GSLC 3

Anastasia Georgina / 1901489115

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1. Suppose Indonesia and China are trading partners. Indonesia initially exports palm
oil to and imports lubricants from China. Using the standard trade model, explain
how an increase in the relative price of palm oil - in relation to lubricant prices would affect production and consumption of palm oil for Indonesia (assuming that the
taste for both goods is the same in both countries). If the income effect of price
change of palm oil is greater than the substitution effect, what would happen to palm
oil consumption in Indonesia? Please explain using graph.
Answer :
The standard trade model predicts that
an import tariff by the home country can increase domestic welfare at the
expense of the foreign country. So if Indonesia increase the import tariff on
lubricant then the price of lubricant relative to the price of palm oil rises for
Indonesian consumers. Likewise, the price of palm oil relative to the price of
lubricant falls for Indonesian consumer. Indonesian producers will receive a
lower relative price of palm oil, and therefore will be more willing to swith to
lubricant production: relative supply of palm oil will decrease.
Indonesian consumers will pay a lower relative price for palm oil and
therefore will be more willing to switch to palm oil consumption: relative
demand for palm oil will increase.

an export subsidy by the home country reduces domestic welfare to the benefit
of the foreign country. So if Indonesia imposes a subsidy on palm oil exports,
the price of palm oil relative to the price of lubricant rises for Indonesian

consumers. Indonesian producers will receive a higher relative price of palm

oil when they export, and therefore will be more willing to switch to palm oil
production : relative supply of palm oil will increase.
Indonesian consumers must pay a higher relative price of palm oil to
producers, and therefore will be more willing to switch to lubricant
consumption: relative demand for palm oil will decrease

2. For each of the following examples, explain whether it is a case of external or internal
economics of scale :
a. A number of firms doing contract research for the drug industry are concentrated in
southeastern South Carolina.
b. All Hondas produced in the United States come from plants in Ohio, Indiana, or Alabama.
c. All airframes for Airbus, Europe's only producer of large aircraft, are assembled in
Toulouse, France.
Answer :

External economies of scale occur when cost per unit of output depends on the size
of the industry.

Internal economies of scale occur when the cost per unit of output depends on the
size of a firm.

a) External economics of scale because a number of firms in the US means there are
perfect competition between small firms
b) External economics of scale because all Hondas products are come from the small
plants all over US countries which means there are perfect competition among them

c) Internal economics of scale because Europe is the only producer of large aircraft are
assembled in France means there are imperfect competition
3. Consider two countries - India and Japan - facing a forward falling supply curve. Both
produce two commodities - cloth and TVs. India, a labor surplus country, produces cloth
using cheap labor. This reduces its domestic price in comparison to Japan. Similarly, Japan
being technologically advanced produces TVs at a lower cost than India. If both are open to
trade, please explain using graph the following.
a. What will happen to the world market price for cloth and TV?
b. What would you expect of the international trade and who would produce what, if neither
Answer:
a.
b. India nor Japan has an initial advantage of lower price?
India will produce cloth and Japan will produce TV
4. It is fairly common for an industrial cluster to break up and for production to move to
locations with lower wages when the technology of the industry is no longer rapidly
improving - when it is no longer essential to have the absolutely most modern machinery,
when the need for highly skilled workers are declined, and when being at the cutting edge of
innovation conveys only a small advantage. Explain this tendency of industrial clusters to
break up in terms of the theory of external economies.
Answer :
External economies are important for firms as technology changes rapidly and as the
cutting edge moves quickly with frequent innovations. As this process slows,
manufacturing becomes more routine and there is less advantage conferred by
external economies. Instead, firms look for low cost production locations. Since
external economies are no longer important, firms find little advantage in being
clustered and it is likely that locations other than the high-wage original locations are
chosen.