ECONOMICS  0115
                                                                                          HOMEWORK  #4

Table 1

US
Food(F)
0
200
400
600
800
1000
Autos(A)
500
400
300
200
100
0
Japan Food(F)
0
100
200
300
400
Autos(A)
800
600
400
200
0

1. Given the data on the production possibility frontiers for the US and Japan in Table 1, do the following:

a. Construct a table showing the opportunity costs for producing food and autos in each country. Which country has the comparative advantage in producing food? In producing autos? Explain.
b. Draw each country's production possibility frontier (PPF) on a separate graph. Using autos on the vertical axis, calculate the slopes of these two PPFs.
2. Assume that the terms of trade (TOT) are set at 1F = 1A.
a. Indicate the specialization point on each PPF.

b. Given the TOT, indicate what will happen to the production of A and F in each country.

c. Given the terms of trade, draw the consumption possibility frontiers (CPF) for the US and Japan.

d. Before trade and specialization, if the US consumed 600 F, it could only consume 200 A. After specialization and trade, how many units of A can be consumed if 600 F are consumed? Explain.

e. Given the combination of F and A in the US after trade and specialization, what combination of F and A will be consumed in Japan? Explain.

f. What amounts of F and A do the US and Japan import and export? Explain.

3. Assume the TOT are 1F = 4A. Explain whether trade will occur with these TOT and who will benefit from them.

                                                                    Table 2
                                                         US Automobile Market

     P      $16      $15      $14      $13      $12      $11      $10      $9      $8      $7

    QD    100      200      300      400      500      600      700    800     900   1000

    QS     900      800     700      600      500      400      300     200     100      0

4. Use the data in Table 2 to do the following:

a. If the world price of autos is $8, how many autos will the US import? Graph and explain this situation.

b. Suppose the US government imposes a $2 tariff on autos. Graph and explain this situation, being sure to note what happens to:

(1) The price of autos

(2) The number of imports

(3) The domestic production of autos

(4) The revenue from the tariff and who collects it

(5) The welfare losses from the tariff

c. Suppose the US government establishes a quota of 400 autos. Graph and explain this situation, being sure to note what happens to:
(1) The price of autos

(2) The domestic production of autos

(3) The revenue from the quota and who collects it

(4) The welfare loss from the quota

d. Suppose the US government negotiates a VER with the government of Japan limiting the number of Japanese exports to the US to 400. Graph and explain this situation, being sure to note what happens to:
(1) The price of autos

(2) The domestic production of autos

(3) The revenue from the VER and who collects it

(4) The welfare loss from the VER

5. Answer the following questions on exchange rates:
a. If the exchange between the dollar and the mark is 2 DM per dollar [e($) = 2 DM/$], what is the exchange rate in dollars per mark? [e(DM) = ?]

b. If a camera sells for 250 DM, what is the dollar price of the camera using the exchange rate from part a?

c. If a computer sells for $1000, what is the DM price of the computer using the exchange rate from part a?

                                                               Table 3

                                                                                                e($)                         e*($)
                                                                                         Exchange Rate       Real Exchange
                     Price Index         Price Index                       between Dollars        Rate between
Year               in the US              in Japan                            and Yen                Dollars & Yen

   1                     100                     100                                 100 Y/$

   2                     125                     100                                 100 Y/$

   3                     125                     100                                   80 Y/$

6. Using the data in Table 1, answer the following:

a. Compute the real exchange rate e*($) in the last column.

b. What happens to e*($) when the price index in the US rises but e($) remains unchanged?

c. What happens to e*($) when the price index in the US rises and e($) falls proportionately?

7. Suppose i(J) = interest rate in Japan = 4%/year and i(US) = interest rate in US = 9%/year. Also suppose that e($) = 100 Y/$ today but is expected to be 95 Y/$ in one year (the dollar is expected to depreciate against the yen). If a firm in the US has $1 million to lend:
a. How much will this firm receive in dollars in one year if it lends this money to an American firm?

b. Suppose that this firm lends $1 million to a firm in Japan (assume that it converts $1 million into yen to do so). How much will this firm receive in yen in one year? Assuming that the exchange rate is 95 Y/$ in one year, what is the dollar return on this firm's loan?

c. Where should the firm make its loan? Explain.

8. Suppose that the money markets for the US and Japan have reached equilibrium at e($) = 80 Y/$. Using this information, do the following:
a. Using two supply-demand graphs, illustrate this situation and briefly explain your graphs.

b. Assume that the demand for dollars increases so that the new exchange rate is e($) = 100 Y/$. Illustrate this situation for both countries and explain your results. Be sure to explain what is occurring at the original exchange rate (increased imports or exports for the US and vice versa for Japan) and how the markets adjust.

c. Begin with the equilibrium established in part a. Then assume that the supply of dollars increases. Illustrate this situation for both countries and explain your results. Be sure to explain what is occurring at the original exchange rate (increased imports or exports for the US and vice versa for Japan) and how the markets adjust.

d. Assume that the situation in part a is altered by the imposition of a fixed exchange rate regime where the exchange rate is fixed at fe($) = 120 Y/$. Illustrate this situation for both countries and explain how the US central bank should act in this situation. Can the central bank maintain this fixed rate indefinitely? What is the danger it faces? Explain.