhe welfare loss Lo deLermlne
whether or not the fixed price would achieve the governments aim.

13


2. A farmer has a flxed amounL of land and workers. Powever, he can vary Lhe number of LracLors
he uses. Pe flnds LhaL hls LoLal producLlon of corn varles wlLh Lhe number of LracLors he uses as
descrlbed by Lhe Lable below:

number of 1racLors 0 1 2 3 4 3 6

CuLpuL of Corn (Lonnes) 10 30 70 100 120 130 130

Marglnal roducL

Average roducL

a) CalculaLe Lhe marglnal producL of each addlLlonal LracLor and record lL ln Lhe Lable above. AL
whaL polnL does Lhe farmer begln sufferlng dlmlnlshlng reLurns from uslng addlLlonal LracLors?

b) CalculaLe Lhe average producL aLLrlbuLable Lo each LracLor for each quanLlLy of LracLors and
record lL ln Lhe Lable above.

c) lf corn prlces are $100/Lonne and lf LracLors cosL $2000 per season Lo own and operaLe, how
many LracLors should Lhe farmer use Lo maxlmlze hls reLurns? Lxplaln your answer.

3. An entrepreneurs business exhibits the following total costs and total revenues:

CuLpuL 1oLal CosLs Marglnal CosLs Average CosLs 1oLal 8evenue Marglnal 8evenue Average 8evenue
0 10 0
1 13 12
2 19 22
3 22 30
4 24 36
3 23 40
6 27 42
7 30 42
8 34 40
9 39 36
10 43 30

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a) From looking at the table, what are the entrepreneurs fixed costs? Explain your answer
b) Thus, what would be the entrepreneurs total variable costs where output is 6? Explain your
answer.

c) Calculate and record in the table the entrepreneurs marglnal and average cosL and marglnal
and average revenue aL each level of ouLpuL.

d) Calculate the entrepreneurs profits at each level of output. At which level of output are
proflLs hlghesL?

e) lrom Lhe evldence provlded by Lhe Lable, ls Lhe enLrepreneur operaLlng ln a compeLlLlve
envlronmenL or ls he operaLlng as a monopollsL? Lxplaln your answer.

f) What would be the entrepreneurs revenue-maxlmlzlng ouLpuL?

g) AL whaL ouLpuL levels does Lhe enLrepreneur roughly break even?

h) Cn Lhe grld that follows, record the entrepreneurs marginal and average costs and revenues.
Mark ln Lhe proflL-maxlmlzlng, revenue-maxlmlzlng and break-even polnLs on Lhe graph.

13


4. A flrm ls operaLlng ln a compeLlLlve markeL and exhlblLs Lhe followlng LoLal cosLs:

CuanLlLy llxed CosL varlable CosL 1oLal CosL Marglnal CosL Avg. var. CosL Avg. 1oLal CosL
0 10
1 16
2 21

3 23
4 28
3 30
6 33

7 37
8 42
9 48

a) CompleLe Lhe Lable above afLer calculaLlng Lhe relevanL cosLs.

b) AL whlch level of ouLpuL are average LoLal cosLs aL a mlnlmum? WhaL ls happenlng lf Lhe
markeL price of the firms output is exacLly Lhls amounL? WhaL ls happenlng lf Lhe markeL prlce
of the firms output is greater than Lhls amounL?

c) AL whlch level of ouLpuL are average varlable cosLs aL a mlnlmum? WhaL ls llkely Lo happen lf
the selling price of the firms output is below this minimum amount? What is likely to happen if
the selling price of the firms output ls above Lhe mlnlmum of average varlable cosL buL below
Lhe mlnlmum of average LoLal cosL?

16



1. 1he followlng are Lhe accounLs of naLlonal expendlLure for 2012:

ConsumpLlon spendlng by households: $100 bllllon
1oLal lnvesLmenL spendlng by flrms: $13 bllllon
Depreciation of firms existing capital stock: $3 bllllon
(le spendlng needed Lo replace worn ouL machlnery and equlpmenL)
CovernmenL spendlng on goods and servlces $20 bllllon
Spendlng on lmporLs $30 bllllon
8ecelpLs from LxporLs $31 bllllon

a) CalculaLe nomlnal Cu from Lhe expendlLure slde for 2012.

b) If the nations population was 40 million, what is the nations nominal GDP per capita?

c) lf the nations GDP deflator was set at 100 in 2011 and was estimated to be 105 in 2012,
what was the nations real GDP in 2012, measured in constant 2011 dollars?

d) If the nations GDP in 2011, measured in 2011 dollars, was 126 billion, what was the raLe of
real economlc growLh beLween 2011 and 2012? WhaL was Lhe nomlnal raLe of economlc growLh
beLween Lhe Lwo years?

e) If the nations workers and firms operating abroad produced (and earned) $10 billion while
Lhe workers and flrms of oLher counLrles operaLlng wlLhln Lhe naLlon produced (and earned) $3
billion in 2012, what would be the nations nominal GNP/GNI for that year?

17


2. As Lhere are ofLen unmeL baslc needs ln poorer counLrles, Lhelr marglnal propenslLy Lo consume
ls ofLen much hlgher Lhan ln rlcher counLrles. lf we assume LhaL Lhe MC ln Lhe naLlon of
overLla ls 0.96 whlle Lhe MC ln Lhe naLlon of Largesse ls 0.7:

a) CalculaLe Lhe keyneslan mulLlpller for boLh naLlons.

b) Using the multipliers from part a, calculate the effecL on Cu of an addlLlonal $1000 of
governmenL spendlng ln each counLry. Pow much would Cu lncrease as a resulL of Lhe lncrease
ln governmenL spendlng?

3. ln AusLralla Lhere were 11 300 000 people worklng and 630 000 people acLlvely looklng for work
in 2012. What was Australias unemployment rate that year?

4. SLaLlsLlclans from Lhe small lsland naLlon of aradlso calculaLe LhaL Lhe average household ln Lhe
counLry spends one quarLer of lLs lncome on houslng, anoLher quarLer on food, and an elghLh on
each of cloLhlng, uLlllLles, LransporLaLlon and enLerLalnmenL.

1he sLaLlsLlclans Lhen declded Lo selecL represenLaLlve goods from each caLegory and Lhen
Lracked Lhe prlces year by year, as shown ln Lhe Lable below:

Cood rlce ln 2010 rlce ln 2011 rlce ln 2012

3 88 Pouse 8enL, per monLh $300 $313 $320
2 88 AparLmenL 8enL, per monLh $330 $373 $383
8read, one loaf $2 $2 $2
8ananas, kg $1 $0.8 $1
Mllk, llLre $1 $1.23 $1.23
LeaLher shoes, one palr $30 $23 $23
Womans coLLon dress $30 $33 $33
LlecLrlclLy, per kWh $0.10 $0.12 $0.13
8us LlckeL $1 $1 $1.10
Casollne, per llLre $1.3 $1.33 $1.40
Clnema LlckeL $7 $7.30 $7.30
uance hall admlsslon $7 $7 $7

a) ConsLrucL a welghLed prlce lndex for aradlso uslng Lhe daLa above. Clve Lhe lndex Lhe value
100 for the prices given for 2010. It is suggested that you follow certain steps when
consLrucLlng your lndex, such as:
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l) ueLermlnlng whlch lLems go under whlch caLegory

ll) ueLermlnlng how Lo welghL Lhe dlfferenL lLems ln each caLegory. As a defaulL lL ls accepLable
Lo welghL each lLem Lhe same wlLhln each caLegory. lor lnsLance, lL would be flne Lo glve
bread, bananas and milk equal weight in the food category (suggesting that I eat a loaf of
bread abouL as ofLen as l eaL a kg of bananas or drlnk a llLre of mllk). Powever, make sure LhaL
food overall is one quarter of your overall index.

lll) llgurlng ouL Lhe ad[usLmenL numbers Lo make your prlces flL Lhe caLegory welghLs. lor
lnsLance, for Lhe food lLems, lf l declde Lo glve each lLem equal welghL, l would wanL each of Lhe
Lhree lLems Lo counL for 8.3 of Lhe lndex (as 8.33 * 3 = 23), as 23 ls Lhe welghL of Lhe food
caLegory ln Lhe overall lndex.

1o geL Lhe $2 prlce of bread Lo 8.3, you would need Lo mulLlply lL by 4.13. 1o geL Lhe $1 prlce of
bananas or mllk Lo 8.3, you would [usL need Lo mulLlply lL by 8.3, as below:

(rlce of 8read*ad[usLmenL #) + (rlce of 8ananas*ad[usLmenL #) + (rlce of Mllk*ad[usLmenL #)

= ($2 * 4.13) + ($1 * 8.3) + ($1 * 8.3) = 23

leel free Lo use Lhe gulde below Lo calculaLe your lndex. AL Lhe end of lL, you should have
someLhlng LhaL looks llke Lhls:

(3 88 Pouse 8enL) * ______ + (2 88 AparLmenL 8enL) * _______ + [should = 23}

(8read rlce) * ______ + (8anana rlce) * ______ + (Mllk rlce) * ______ + [should =23}

(rlce of Shoes) * ______ + (rlce of CoLLon uress) * ______ + [should = 12.3}

(LlecLrlclLy rlce) * ______ + [should = 12.3}

(8us 1lckeL rlce) * ______ + (rlce of a llLre of gasollne) * ______ + [should = 12.3}

(Clnema 1lckeL rlce ) * ______ + (uance Pall 1lckeL rlce) * ______ = 100 [should = 12.3}

The blanks (ie ___) are the weights given to each item in your index. Keeping these weights the
same you wlll Lhen be able Lo calculaLe new lndex numbers easlly for 2011 and 2012 by slmply
plugglng ln Lhe changed prlces for each lLem.

19


b) keeplng Lhe welghLs Lhe same, whaL ls Lhe value of Lhe prlce lndex for 2011 and 2012?

c) WhaL Lhen was Lhe raLe of lnflaLlon beLween 2011 and 2012?

3. Cllllan has Lwo [ob offers Lo work ln nelghborlng sLaLes. 1he sLaLed salary for boLh poslLlons ls
$83 000. Powever, Lhe lncome Lax reglmes are very dlfferenL ln each sLaLe, as descrlbed ln Lhe
Lable below:

SLaLe A SLaLe 8
lncome Level 1ax 8aLe lncome Level 1ax 8aLe
8elow $13 000 0 8elow 10 000 0
13 001-23 000 10 10 001-30 000 20
23 001-33 000 20 30 001-30 000 40
33 001-43 000 30 30 001-70 000 30
43 001-33 000 40 Above 70 000 60
33 001-63 000 30
Above 63000 60

a) What would be Gillians marginal rate of income tax in each state?

b) Pow many dollars of Lax would Cllllan pay ln each sLaLe?

c) What then is Gillians average rate of tax in each state?

d) Gillians brother Jake faces a similar cholce Lo Cllllan, excepL LhaL he has been offered a salary
of $30 000. WhaL would be hls marglnal raLe of Lax ln each sLaLe? WhaL would be hls Lax burden
and average raLe of Lax ln each sLaLe?

20



1. AusLralla and lndonesla each produce 2 goods frulL and mlnerals. AL Lhe momenL, lndonesla
can produce one unlL of mlnerals aL an opporLunlLy cosL of Lwo unlLs of frulL whlle AusLralla can
produce one unlL of mlnerals aL an opporLunlLy cosL of [usL one unlL of frulL. lf lndonesla were Lo
devoLe a cerLaln quanLlLy of producLlve resources Lo Lhe producLlon of frulL lL would be able Lo
produce 1200 unlLs per year, whlle lf AusLralla were Lo devoLe Lhe same quanLlLy of producLlve
resources Lo Lhe producLlon of frulL, Lhey would only be able Lo produce 300 unlLs per year.

a) Cn Lhe grld below, draw Lhe Cs for lndonesla and AusLralla for frulL and mlnerals.

Mlnerals

lrulL

b) Whlch counLry en[oys an absoluLe advanLage ln Lhe producLlon of frulL and of mlnerals?
Lxplaln your answer wlLh reference Lo resource cosLs.

c) lor whlch good does lndonesla en[oy a comparaLlve advanLage and for whlch good does
AusLralla en[oy a comparaLlve advanLage? Lxplaln your answer wlLh reference Lo opporLunlLy
cosLs.

21


c) lf lndonesla and AusLralla dld noL Lrade, buL lnsLead slmply devoLed half of Lhelr producLlve
resources Lo Lhe producLlon of frulL and Lhe oLher half Lo Lhe producLlon of mlnerals, how much
of each good could each produce?
Mlnerals lrulL
lndonesla

AusLralla

1oLal

d) now, lf AusLralla were Lo devoLe all of lLs resources Lo produclng mlnerals, and lf lndonesla
were Lo devoLe enough of lLs resources Lo produclng mlnerals Lo keep Lhe LoLal mlneral
production the same for the two countries as in part c, how much fruit could Indonesia
produce? Is this amount greater than the total fruit produced in part c? What does this answer
suggesL abouL Lhe galns Lo be had from Lrade based on comparaLlve advanLage?

2. 1he followlng dlagram shows Lhe lrench markeL for bereLs:

rlce (dollars)

20
18
uomesLlc Supply
16 (Cs = -3000 + 2300 )

14
12

10
8

6

4
2
uemand (Cd = 30 000 1000 )
0
0 3 10 13 20 23 30 33 40 43 30 Quantity (000s)

22


a) WhaL ls Lhe equlllbrlum prlce and quanLlLy ln Lhe absence of Lrade?

b) lf lrance were Lo Lhrow open Lhe doors Lo free Lrade ln bereLs, manufacLurers ln vleLnam and
oLher counLrles know Lhey can supply an unllmlLed quanLlLy of bereLs aL a prlce of $6. WhaL
would be Lhe new equlllbrlum prlce and quanLlLy sold of bereLs ln lrance when forelgn-made
bereLs are made avallable for sale? Change Lhe dlagram above Lo reflecL Lhe enLry of forelgn
manufacLurers.

c) Pow have Lhe revenues of lrench bereL makers been affecLed by Lhe enLry of Lhe lmporLed
bereLs? uslng Lhe dlagram, compare Lhelr revenues before and afLer Lhe evenL. Pow much
revenue are Lhe forelgn manufacLurers earnlng from lrench bereL buyers?

d) Pow has consumer surplus been affecLed by Lhe enLry of Lhe lmporLs? CalculaLe Lhe
consumer surplus en[oyed ln Lhe lnlLlal slLuaLlon wlLh Lhe surplus en[oyed when $6 bereLs are
made avallable.

e) ln order Lo sLem Lhe Llde of forelgn bereLs, Lhe lrench governmenL lmposes a $2 Larlff on
lmporLed bereLs.
l) Show Lhe lmpacL of Lhe Larlff on Lhe dlagram above

ll) WhaL ls Lhe new equlllbrlum prlce and quanLlLy?

lll) Pow much revenue ls Lhe lrench governmenL collecLlng from Lhe Larlff?

lv) Pow much addlLlonal revenue ls belng earned by lrench bereL makers?

v) Pow much less revenue ls belng earned by forelgn bereL makers ln Lhe lrench
markeL?
23


vl) WhaL has been Lhe lmpacL of Lhe Larlff on consumer surplus as compared Lo Lhe free-
trade case described in part d above?

f) laced wlLh complalnLs from Lhe publlc LhaL Lhe Larlff ls a governmenL Lax on bereLs, Lhe
governmenL ellmlnaLes Lhe Larlff ln favour of an lmporL quoLa of 7000 bereLs.

l) Show Lhe lmpacL of such a quoLa on Lhe dlagram below:

rlce (dollars)

Supply
18

16
14

12

10
8

6
8

2
uemand
0
0 3 10 13 20 23 30 33 40 43 Quantity (000s)

ll) WhaL would be Lhe new equlllbrlum prlce and quanLlLy afLer Lhe lmposlLlon of Lhe
lmporL quoLa?

lll) WlLh Lhe quoLa ln place, how many bereLs would lrench bereL-makers be able Lo
sell? WhaL has been Lhe lmpacL of Lhe quoLa on Lhelr sales revenue as compared Lo Lhe
free-trade case described in part c above?
lv) WhaL has been Lhe lmpacL of Lhe quoLa on Lhe lrench revenues of forelgn bereL
makers? Why have Lhelr revenues noL been reduced as much as was Lhe case when Lhe
tariff was imposed in part e above?
24


v) What has been the quotas impact on consumer surplus as compared to the free
trade case described in part d above?

g) 8aLher lmprobably, consumer complalnLs abouL rlslng bereL prlces cause Lhe governmenL Lo
ellmlnaLe Lhe quoLa and lnsLead glve a $2 per bereL subsldy Lo lrench bereL makers. As ln parL
b, foreign manufacturers are once again welcome to sell as many berets in lrance as Lhey wlsh.

l) Show Lhe lmpacL of such a subsldy on Lhe dlagram below:
rlce ($)

Supply
18

16
14

12

10
8

6

4
2
uemand
0
0 5 10 15 20 25 30 35 40 45 50 Quantity (000s)

ll) WhaL ls Lhe new equlllbrlum prlce and quanLlLy afLer Lhe subsldy ls granLed Lo lrench
bereL makers?

23


lll) WlLh Lhe subsldy ln place, how many bereLs are lrench manufacLurers able Lo sell?
WhaL ls Lhelr LoLal revenue ln Lhls slLuaLlon? 8e sure Lo lnclude boLh Lhe revenue
earned from consumers and Lhe revenue earned from Lhe governmenL ln Lhe form of
Lhe subsldy.

lv) Why would consumers be happler wlLh Lhe subsldy Lhan elLher Lhe quoLa or Lhe
Larlff? Why would forelgn producers prefer Lo face quoLas Lhan Larlffs or subsldles? use
revenue and surplus calculaLlons Lo [usLlfy your answers.

3. AfLer Lravelllng Lo lrance from Morocco, Ma[ld recelved hls credlL card blll and noLlced LhaL Lhe
resLauranL meal LhaL had cosL hlm 30 Luros was llsLed on hls sLaLemenL as cosLlng 340 ulrham.
WhaL does Lhls suggesL ls Lhe currency exchange raLe of Luros ln Lerms of ulrhams?

4. It has always been Julias dream to buy a Ural motorcycle from Russia. Searching online one day,
she noLlced a recenL model for sale for 330 000 8usslan rubles. lf Lhe exchange raLe of uS dollars
ln Lerms of rubles ls 32, how much would her dream moLorcycle cosL ln Lerms of uSu?

3. Whlle on hollday ln 1halland, Lee Pong from Slngapore noLlced LhaL whlle he had goLLen 2300
1hal 8ahL lasL week per $100 SCu noLe, on hls mosL recenL Lrlp Lo Lhe money changer he had
recelved 2630 8ahL per $100 SCu noLe.
a) CalculaLe Lhe lnlLlal exchange raLe for 1hal 8ahL ln Lerms of Slngapore dollars.

b) Had the Thai Baht appreciated or depreciated during Lee Hongs holiday? By what percentage
had lL changed ln value?

26


6. lf Lhe demand and supply funcLlons for Lhe hlllpplne eso are deflned as Cd = 10000 3000
and Cs = -3000 + 2000, and where ls Lhe prlce of Lhe hlllpplnes eso ln Lerms of uS cenLs:

a) WhaL ls Lhe equlllbrlum exchange raLe of Lhe hlllpplne eso ln Lerms of uS cenLs? ueLermlne
your answer Lhrough solvlng Lhe sysLem of equaLlons. lf you would llke Lo check your answer by
consLrucLlng a supply and demand dlagram, feel free Lo do so.

b) Clven Lhls exchange raLe, whaL would be Lhe exchange raLe of uS dollars ln Lerms of
hlllpplne esos?

7. An oll-produclng naLlon ln WesL Afrlca has [usL publlshed lLs balance of paymenLs accounLs for
2012:

lmporLs of Coods $30 bllllon
LxporLs of Coods $80 bllllon
lmporLs of Servlces $13 bllllon
LxporLs of Servlces $2 bllllon
lncome from lorelgn Sources $1 bllllon
aymenLs Lo lorelgn 8eneflclarles $8 bllllon
CurrenL 1ransfers from lorelgn Sources $1 bllllon
CurrenL 1ransfers Lo lorelgn 8eneflclarles $3 bllllon

uebL lorglveness and oLher CaplLal 1ransfers 0.3 bllllon
ulrecL lnvesLmenL from lorelgn Sources $3 bllllon
ulrecL lnvesLmenL Abroad from uomesLlc Sources nll
orLfollo lnvesLmenL from lorelgn Sources nll
orLfollo lnvesLmenL Abroad from uomesLlc Sources $6 bllllon
Change ln 8eserve AsseLs $3.3 bllllon

a) CalculaLe:
l) 1he balance of Lrade ln goods

ll) 1he balance of Lrade ln servlces, lncome and currenL Lransfers

lll) 1he overall currenL accounL balance

lv) 1he balance ln Lhe caplLal accounL

v) 1he balance ln Lhe flnanclal accounL
27


b) 1he presence of a large, mulLlnaLlonal oll company (such as Shell or Lxxon-Mobll) employlng
some expaLrlaLe Lechnlclans and managers would llkely affecL whlch enLrles ln Lhe accounLs?
Lxplaln your answer.

8. A naLlon operaLlng under a flxed exchange raLe currency reglme ls sufferlng from a currenL
accounL deflclL of $100 (lmporLs are $1000 and exporLs are $900) and wlshes Lo Lry Lo reduce
Lhe deflclL Lhrough devalulng lLs currency by 20. LconomlsLs esLlmaLe LhaL Lhe Lu for Lhe
countrys imports is 0.6 while the PED for the countrys exports is 0.3.

a) Wlll Lhe devaluaLlon have lLs lnLended effecL? Lxplaln your answer wlLh Lhe help of a
calculaLlon uslng Lhe numbers above.

b) Agaln uslng calculaLlons Lo supporL your answer, show you Lhe devaluaLlon would have a
dlfferenL effecL lf Lhe Lu of lmporLs and Lhe Lu of exporLs were boLh 0.8.

9. The prices of a countrys imports and exports are given in the table below:

Cood rlce ln 2011 rlce ln 2012 rlce ln 2013

Cll (lmporL) $100/barrel $120 $90

8ananas (lmporL) $1/kg $1.10 0.90

lron Cre (exporL) $100/Lonne $90 $120

Machlnery (exporL) $100/plece $100 $103

28


a) 1aklng Lhe flgures from 2011 as represenLlng Lhe base year (with a value of 100), and
assuming that oil comprises 3/4 of the value of the countrys imports (while bananas comprise
[usL one quarLer) and LhaL lron ore and machlnery boLh make up half of Lhe value of Lhe
countrys exports, calculate the countrys Lerms of Lrade ln 2012, by, ln order:
l) CalculaLlng Lhe lndex of exporL prlces

ll) CalculaLlng Lhe lndex of lmporL prlces

lll) using these two figures to arrive at the countrys 2012 terms of trade

b) Agaln uslng Lhe flgures from 2011 Lo represenL Lhe base year, uslng a slmllar meLhod Lo parL
a calculate the countrys terms of trade in 2013.
l) lndex of exporL prlces

ll) lndex of lmporL prlces

lll) 2013 Lerms of Lrade

c) In what year did the countrys terms of Lrade lmprove? ln whaL year dld Lhey deLerloraLe?

29


d) Can you assume that the countrys current account balance would have improved in the year
ln whlch lLs Lerms of Lrade lmproved? Lxplaln your answer wlLh reference Lo Lhe prlce elasLlclLy
of demand for exporLs and lmporLs and Lhe followlng Lrade volume flgures:

Cood volume Lraded, 2011 2012 2013

Cll 73 barrels 73 90

8ananas 2300 kg 2300 2800

lron Cre 30 Lonnes 60 40

Machlnery 30 pleces 30 40

(noLe LhaL ln 2011 Lhere ls a balance ln Lhe Lrade ln goods, as lmporLs are 73 barrels *
$100/barrel plus 2300 kg * $1/kg = $10 000 and exporLs are 30 Lonnes * $100/Lonne plus 30
pleces * $100/plece = $10 000)

30


Add|t|ona| nL aper 3 Lxerc|ses Sect|on 1 So|ut|ons

1. a) rlce ($) Cd = 100 2 Cs = -30 + 4

0 100 -30

10 80 -10

20 60 30

30 40 70

40 20 110

rlce ($)

30

40 Supply

30

20

10

uemand
0 CuanLlLy
0 10 20 30 40 30 60 70 80 90 100 110

b) SeLLlng Cd = Cs and solvlng for :
100 2 = -30 + 4
130 = 6
23 =

1hen subsLlLuLlng 23 for ln elLher (or boLh) equaLlons and solvlng for C:
Cd = 100 2 or Cs = -30 + 4
Cd = 100 2(23) Cs = -30 + 100
Cd = 30 Cs = 30

Conflrmlng LhaL aL Lhe equlllbrlum prlce $23, Lhe Cd and Cs are boLh 30 as suggesLed
by Lhe graph.
31


c) Looklng aL Lhe graph, we are looklng aL a welfare Lrlangle LhaL looks llke:

=30

(30, 23)

= 12.3

We can conflrm Lhe y-lnLercepLs suggesLed by Lhe graph algebralcally as follows:

1o flnd Lhe y-lnLercepL of Lhe demand curve, flnd Lhe prlce when Lhe quanLlLy ls seL Lo 0.

Cd = 100 2
0 = 100 2
2 = 100
= 30

1 o flnd Lhe y-lnLercepL of Lhe supply curve, flnd Lhe prlce when Lhe quanLlLy ls seL Lo 0.

Cs = -30 + 4
0 = -30 + 4
30 = 4
12.3 =

1hus, Lhe consumer surplus ls Lhe area represenLed by Lhe followlng Lrlangle:

= 30

= 23 (30, 23)

A = x 8ase * PelghL
A = x (30) * 23
A = 623, so Lhe consumer surplus ls $623

Meanwhlle, Lhe producer surplus ls Lhe area represenLed by Lhe followlng Lrlangle:

= 23 (30, 23)

= 12.3

A = x 8ase * PelghL
A = x (30) * 12.3
A = 312.3, so Lhe producer surplus ls $312.30
32


d) llnd Lhe quanLlLy demanded and Lhe quanLlLy supplled aL = 20 by plugglng 20 lnLo boLh
equaLlons and flndlng C

Cd = 100 2
Cd = 100 2 (20)
Cd = 60

Cs = -30 + 4
Cs = -30 + 4 (20)
Cs = 30

As quanLlLy demanded ls 60 whlle quanLlLy supplled ls 30, Lhere ls an excess demand of 30 unlLs
aL a prlce of $20.

e) l can easlly Lell how many unlLs people wlll wanL Lo buy aL a prlce of zero, as LhaL ls Lold Lo me
by Lhe flxed Lerm ln Lhe demand funcLlon. lor example, uslng Lhe demand funcLlon Cd = 100
2, l can easlly see LhaL aL a prlce of zero, Cd = 100, as Cd = 100 2(0).

Whlle lL ls noL so easy Lo flnd Lhe prlce aL whlch sellers wlll begln Lo brlng Lhe good Lo markeL, as
LhaL requlres me Lo flnd Lhe prlce when quanLlLy ls equal Lo zero, lL ls noL dlfflculL. Agaln uslng
our supply funcLlon, [usL seL C = 0 and solve for , as ln 0 = -30 + 4
30 = 4
12.3 =

f) 1he demand funcLlon should geL flaLLer, as Lhe slope coefflclenL wlll have goLLen larger. 1he
quanLlLy demanded has become more responslve Lo changes ln prlce. lor lnsLance, looklng aL
our demand funcLlon, lf lL were Cd = 100 4, a drop ln prlce of $1 would resulL ln 4 more unlLs
belng demanded, noL 2.

Slmllarly, Lhe supply funcLlon would become flaLLer, as lLs slope coefflclenL would have also
goLLen larger as Lhe quanLlLy supplled ls now more responslve Lo changes ln prlce. lor lnsLance,
looklng aL our supply funcLlon, lf lL were Cs = -30 + 8, a prlce lncrease of $1 would brlng 8 more
unlLs Lo markeL lnsLead of [usL 4.

33


2. a) rlce ($)

30
Supply wlLh $3 Lax

40
Supply

30

20

10

uemand
0 CuanLlLy
0 10 20 30 40 30 60 70 80 90 100 110

b) 1he equlllbrlum markeL prlce appears Lo have rlsen Lo around $28 (from $23) whlle Lhe
quanLlLy sold has fallen Lo around 43 unlLs (from 30).

1o flnd Lhe new equlllbrlum polnL algebralcally, lL would be necessary Lo flrsL derlve Lhe new
(posL-Lax) supply curve. lf Lhe Lax has shlfLed Lhe supply curve up $3, and lf Lhe slope of Lhe
supply curve ls 4, Lhen Lhe LranslaLlon of Lhe curve $3 hlgher would suggesL LhaL Lhe x-lnLercepL
of Lhe new curve would be 20 unlLs furLher Lo Lhe lefL. 1hus, Lhe posL-Lax supply curve funcLlon
would be Cs = -70 + 4.

1o flnd Lhe new equlllbrlum polnL, slmply seL Cd = Cs and solve for

-70 + 4 = 100 2
6 = 170
= 28.3

Whlch lmplles an equlllbrlum quanLlLy of: Cd = 100 2
Cd = 100 2(28.3)
Cd = 43.4

Powever, Lhe answers LhaL follow are calculaLed accordlng Lo Lhe equlllbrlum polnL (43, 28), as
my readlng of Lhe syllabus suggesLs LhaL sLudenLs wlll noL be expecLed Lo derlve new supply
curve funcLlons resulLlng from Lhe lmposlLlon of lndlrecL, speclflc Laxes.

c) 1he governmenL has earned $3 on each of Lhe 43 unlLs sold, so $213.

34


1he consumer surplus ls Lhe area of Lhe followlng Lrlangle:

= 30

= 28 (43, 28)

So, as A = x 8ase * PelghL
A = x (43) * 22
A = 473 so Lhe consumer surplus ls $473.

1he producer surplus ls Lhe area of Lhe followlng Lrlangle aL rlghL (remember LhaL Lhe $3 Lax
comes beLween Lhe prlce consumers pay ($28) and whaL producers recelve ($23):

= 23 (43, 23)

= 12.3

So, as A = x 8ase * PelghL
A = x (43) * 10.3
A = 223.73 so Lhe producer surplus ls $223.73.

Comparlng Lhe sum of Lhese Lhree flgures ($213 + $473 + $223.73 = $913.73) Lo Lhe sum of
producer and consumer surplus before Lhe Lax was lmposed ($623 + $312.30 = $937.30) we can
see that the sum from part c is greater. Thus, we can conclude that the tax has led to a
decrease ln overall welfare of roughly $23.73.

d) 8efore Lhe Lax was applled, consumer expendlLures and producer revenues were boLh (30 *
$23) $1230. AfLer Lhe Lax was applled, consumer expendlLures were (43 * $28) $1204 whlle
producer revenue was (43 * $23) $989. 1he dlfference beLween Lhe Lwo numbers (1204 989)
was Lhe Lax collecLed by Lhe governmenL. ln Lhls case, Lhe Lax reduced boLh consumer
expendlLure (a llLLle blL) and producer revenue (slgnlflcanLly).

e) Well, as Lhe lnlLlal prlce was $23, Lhe facL LhaL Lhe prlce consumers pay rose Lo $28 whlle Lhe
prlce recelved by producers fell Lo $23 would suggesL LhaL consumers ended up paylng $3 of Lhe
$3 Lax whlle producers ended up paylng Lhe remalnlng $2. 1he reason Lhe Lax has been borne
unevenly ls LhaL Lhe prlce elasLlclLy of demand ls less Lhan Lhe prlce elasLlclLy of supply around
Lhe old equlllbrlum prlce and quanLlLy.

1o calculaLe:
Lu from (60, 20) Lo (40, 30) ls: -(40 60)/60 = 0.33 = 0.66
(30-20)/20 0.3

LS from (30, 20) Lo (70, 30) ls (70-30)/30 = 1.33 = 2.66
(30-20)/20 0.3
33


1he consumers end up paylng more of Lhe Lax as Lhelr demand ls less senslLlve Lo prlce changes
Lhan ls producer supply. Whoever ls less llkely Lo change Lhelr behavlor ln response Lo a prlce
change wlll end up belng hlL wlLh a greaLer prlce change whenever a Lax ls applled. uL more
slmply, whoever ls less llkely Lo duck ls more llkely Lo geL hlL.

3. a)
rlce ($)

30

Supply
40
Supply wlLh $3 subsldy

30

20

10

uemand
0 CuanLlLy
0 10 20 30 40 30 60 70 80 90 100 110

b) 1he subsldy has lncreased Lhe equlllbrlum quanLlLy from 30 Lo 36 whlle decreaslng Lhe
equlllbrlum prlce from $23 Lo $22.

c) 1he consumer surplus assoclaLed wlLh Lhe new posL-subsldy equlllbrlum polnL can be
calculaLed by flndlng Lhe area of Lhe Lrlangle under Lhe demand curve from C = 0 Lo C = 36 from
= $22 Lo = $30:
A = x 8ase * PelghL
A = x (36) * 28

1he producer surplus assoclaLed wlLh Lhe same equlllbrlum polnL can be calculaLed by flndlng
Lhe area of Lhe Lrlangle above Lhe supply curve from C = 0 Lo C = 36 from = $7.3 Lo = $22:
A = x 8ase * PelghL
A = x (36) * 14.3
A = 406, so Lhe producer surplus ls $408

1he lnlLlal producer and consumer surplus ln quesLlon 1 were $623 and $312.30, so Lhe subsldy
has clearly had a poslLlve effecL on boLh consumer and producer surplus, and hence overall
welfare. Powever, Lhe subsldy dld cosL Lhe governmenL money, Lo Lhe Lune of $3 per unlL for
each of Lhe 36 unlLs produced, or $280.
36


d) AfLer Lhe subsldy was granLed, consumers spenL (36 * $22) $1232, whlle producers would
have recelved (36 * $27) $1312. 8ecall LhaL whlle consumers only pay $22, Lhe amounL golng Lo
Lhe producers ls LhaL amounL plus Lhe amounL of Lhe subsldy. 1he dlfference beLween Lhese Lwo
numbers ls Lhe cosL of Lhe subsldy Lo governmenL ($1312 1232 = $280).

Comparlng Lhese flgures Lo Lhe lnlLlal consumer expendlLure/producer revenue of ($23 * 30)
$1230, we can see LhaL Lhe subsldy has resulLed ln a sllghL reducLlon ln consumer expendlLure
and a slgnlflcanL lncrease ln producer revenue.

e) Comparlng Lhe lnlLlal equlllbrlum prlce of $23 wlLh Lhe posL-subsldy equlllbrlum prlce of $22,
we can see LhaL $3 of Lhe $3 subsldy has been Lransferred Lo consumers, whereas producers are
only galnlng $2 (recall LhaL whlle Lhe prlce ls $22, producers are recelvlng $22 + $3 = $27).

Consumers are en[oylng a greaLer porLlon of Lhe subsldy Lhan producers due Lo consumers and
producers havlng dlfferenL responses Lo a change ln prlce, as measured by Lu and LS. As we
saw ln our answer Lo quesLlon 2 e), Lhe prlce elasLlclLy of demand around Lhe lnlLlal equlllbrlum
polnL ls only 0.66 whlle Lhe prlce elasLlclLy of supply ls 2.66.

WhaL Lhls means ls LhaL producers are more llkely Lo lncrease ouLpuL ln response Lo a prlce
lncrease Lhan consumers are llkely Lo lncrease purchases ln response Lo a prlce drop. So, when
faced wlLh a subsldy, whlch has Lhe effecL of lncreaslng Lhe prlce pald Lo producers even whlle
reduclng Lhe prlce pald by consumers, producers are more llkely Lo lncrease ouLpuL Lhan
consumers are Lo lncrease purchases. 1hls belng Lhe case, Lhe subsldy ln Lhls lnsLance lowers
consumer prlces more Lhan lL lncreases producer prlces.

4. rlce ($)
11

10

9
8
Supply
7

6
3

4
3 uemand

2

1

0 CuanLlLy
0 10 20 30 40 30 60 70 80 90 100 110

37


rlce Cd = 200 30 Cs = -30 + 20

0 200 -30

1 170 -30

2 140 -10

3 110 10

4 80 30

3 30 30

6 20 70

b) SeLLlng Cd = Cs and Lhen solvlng for :

200 30 = -30 + 20
230 = 30
3 =

SubsLlLuLlng Lhls value for ln elLher (or boLh) equaLlons Lo flnd C:

Cd = 200 30 Cs = -30 + 20
Cd = 200 30 (3) Cs = -30 + 20 (3)
Cd = 30 Cs = 30

1hus showlng LhaL aL a prlce of $3, Cd = Cs aL 30 unlLs, whlch ls ln agreemenL wlLh Lhe graph.

c) 1he consumer surplus can be descrlbed by Lhe area of Lhe Lrlangle below Lhe demand curve
from lLs y-lnLercepL Lo Lhe equlllbrlum polnL. Whlle l know Lhe equlllbrlum polnL, l need Lo flnd
Lhe y-lnLercepL, or Lhe prlce aL whlch Lhe quanLlLy demanded ls zero.

Cd = 200 30
0 = 200 30
30 = 200
= 200/30 or 6.66

1hus, Lhe consumer surplus can be calculaLed as Lhe area of Lhe followlng Lrlangle:
= 6.66

= 3 (30, 3)

38


A = x 8ase * PelghL
A = x (30) * 1.66
A = 41.66 so Lhe consumer surplus ls $41.66

1he producer surplus can be descrlbed by Lhe area of Lhe Lrlangle above Lhe supply curve from
lLs y-lnLercepL Lo Lhe equlllbrlum polnL. 1o flnd Lhe y-lnLercepL of Lhe supply curve l need Lo flnd
Lhe prlce aL whlch Lhe quanLlLy supplled ls zero.

Cs = -30 + 20
0 = -30 + 20
30 = 20
30/20 = , or ln oLher words, = $2.3

1hus, Lhe producer surplus can be calculaLed as Lhe area of Lhe followlng Lrlangle:

= 3 (30, 3)

= 2.3

A = x 8ase * PelghL
A = x (30) * 2.3
A = 62.3 so Lhe producer surplus ls $62.30

d) lf Lhe governmenL were Lo lmpose a prlce floor of $6, we can calculaLe Lhe Cd and Cs as
follows:

Cd = 200 30 Cs = -30 + 20
Cd = 200 30 (6) Cs = -30 + 20 (6)
Cd = 20 Cs = 70

1hus, as Cs ls greaLer Lhan Cd, Lhere would be a surplus of 30 unlLs.

e) ln Lhe lnlLlal slLuaLlon, producer revenue and consumer expendlLure would boLh be (30 unlLs
aL $3 each) $230. Powever, afLer Lhe prlce floor has been puL lnLo place, whlle suppllers wanL Lo
sell 70 unlLs, only 20 wlll acLually change hands. 1hus, producer revenue/consumer expendlLure
wlll fall Lo (20 unlLs aL $6 each) $120.

f) lf Lhe governmenL were commlLLed Lo buylng Lhe addlLlonal 30 unlLs aL Lhe floor prlce, Lhey
would have Lo spend (30 unlLs aL $6 each) $300.

g) lf Lhe governmenL were Lo lmpose a prlce celllng of $4, we can see from looklng aL Lhe Lable
of values in part a that there would be a shortage of 50 units as at that price the Qd is 80 units
whlle Lhe Cs ls [usL 30 unlLs.

39


h) WlLh a $4 prlce celllng, whlle consumers would llke Lo buy 80 unlLs, only 30 wlll be supplled by
producers, so as a resulL LoLal consumer expendlLure and producer revenue wlll fall Lo (30 unlLs
aL $4 each) $120.

l) rlce ($)

9
8 Supply

7

6
3

4

3 uemand
2

1

0 CuanLlLy
0 10 20 30 40 30 60 70 80 90 100 110

WlLh a $4 prlce celllng, Lhe consumer surplus can be represenLed by Lhe lrregular area under Lhe
demand curve from Lhe verLlcal axls unLll C = 30. l wlll decompose lL lnLo Lwo regular shapes as
follows:

A Lrlangle: = 6.66

= 3.66 (30, 3.66)

And Lhe recLangle below:
= 3.66 (30, 3.66)

= 4 (30, 4)

1he areas of each shape are: A = x 8ase * PelghL and A = LengLh * WldLh
A = x (30) * 1 A = 30 * 1.66
A = 13 A = 49.8

So Lhe LoLal consumer surplus ls (13 + 49.8) $64.8

1he producer surplus ls slmpler Lo flgure ouL, belng [usL Lhe area of Lhe Lrlangle above Lhe supply
curve from Lhe verLlcal axls unLll C = 30, as shown below:
= 4 (30, 4)

= 2.3
40


A = x 8ase * PelghL
A = x (30) * (1.3)
A = 22.3 so Lhe producer surplus ls $22.30

1hus, Lhe overall welfare (producer and consumer surplus) ln Lhls slLuaLlon ls (64.8 + 22.3) $87.3

Looking at the results from part c, where Lhe consumer surplus was $41.66 and Lhe producer
surplus was $62.30 we can see LhaL some producer surplus has been Lransferred Lo consumers
as a resulL of Lhe prlce celllng. Powever, clearly some welfare has been losL as well, as LoLal
welfare before was $104.16 before Lhe prlce celllng was puL ln place buL [usL $87.30 afLerwards.

Looklng aL Lhe graph we can Lry Lo measure Lhe area of Lhe welfare loss (Lhe Lrlangle from C =
30 rlghL Lowards Lhe old equlllbrlum aL (30,3) and see lf lL glves us a flgure slmllar Lo Lhe loss
arrlved aL by subLracLlng $87.30 from $104.16 (le $16.86).

1he welfare loss can be represenLed by Lhe Lrlangle descrlbed below:

(30, 3.66)
(30, 3)

(30, 4)

1aklng Lhe verLlcal slde as Lhe base, we can calculaLe Lhe area as follows:

A = x 8ase * PelghL
A = x (1.66) * 20
A = 16.6, or $16.60 whlch ls qulLe close Lo Lhe amounL calculaLed above ($16.86)

41


Add|t|ona| nL aper 3 Lxerc|ses Sect|on 2 - So|ut|ons

1. a)

rlce $10 $9 $8 $7 $6 $3 $4 $3 $2

Cd = 10 0 1 2 3 4 3 6 7 8

1oLal 8evenue 0 9 16 21 24 23 24 21 16

Marglnal 8evenue - 9 7 3 3 1 -1 -3 -3

Average 8evenue - 9 8 7 6 3 4 3 2

b)

rlce ($)
11

10
9

8
7

m 6

3
4

c 3 MC = AC
2

1
M8 A8
0
0 1 2 3 4 3 6 7 8 9 10
Cm Cc

c) c = $3 and Cc = 7 unlLs on Lhe graph above

d) 1here ls no producer surplus as all ouLpuL ls aL lowesL average and marglnal cosL. Consumer
surplus ls Lhe area of Lhe Lrlangle from $3 Lo $10 from ouLpuL 0 Lo ouLpuL 7, calculaLed as:
A = x 8ase * PelghL
A = x (7) * 7
A = 24.30, so Lhe consumer surplus ls $24.30

42


e) 1he proflL maxlmlzlng monopollsL would choose Lo produce 4 unlLs and charge $6, as shown
on Lhe graph.

f) 1he producer surplus would be Lhe recLangle from ouLpuL 0 Lo 4 and from prlce $3 Lo $6,
calculaLed as: A = l * w
A = 4 *3
A = 12, so Lhe producer surplus ls $12

Consumer surplus can be calculaLed by Laklng Lhe area of Lhe Lrlangle from ouLpuL 0 Lo 4 and
beLween Lhe prlce $6 and $10, as follows:
A = x 8ase * PelghL
A = x (4) * 4

g) $12 of surplus was Lransferred from consumers Lo producers and, as lnlLlally consumer
surplus was $24.30, clearly $4.30 was slmply losL. We can conflrm Lhls loss by calculaLlng Lhe
area of Lhe welfare loss Lrlangle, whlch ls Lhe Lrlangle beneaLh Lhe A8 curve beLween ouLpuL 4
and 7 from $3 Lo $6 as follows:
A = x 8ase * PelghL
A = x (3) * 3
A = 4.3, so Lhe welfare loss ls conflrmed as belng $4.30

h) lf Lhe governmenL mandaLes a prlce of $4 per unlL, Lhe new equlllbrlum prlce and quanLlLy
would be $4 and 6. 1he demand curve would sLlll exlsL buL Lhe monopollsL would no longer be
aware of lL or able Lo use lL Lo calculaLe marglnal revenue as under Lhe flxed prlce, hls marglnal
revenue (and hence average revenue) ls $4 for every unlL sold.

So, Laklng Lhls new equlllbrlum polnL, we can see LhaL Lhe consumer surplus ls now represenLed
by Lhe Lrlangle from C = 0 Lo C = 6 and from = 4 Lo = 10, whlch can be calculaLed as follows:
A = x 8ase * PelghL
A = x (6) * 6
A = 18, so Lhe consumer surplus ls now $18

roducer surplus ls represenLed by Lhe area of Lhe recLangle from C = 0 Lo C = 6 beLween = 3
and = 4, and can be calculaLed as follows:
A = l * w
A = 6 * 1, so Lhe producer surplus ls now $6

1hus, LoLal welfare ls now $24, suggesLlng LhaL Lhe welfare loss has been reduced Lo $0.30. lf
you calculaLe Lhe area of Lhe welfare loss Lrlangle you can conflrm Lhls resulL.

43


2. A farmer has a flxed amounL of land and workers. Powever, he can vary Lhe number of LracLors
he uses. Pe flnds LhaL hls LoLal producLlon of corn varles wlLh Lhe number of LracLors he uses as
descrlbed by Lhe Lable below:

number of 1racLors 0 1 2 3 4 3 6

CuLpuL of Corn (Lonnes) 10 30 70 100 120 130 130

Marglnal roducL - 20 40 30 20 10 0

Average roducL - 30 33 33.3 30 26 21.6

a) See Lable above. Pe beglns Lo suffer dlmlnlshlng reLurns from Lhe 3
rd
LracLor onwards, as hls
marglnal producL falls from 40 Lonnes wlLh Lhe second LracLor Lo [usL 30 Lonnes wlLh Lhe Lhlrd
LracLor.

b) See Lable above.

c) 1he farmer should use 4 LracLors Lo maxlmlze hls reLurns. 1he marglnal revenue from hls 4
Lh

LracLor ls equal Lo 20 Lonnes * $100/Lonne = $2000. 1he marglnal cosL of Lhe 4
Lh
LracLor ls also
$2000. Powever, Lhe 2
nd
and 3
rd
LracLors yleld more revenue Lhan Lhey cosL. 1he 3
Lh
and
subsequenL LracLors, meanwhlle, yleld less revenue Lhan Lhey cosL.

3. An entrepreneurs business exhibits the followlng LoLal cosLs and LoLal revenues:

CuLpuL 1oLal CosLs Marglnal CosLs Average CosLs 1oLal 8evenue Marglnal 8evenue Avg. 8ev. roflL
0 10 - - 0 - - -10
1 13 3 13 12 12 12 -3
2 19 4 9.3 22 10 11 3
3 22 3 7.3 30 8 10 8
4 24 2 6 36 6 9 12
3 23 1 3 40 4 8 13
6 27 2 4.3 42 2 7 13
7 30 3 4.3 42 0 6 12
8 34 4 4.23 40 -2 3 6
9 39 3 4.3 36 -4 4 -3
10 43 6 4.3 30 -6 3 -13

a) The entrepreneurs fixed costs are $10, as Lhese are hls cosLs when ouLpuL ls equal Lo zero,
lndlcaLlng LhaL Lhese cosLs do noL vary accordlng Lo ouLpuL.

b) 1oLal varlable cosLs when ouLpuL ls 6 are $17. 1oLal cosLs are $27 aL Lhls ouLpuL level.
SubLracLlng flxed cosLs of $10 from $27 glves us $17.

c) See Lable above.

d) See Lable above. Pls proflLs are hlghesL ($13) when ouLpuL ls 3 or 6.
44


e) 1he enLrepreneur ls operaLlng as a monopollsL, as he faces a downward sloplng marglnal
revenue curve, whlch lmplles LhaL he or she knows Lhe demand curve for Lhe producL and ls noL
Lherefore a prlce-Laker.

f) The entrepreneurs revenue-maxlmlzlng ouLpuL ls 6 or 7, where LoLal revenue ls $42.

g) 1he enLrepreneur roughly breaks even aL Lwo polnLs Lhe flrsL polnL ls aL an ouLpuL level
beLween 1 (loss of $3) and 2 (proflL of $2) and Lhe second polnL ls aL an ouLpuL level beLween 8
(proflL of $6) and 9 (loss of $3).

h)

rlce ($)

16
14 8reak-Lven olnLs where A8 = AC

12
10

8

6 Marglnal CosL
4 Average CosL
Average 8evenue
2

0
-2

-4
Marglnal 8evenue
-6 CuanLlLy
0 1 2 3 4 3 6 7 8 9 10 11
8evenue Maxlmlzlng olnL where M8 = 0, (C = 7)

roflL Maxlmlzlng olnL where M8 = MC, (C = 6, = $7)

noLe LhaL Lhe proflL maxlmlzlng polnL ls where M8 = MC, and LhaL Lhe break-even polnLs occur
where A8 = AC. 1he revenue maxlmlzlng polnL ls where M8 = 0, as so long as M8 ls poslLlve,
produclng more unlLs wlll lncrease LoLal revenue.

43


4. a)

CuanLlLy llxed CosL varlable CosL 1oLal CosL Marglnal CosL Avg. var. CosL Avg. 1oLal CosL
0 10 0 10 - - -
1 10 6 16 6 6 16
2 10 11 21 3 3.3 10.3

3 10 13 23 4 3 8.33
4 10 18 28 3 4.3 7
3 10 20 30 2 4 6

6 10 23 33 3 3.83 3.3
7 10 27 37 4 3.83 3.29
8 10 32 42 3 4 3.23
9 10 38 48 6 4.2 3.33

b) Average LoLal cosLs are aL a mlnlmum of $3.23 aL an ouLpuL of 8 unlLs. lf Lhe markeL prlce of
the firms output is also $5.25 and if the firm produces 8 units the firm will be breaklng even
(nelLher earnlng proflLs nor lncurrlng losses). As well, whaL ls suggesLed by a slLuaLlon where Lhe
markeL prlce of a good ls equal Lo Lhe mlnlmum average cosL Lo produce Lhe good ls LhaL Lhe
flrm ls operaLlng ln a perfecLly compeLlLlve lndusLry, as flrms operaLlng ln perfecLly compeLlLlve
lndusLrles are producLlvely efflclenL and produce aL lowesL average cosL. lf Lhe markeL prlce ls
above $3.23 Lhe flrm wlll poLenLlally be maklng proflLs, so long as Lhey produce where Lhe
markeL prlce ls above average revenue. ln a perfecLly compeLlLlve markeL, a prlce above $3.23
would only be a shorL-Lerm phenomenon as Lhe proflLs earned aL hlgher prlces would aLLracL
new enLranLs Lo Lhe lndusLry whlch would ln Lurn depress prlces back Lowards $3.23. lf Lhe prlce
remalns above $3.23 conslsLenLly, Lhe flrm ls noL operaLlng ln a perfecLly compeLlLlve lndusLry.

c) Average varlable cosLs are aL a mlnlmum of $3.83 aL an ouLpuL of 6. lf Lhe selllng prlce of Lhe
firms output is below $3.83 the firm is likely to shuL down as every unlL produced wlll resulL ln
additional losses. If the selling price of the firms output is between $3.83 and $5.25 the firm will
llkely sLay ln buslness buL operaLe aL a loss, as whlle Lhe flrm wlll lose money aL such a prlce, lf lL
shuL down and had Lo pay lLs flxed cosLs wlLhouL any revenue lLs losses would be even greaLer.

lor lnsLance, lf Lhe prlce were $3, and lf Lhe flrm were Lo sell 7 unlLs, Lhe flrm would earn $33.
1hls suggesLs a loss of $2 as Lhe LoLal cosL Lo produce 7 unlLs ls $37. 1hls loss of $2 ls less Lhan
Lhe loss LhaL would be lncurred lf Lhe flrm were Lo shuL down and sLlll be responslble for lLs flxed
cosLs of $10.

Lven lf Lhe prlce were $4, Lhe same slLuaLlon would apply. 1he revenues earned of $28 from 7
unlLs are only $9 less Lhan Lhe $37 lL cosL Lo produce Lhe goods, agaln less Lhan Lhe $10 loss LhaL
would be lncurred were Lhe flrm Lo shuL down and cease producLlon.

46



1. a) ? = C + l + C + (x-M)
? = 100 + 13 + 20 + (31-30)
? = 136 bllllon dollars

b) 136 8llllon / 40 Mllllon = 3400, so nomlnal Cu per caplLa ls $3400

c) 136 = 103 solvlng for x, x = 129 323 800 000, or around $129.3 bllllon
x 100

d) 8eal Cu growLh, llke any percenL change problem, ls calculaLed by: (new old) * 100
old
(129 323 800 000 - 126 000 000 000) * 100 = 2.79666
126 000 000 000

So real Cu growLh was around 2.8 beLween 2011 and 2012

lor nomlnal Cu growLh, do a slmllar calculaLlon:

(136 bllllon 126 bllllon) * 100 = 7.9363
126 bllllon

So nomlnal Cu growLh was around 7.9 beLween 2011 and 2012

e) nomlnal Cn ln 2012 = 136 bllllon + 10 bllllon 3 bllllon = $ 141 bllllon

2. a) 1he keyneslan mulLlpller = 1/1-MC, so for overLla, lL ls:
1/1-0.96 = 1/0.04 = 23

whlle for Largesse lL ls:
1/1-0.7 = 1/0.3 = 3.333

b) uslng Lhe keyneslan mulLlpller, we can see LhaL an addlLlonal $1000 of governmenL spendlng
would resulL ln an lncrease ln Cu of ($1000 * 23 = ) $23000 ln overLla and ($1000 * 3.333 =)
$3333 ln Largesse.

3. a) (630 000/ 11 300 000 + 630 000) * 100 = 3.33, so Lhe unemploymenL raLe was 3.33

4. a) l), ll) and lll)are suggesLed by Lhe quesLlon. lf Lhe blanks were fllled ln wlLh Lhe
approprlaLe welghLs as suggesLed Lhe flnal resulL for 2010 would look as follows:
(3 88 Pouse 8enL) * _0.023_ + (2 88 AparLmenL 8enL) * _0.0337_ + [should = 23}
(8read rlce) * _4.13_ + (8anana rlce) * _8.3_ + (Mllk rlce) * _8.3_ + [should =23}
(rlce of Shoes) * _0.208_ + (rlce of CoLLon uress) * _0.208_ + [should = 12.3}
(LlecLrlclLy rlce) * _123_ + [should = 12.3}
(8us 1lckeL rlce) * _6.23_ + (rlce of a llLre of gasollne) * _4.166_ + [should = 12.3}
(Clnema 1lckeL rlce ) * _0.892_ + (uance Pall 1lckeL rlce) * _0.892_ = 100 [should = 12.3}

47


b) 2011:
($313) * 0.023 + ($373) * 0.0337 +
($2) * 4.13 + ($0.8) * 8.3 + ($1.23) * 8.3 +
($23) * 0.208 + ($33) * 0.208 +
($0.12) * 123 +
($1) * 6.23 + ($1.33) * 4.166 +
($7.3) * 0.892 + ($7) * 0.892
= 103.448

2012:
($320) * 0.023 + ($383) * 0.337 +
($2) * 4.13 + ($1) * 8.3 + ($1.23) * 8.3 +
($23) * 0.208 + ($33) * 0.208 +
($0.13) * 123 +
($1.10) * 6.23 + ($1.40) * 4.166 +
($7.3) * 0.892 + ($7) * 0.892
= 108.084

c) 1he raLe of lnflaLlon can be calculaLed llke any percenL change [le (new old)/old}

rlce lndex number 2012 rlce lndex number 2011 * 100
rlce lndex number 2011

108.084 103.448 * 100 = 4.48, so Lhe raLe of lnflaLlon was 4.48
103.448

3. a) SLaLe A 60, SLaLe 8 60

b) 1ler SLaLe A SLaLe 8
8aLe * lncome 1ler = 1ax 8aLe * lncome 1ler = 1ax
1 0 * 13000 = $0 0 * 10000 = $0
2 0.1 * 10000 = $1000 0.2 * 20000 = $4000
3 0.2 * 10000 = $2000 0.4 * 20000 = $8000
4 0.3 * 10000 = $3000 0.3 * 20000 = $10000
3 0.4 * 10000 = $4000 0.6 * 13000 = $9000
6 0.3 * 10000 = $3000
7 0.6 * 20000 = $12000

1oLals: $83000 $27000 $83000 $31000

c) Gillians average tax rate ln SLaLe A would be (27000/83000) 31.7 whlle her average Lax
raLe ln SLaLe 8 would be (31000/83000) 36.4.

d) l) !ake would face a 40 marglnal Lax raLe ln boLh sLaLes
ll) !ake would have Lo pay $8000 Lax ($0 + $1000 + $2000 + $3000 + $2000) ln SLaLe A
and $12000 Lax ($4000 + $8000) ln SLaLe 8.
iii) Jakes average tax rates are (8000/50000) 16% in State A and (12000/50000) 24% in
SLaLe 8.
48



1. a) Mlnerals
600

AusLralla
300
lndonesla

400

300

200

100

0
lrulL
0 100 200 300 400 300 600 700 800 900 1000 1100 1200

b) lndonesla en[oys an absoluLe advanLage ln Lhe producLlon of boLh goods as wlLh Lhe same
quanLlLy of producLlve resources Lhey can produce boLh more frulL (1200 Lo 300) and more
mlnerals (600 Lo 300) Lhan AusLralla.

c) AusLralla en[oys a comparaLlve advanLage ln Lhe producLlon of mlnerals, as Lhe opporLunlLy
cosL of an exLra unlL of mlnerals ls [usL 1 unlL of frulL ln AusLralla, as opposed Lo 2 unlLs of frulL ln
lndonesla

Conversely, lndonesla en[oys a comparaLlve advanLage ln Lhe producLlon of frulL, as Lhe
opporLunlLy cosL of an exLra unlL of frulL ls [usL 0.3 unlLs of mlnerals, as opposed Lo 1 unlL of
mlnerals ln AusLralla.

d) WlLhouL Lrade, lndonesla would produce 300 unlLs of mlnerals Anu 600 unlLs of frulL,
and AusLralla would produce 230 unlLs of mlnerals Anu 230 unlLs of frulL,
maklng a LoLal producLlon of 330 unlLs of mlnerals and 830 unlLs of frulL

e) lf AusLralla were Lo devoLe all of lLs producLlve resources Lo produclng mlnerals, lL would
produce 300 unlLs. ln order Lo lncrease LoLal producLlon Lo 330 unlLs of mlnerals (Lhe amounL
arrived at in part d above), Indonesia would only have to produce 50 units. Looking at the
graph above, LhaL would requlre lndonesla Lo operaLe aL Lhe polnL (1100, 30) on Lhelr C.

49


Cverall producLlon wlLh Lrade Lhen would be 330 unlLs of mlnerals and 1100 unlLs of frulL. 1hls ls
an lmprovemenL of 230 unlLs of frulL (1100 830) over Lhe no-Lrade case, suggesLlng LhaL Lrade
based upon comparaLlve advanLage does offer slgnlflcanL galns Lo Lhe parLles lnvolved.

2. a) = $10, C = 20 000

leel free Lo conflrm Lhe resulL from your graph algebralcally, as follows:

-3000 + 2300 = 30 000 1000
3300 = 33 000
= 10

SubsLlLuLlng =10 lnLo elLher Lhe demand or supply funcLlon wlll glve C = 20 000

b) See ulagram Lhe new equlllbrlum prlce would be $6 and Lhe quanLlLy sold would be 24 000.

rlce ($)

20

18
uomesLlc Supply
16 (Cs = -3000 + 2300 )
14

12
10

World rlce+1arlff=8 WS (wlLh Larlff)
} $2 1arlff
World rlce = 6 World Supply
4

2
uemand (Cd = 30000 1000 )
0 Quantity (000s)
0 3 10 13 20 23 30 33 40 43 30

leel free Lo use algebra Lo conflrm LhaL aL a prlce of $6, Lhe quanLlLy demanded of bereLs wlll be
24 000 as follows: Cd = 30 000 1000
Cd = 30 000 1000 (6)
Cd = 24 000

c) 8efore Lhe enLry of lmporLed bereLs, lrench bereL makers earned $10 * 20 000 bereLs, or a
LoLal of $200 000. AfLer Lhe lmporLs are permlLLed, Lhey only earn $6 * 10 000, or $60 000.
lorelgn bereL-makers, meanwhlle, are selllng (24 000 10 000) 14 000 bereLs ln lrance for $6
each, glvlng Lhem earnlngs of $84 000.
30


d) llrsL, flnd Lhe y-lnLercepL of Lhe demand funcLlon by flndlng Lhe value of where C = 0
Cd = 30 000 1000
0 = 30 000 1000
1000 = 30 000
= 30

1hen, Lhe lnlLlal consumer surplus ls Lhe area of Lhe Lrlangle below Lhe demand curve and above
Lhe llne = 10 from C = 0 Lo C = 20 000

A = x 8ase * PelghL
A = x 20 000 * (30 10)
A = 200 000, so lnlLlally Lhe consumer surplus was $200 000.

1he consumer surplus under free Lrade ls Lhe area of Lhe Lrlangle below Lhe demand curve and
above Lhe llne = 6 from C = 0 Lo C = 24 000

A = x 8ase * PelghL
A = x 24 000 * (30 6)
A = 288 000, so consumer surplus under free Lrade ls $288 000.

Clearly free Lrade ln bereLs has lncreased consumer surplus.

e) i)See diagram above from part b

ll)1he new equlllbrlum prlce and quanLlLy ls = 8 and C = 22 000. leel free Lo conflrm
Lhls by plugglng ln a prlce of $8 lnLo Lhe demand funcLlon and solvlng for Cd.

lll) under Lhe Larlff, domesLlc producers are now able Lo sell 13 000 unlLs, leavlng 7000
unlLs Lo be lmporLed (22 000 13 000). As Lhe governmenL ls collecLlng $2 from each
lmporLed bereL, Lhe governmenL ls Lhen collecLlng a LoLal of $14 000.

lv) French beret makers were only earning $60 000 before (see part c above), but are
now selllng 13 000 bereLs aL $8 each, maklng a LoLal of $120 000. 1hls ls $60 000 more
Lhan was Lhe case under free Lrade.

v) While foreign beret makers were earning $84 000 under free trade(see part c
above), Lhey are now selllng [usL 7000 bereLs and are sLlll recelvlng [usL $6 per bereL as
Lhe exLra $2 Larlff goes Lo Lhe lrench governmenL. So, Lhelr overall revenues have fallen
Lo $42 000, whlch ls $42 000 less Lhan was Lhe case under free Lrade.

vl) 1he Larlff has reduced consumer surplus. Whlle under free Lrade consumer surplus
was $288 000 (see part d above) it is now represented by the area beneath the
demand curve and above Lhe llne =8 from C = 0 Lo C = 22 000.

A = x 8ase * PelghL
A = x 22 000 * 22
A = 242 000, so consumer surplus has fallen Lo $242 000 from $288 000 due Lo
Lhe lmposlLlon of Lhe Larlff.
31


f) l) See dlagram below:
rlce ($)

20

18
uomesLlc Supply
16
14
uomesLlc Supply afLer CuoLa CLy used up
12

10
8

4

2
uemand
0 Quantity (000s)
0 3 10 13 20 23 30 33 40 43 30

CuoLa of 7000 unlLs (from 10 000 Lo 17 000 unlLs)

ll) 1he new equlllbrlum prlce and quanLlLy are $8 and 22 000. ?ou can conflrm Lhls resulL
uslng algebra lf you llke. 1he quoLa has Lhe effecL of shlfLlng Lhe orlglnal supply curve
over 7000 unlLs Lo Lhe rlghL aL prlces above $6. 1hus, Lhe lnlLlal supply curve
Cs = -3000 + 2300 becomes Cs = 2000 + 2300

Solvlng for Lhe equlllbrlum polnL of Lhls new supply funcLlon and Lhe orlglnal demand
funcLlon as follows: 2000 + 2300 = 30 000 1000
3300 = 28 000
= 8
Cs = 2000 + 2300
Cs = 2000 + 2300 (8)
Cs = 22 000

Conflrms LhaL Lhe equlllbrlum polnL ls (22 000, 8).

lll) As LoLal sales are 22 000 and as only 7000 lmporLs are allowed wlLh Lhe quoLa, lrench
manufacLurers can be seen Lo have sold 13 000 bereLs (Lhose from C = 0 Lo C = 10 and
Lhose from C = 17 Lo C = 22). 1helr revenue ls much healLhler under Lhe quoLa reglme
Lhan under free Lrade under quoLas Lhey earn (13 000 * $8) $120 000, whlch ls double
Lhe $60 000 ln revenue earned under free Lrade.

lv) 1he revenues of forelgn bereL makers ln lrance rlse Lo (7000 * $8) $36 000 under Lhe
quoLa reglme, whlch ls hlgher Lhan Lhe $42 000 earned under Lhe Larlff reglme. 1helr
32


revenues are hlgher under Lhe quoLa Lhan under Lhe Larlff as wlLh Lhe quoLa Lhey are
able Lo Lake advanLage of Lhe hlgher prlces LhaL have resulLed from Lhe lmposlLlon of
Lhe quoLa, and collecL Lhe full $8 per bereL from lrench consumers. 8y conLrasL, under
Lhe Larlff, Lhe addlLlonal $2 ln Lhe flnal prlce charged Lo consumers goes Lo Lhe lrench
governmenL.

v) As Lhe equlllbrlum prlce and quanLlLy are Lhe same under Lhe quoLa as under Lhe
Larlff, so Loo ls Lhe consumer surplus. 1he consumer surplus under Lhe Larlff or Lhe
quoLa, aL $242, ls less Lhan Lhe $288 of consumer surplus under free Lrade.

g) l) See dlagram below
rlce ($)

20

18 uomesLlc Supply
16
uomesLlc Supply (afLer subsldy)
14
12 Subsldy

10

8

4
2
uemand
0 Quantity (000s)
0 3 10 13 20 23 30 33 40 43 30

ll) 1he equlllbrlum prlce and quanLlLy would be Lhe same wlLh a subsldy Lo domesLlc
producers as lL would be under free Lrade: = $6 and C = 24 000. 1he subsldy allows
more domesLlc producLlon Lo be avallable aL Lhe world prlce of $6.

lll) lrench manufacLurers are now able Lo sell 13 000 bereLs aL Lhe world prlce, $6. 1helr
revenue from Lhese sales would be a LoLal of $120 000 - $90 000 from consumers (who
are buylng 13 000 bereLs aL $6 each) and $30 000 from Lhe governmenL due Lo Lhe
subsldy (13 000 * $2).

lv) Consumers would be happlesL wlLh Lhe subsldy as lL glves Lhem Lhe mosL welfare
wlLh Lhe subsldy Lhey malnLaln Lhelr free-Lrade level of consumer surplus of $288 000.
lorelgn producers, meanwhlle, would prefer quoLas as Lhelr revenues are hlgher under
quoLas (7000 * $8 = $36 000) Lhan Lhey are under subsldles (9000 * $6 = $34 000) or
Larlffs (7000 * $6 = $42 000).

33


3. uh/Lur = 340/30 = x/1
x = (340 * 1)/30
x = 11.3
1herefore Lhe exchange raLe ls 1 Luro for 11.3 uh

4. uSu/8uble = 1/32 = x/330 000
x = (1 * 330 000)/32
x = 10 937.30
1herefore Lhe cosL of Lhe moLorcycle ln uSu ls $10 937.30

3. a) 1P8/SCu = 2300/100 = 1/x
x = (1 * 100)/2300
x = 0.04
1herefore Lhe exchange raLe ls one 1hal 8ahL for 0.04 Slngapore dollars, or 4 Slngapore cenLs

b) lL has depreclaLed as now he recelves more 8ahL for each Slngapore dollar

1he percenLage change ls calculaLed llke any oLher percenLage change: (new Cld/Cld) * 100
(2630 2300) * 100 = 130 * 100 = 6, so Lhe 8ahL depreclaLed by 6 agalnsL Lhe SCu
2300 2300

6. a) 1o solve, seL Cd = Cs and solve for
10 000 3000 = -3 000 + 2000
13 000 = 3000
3 = , so Lherefore Lhe exchange value of a eso ls 3 uS cenLs

b) lf one eso ls worLh 3 uS cenLs, Lhen we can flnd Lhe value of a uSu by seLLlng up Lhe
followlng equlvalency:

uSu/eso = 0.03/1 = 1/x
x = (1 * 1)/0.3
x = 33.33
1herefore Lhe exchange value of 1 uSu ls 33.33 hlllpplnes esos

7. a) l) 80 30 = + $30 bllllon
ll) -13 7 4 = - $24 bllllon
lll) + 30 24 = + $6 bllllon
lv) + $0.3 bllllon
v) 3 6 = - $3 bllllon

b) lmporLs of servlces would llkely be hlgher as ofLen local subsldlarles employ Lhe flnanclal and
markeLlng servlces of Lhe head offlce.
ulrecL lnvesLmenL from forelgn sources would llkely be hlgher as Lhe mulLlnaLlonal would
regularly lnvesL caplLal from lLs home counLry ln local operaLlons.
CurrenL Lransfers Lo forelgn beneflclarles would llkely be hlgher as Lhe forelgn workers and
professlonals worklng for Lhe mulLlnaLlonal would send remlLLances Lo Lhelr home counLrles.

34


8. a) 1o check uslng Lhe Marshall-Lerner condlLlon:
Lu (lM) + Lu (x) = 0.6 + 0.3 = 0.9, As 0.9 ls less Lhan 1, a devaluaLlon wlll noL correcL Lhe
balance of paymenLs deflclL and ln facL wlll llkely make lL worse.

1o demonsLraLe LhaL Lhe Marshall-Lerner condlLlon holds, look aL Lhe effecL of Lhe devaluaLlon
on exporLs:
1he prlce of exporLs falls 20 ln Lerms of forelgn currencles.
1he Lu of exporLs ls 0.3.
1herefore exporL volumes rlse by 6 (as Lu = change ln qnLy/ change ln prlce, 0.3=6/20).
lrom Lhe polnL of vlew of Lhe exporLlng counLry, exporL recelpLs Lherefore rlse by 6, as Lhe
recelpLs are ln Lhelr own currency.
1herefore, exporL recelpLs rlse Lo $900 * 1.06 = $934

1o look aL Lhe effecL on lmporLs:
A 20 devaluaLlon has Lhe effecL of pushlng up lmporL prlces by 23. lor lnsLance, lf Lhe
currency had once been worLh one unlL of forelgn currency (le lL had been valued aL par), a
devaluaLlon of 20 would push Lhe value of Lhe currency down Lo 0.8 forelgn currency unlLs.
1hls belng Lhe case, lL would Lhen Lake 1.23 of your currency unlLs Lo purchase one forelgn
currency unlL.
1he Lu of lmporLs ls 0.6.
1herefore lmporL volumes fall by 13 (as Lu = change ln qnLy/ change ln prlce, 0.6=13/23).
So, lmporL volumes fall Lo (0.83 * $1000) $830 worLh measured ln old, sLrong currency unlLs,
buL ($830 * 1.23) $1062.30 measured ln new, devalued currency unlLs.

1aklng Lhese Lwo flgures LogeLher, we can see LhaL Lhe currenL accounL deflclL has lndeed goLLen
worse, golng from $100 lnlLlally Lo (1062.30 934) $108.30, as suggesLed by Lhe Marshall-Lerner
condlLlon.

b) ln Lhls case Lhe currenL accounL deflclL should be lmproved by Lhe depreclaLlon as Lhe
Marshall Lerner condlLlon holds Lhe Lu(lM) + Lu (Lx) = 0.8 + 0.8 = 1.6

Checklng Lhe exporL slde:
LxporL volumes should rlse by 16, as Lhelr prlce wlll fall by 20 ln Lerms of forelgn currency
and as Lhe Lu of exporLs ls 0.8 (recall Lhe Lu calculaLlon: 0.8 = x/20, x = 16)
1herefore exporL recelpLs wlll also rlse by 16 Lo (900 * 1.16) $1044

Checklng Lhe lmporL slde:
As Lhe prlces of lmporLs wlll rlse by 23, and as Lhe Lu of lmporLs ls 0.8, lmporL volumes wlll
fall by 20. So, measured ln Lerms of old, sLrong currency unlLs, lmporLs wlll fall Lo $800.
Powever, ln Lerms of new, depreclaLed currency unlLs, Lhe lmporL blll wlll be (800 * 1.23) $1000.

1aklng lmporLs and exporLs LogeLher, we can see LhaL Lhe old $100 currenL accounL deflclL has
been Lurned lnLo a $44 currenL accounL surplus. As our M-L resulL suggesLed, Lhe devaluaLlon
dld lmprove Lhe currenL accounL balance.

33


9. a) l) (90 + 100)/2 = 93

ll) (3 * 120) + (100 * 1.10) = (360 + 110)/4 = 117.3
4

LxplanaLory noLe as lron ore prlces and machlnery prlces boLh sLarLed aL $100, and as Lhey
both make up half of the value of countrys exports, a simple average is sufficienL Lo deLermlne
Lhe exporL prlce lndex value for 2012. Powever, for lmporLs Lhe plcLure ls more compllcaLed.
llrsL, you should ad[usL for Lhe dlfferenL lnlLlal prlces for oll and bananas. As oll prlces are 100
Llmes banana prlces, mulLlplylng banana prlces by 100 wlll make Lhe values for oll and bananas
comparable. nexL, Lhough, as oll accounLs for of lmporLs Lo bananas x, lL ls necessary Lo
mulLlply Lhe oll prlce by 3 and Lhe banana prlce by 1, and Lhen dlvlde Lhe sum by 4 Lo accuraLely
reflecL Lhe welghL of each.

iii) 95/117.5 = 80.8 is the countrys 2012 terms of trade

b) l) (120 + 103)/2 = 223/2 = 112.3

ll) (3 * 90) + (100 * 0.9) = (270 + 90)/4 = 90
4

lll) 112.3/90 = 1.23

c) The countrys terms of trade improved in 2013 and deLerloraLed ln 2012.

d) No, you cant assume that a countrys current account balance would improve as a result of
an lmprovemenL ln Lhe Lerms of Lrade. 1aklng Lhe flgures glven for 2013:

lmporLs: 90 barrels of oll * $90/8arrel + 2800 kg of bananas * $0.9/kg = $8100 + $2320 = $10620

LxporLs: 40 L lron ore * $120/L + 40 unlLs of machlnery * $103/unlL = $4800 + $4200 = $ 9000

LxporLs lmporLs = - $1620, a currenL accounL deflclL of $1620.

1hls resulL can be explalned by looklng aL Lhe Lu of Lhe goods. 8eLLer exporL prlces led Lo sLeep
falls ln exporL volumes compared Lo Lhe flgures from 2011. lor example, Lhe Lu of lron ore
beLween 2011 and 2013 ls (-20/+20) = 1, whlle Lhe Lu of machlnery ls (20/+3) = 4. 1he very
hlgh Lu of machlnery Lells us LhaL an lncrease ln prlces wlll resulL ln a fall ln exporL volumes
LhaL more Lhan offseLs Lhe lmprovemenL ln Lhe Lerms of Lrade, leadlng Lo lower overall revenue.

Looklng aL lmporLs, a slmllar sLory emerges. 1he Lu of oll ln Lhe example ls (20/-10) = 2, whlle
Lhe Lu of bananas ls (12/-10) = 1.2. 8oLh of Lhese flgures are elasLlc, whlch means LhaL
decreases ln prlce are meL wlLh proporLlonally larger lncreases ln quanLlLy demanded, resulLlng
ln hlgher overall expendlLure.

1aken LogeLher, Lhe lmprovemenL ln Lhe Lerms of Lrade led Lo a deLerloraLlon in the countrys
currenL accounL balance due Lo Lhe conslsLenLly hlgh prlce elasLlclLy of demand for boLh Lhe
countrys imports and exports.

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