Part II: Attempt two of the following exercises. Justify your answers. 

Exercise 1: 

Many economists and social reformers have claimed that the main impediment to economic development is the relentless movement in one direction of the terms of trade of poor countries.

Answer the following questions. Justify your answers.

1. Is the claim consistent with the Heckscher-Ohlin model view of international trade?
2. In which direction does the statistical evidence show the terms of trade have moved relentlessly? Is the claim by the afore-mentioned economists and social reformers correct?
3. Does not this direction of movement of the terms of trade make the products of the poor countries more competitive and therefore it is favourable to economic development? Why or why not?
4. How do we reconcile your answer to question b) with the fast-economic development of the newly industrialized countries, such as South Korea?
5. When does a customs union cause trade diversion? Define the underlined term 
6. What are the advantages and disadvantages if any of a quota compared to a tariff? Define the underlined term

Exercise 2:

Answer the following questions. Justify your answers.

1. Discuss the following claim. Justify your answer. 
   “Free trade requires the elimination of all barriers to trade including tariffs. It follows that for every country, the optimal tariff rate is zero”. 
2. Which kind of a country can impose an optimal tariff rate and why? Will that strategy backfire and how? 
3. Will all its citizens benefit from the optimal tariff in the short and long term? 
4. Is the following statement true, false, or uncertain? Explain why
   “Quotas are better than tariffs. That is why the WTO (World Trade Organization) promotes the replacement of tariffs by quotas”
5. Does a common market necessarily cause trade diversion?  
6. What is the effect of free movements of financial capital and labour on the income distribution of both the country that is exporting and the host country that is receiving the inflows of financial capital or labour? 

Exercise 3: 

In figure 1, curves AB and CD represent respectively country’s A demand curve and supply curve of an importable product X. Suppose that country B is also a producer of product X according to a constant marginal cost equal to $6 under conditions of perfect competition. Furthermore, suppose that in the rest of the world, not including countries A and B, the production of product X takes place under constant returns to scale at a constant marginal cost equal to $4.  The price of product X outside of countries A and B is equal to its marginal cost there. The price of product X in country B is equal to its marginal cost in country B.

Let the government of country A impose a tariff equal to $4 on its imports of product X from every other country.

Figure 1 

Answer the following questions. Justify your answers 

1. What is the quantity demanded by country A’s consumers, the quantity produced by country A’s producers, the quantity of product X imported by country A from country B, and the quantity of product X imported by country A from the rest of the world not including country B? 
2. What are the dollar values of the consumer surplus, producer surplus, and government revenue for country A?

Suppose that countries A and B form a customs union, country A maintains its tariff on imports from the rest of the world equal to $4.

1. What is the quantity demanded by country A’s consumers, the quantity produced by country A’s producers, the quantity of product X imported by country A from country B, and the quantity of product X imported by country A from the rest of the world not including country B? 
2. What are the dollar values of the consumer surplus, producer surplus, and government revenue for country A under the customs union?
3. Is country A better off after than before entering the customs union?
4. Estimate the amount of trade creation and trade diversion in terms of units of product X and the amount of trade creation and trade diversion in terms of dollars.