XJTLU IBSS Year 2016/2017 Semester 2

ECO312: INTERNATIONAL ECONOMIC RELATIONS

Problem Set 1 Solutions

Question A
If soybeans are one of the ingredients in cattle feed, how does a price support program in soybean
market (i.e., raising the price of soybeans) affect the equilibrium price and quantity of beef?
Answer Key:
By raising the price of soybeans, an input used in beef production, the price support program raises
the price of cattle feed, which causes a leftward shift in the supply schedule for beef. This, in turn,
results in an increase in the equilibrium price and a reduction in the equilibrium quantity of beef.

Question B: Rent controls

In order to consider the well-being of low-income citizens, the government passes a rent control law.
For instance, in a hypothetical urban apartment market, the supply and demand functions are =
10 and = 1200 10 , respectively. Here is measured in dollars/month and 1000s of
apartments/month. The law says to hold the rents at = $400/, which is below the market-
clearing value. Explain possible problems on the implementation of this law based on the supply and
demand analysis.
Answer Key:
constitutes a price ceiling for rents. At $400/month, there is an excess demand of 40,000 units. In
an unregulated market, the immediate response would be for rents to rise sharply. But here the law
prevents them from rising above . Possible consequences: owners to spend less on maintaining
their rental units, high finders fees or key deposits, and so on.

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XJTLU IBSS Year 2016/2017 Semester 2

Question C: Tennis clubs

Tennis clubs always have an annual membership charge in addition to their hourly court fees.
Suppose a suburban tennis club rents its courts for $25 per person per hour: Johns demand curve for
court time is = 50 0.25, where is measured in hours per year. Assuming there were no other
tennis clubs in town, what is the maximum annual membership fee John would be willing to pay for
the right to buy court time for $25/hr?
Answer Key:
If the club charged a fee higher than the consumer surplus (CS) John receives from being able to buy
court time, John would be better off not renting any court time at all. Here, = 0.5(50 25)
100 = $1250/.

Question D: Minimum wage laws

Minimum wage laws applied in many countries prohibit employers from hiring employees or workers
for less than a given minimum wage. The laws help the low-wage workers. What is the effect of a
minimum wage law on employment of skilled labor?
Answer Key:
Unskilled labor and skilled labor are substitutes for one another in many production processes. What
mix of the two skill categories the firm chooses to use depends strongly on relative prices. When the

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price of unskilled labor rises, the slope of the isocost line rises, causing many firms to increase their
employment of skilled labor. (isocost line will be introduced in lecture 3.)

Question E: Chicken
The classic toy game called Chicken derives from the James Dean movie Rebel without a Cause, in
which two teenage boys drive cars toward a cliff edge to see who chickens out first. The same game
is played by middle-aged drivers who approach each other in streets too narrow for them to pass
without someone slowing down. If both of them speed up, each gets a utility of -1. If both of them
slow down, each gets a utility of 2. If one speeds up and the other slows down, the former gets a
utility of 3 and the latter 0. Show the payoff matrix and find the Nash equilibria of this game.
Answer Key:
(slow, speed) and (speed, slow) are Nash equilibria.