Trade Theory and Adam Smith's Wealth of Nations: Key Concepts and Solutions, Assignments of Economics

Download Trade Theory and Adam Smith's Wealth of Nations: Key Concepts and Solutions and more Assignments Economics in PDF only on Docsity! HW1 Solution Key UCDavis, 160a, SSII 2008 Prof. Farshid Mojaver Some Trade Terminology 1- What does autarky mean? No trade 2- What is a “laissez faire” policy with respect to trade? Hands off – no restrictive trade policy – free trade 3- Is export promotion considered to be a “laissez faire” policy? If not then what is it? No! Export promotion is intended to protect export industries. This is done through various regulations and government interventions. 1- In the trade spectrum show autarky, free trade, export promotion, and a move toward protectionism/trade liberalization. 2- What is protectionism? What is being protected and against what? Protectionism protects domestic industries against foreign competition via various regulations and government interventions in the market. 3- What is trade liberalization? What is being liberalized? A movement in the direction of free trade occurs when regulations on trade are removed. Since the elimination of trade policies will generally increase the amount of international trade, it is referred to as trade liberalization. Pure Exchange Model Consider two farmers, one with an endowment of 5 pounds of peaches, the other with an endowment of five pounds of cherries. Suppose these two farmers meet daily and make a mutually agreeable exchange of 2 pounds of peaches for 3 pounds of cherries. a. Write down an expression for the terms of trade. Explain how the terms of trade relates to the dollar prices of the two goods. TOT = 3 lb cherries /2lb peaches = ($/lb peaches)/($/lb cherries) = Pcherries/Ppeaches=3/2 (At this point it is immaterial to write ToT as Ppeaches/Pcherries or Pcherries/Ppeaches) b. Consider the following shocks (or changes). Explain how each of these shocks may influence the terms of trade between the farmers. Assume that each farmer's sole interest is to maximize her own utility. 1. The cherry farmer arrives at the market with 5 extra pounds of cherries. TOT↑ (here defined as lb peaches/ lb cherries) because of the increase in supply of cherries No trade 2. The peach farmer has just finished reading a book titled "How to Influence People." TOT↑ because the peach seller can increase demand for his peach 3. Damp weather causes mold to grow on 40% of the peaches. TOT↑ because supply of peaches goes down 4. News reports indicate that cherry consumption can reduce the risk of cancer. TOT↓ because demand for cherries goes down Adam Smith and gains from trade Answer the following questions pertaining to the excerpts from Adam Smith’s Wealth of Nations (posted on the class web page). 1- How does Adam Smith measure the contribution of any individual to national wealth? By his/her income 2- Adam Smith argues that social interest is promoted best when individuals pursue their self-interest, what is meant by “social interest” and how is it measured by Adam Smith? It seems that Adam Smith views social interest as the level of consumption or power to consume in the society (and of course security). Social consumption capacity is measured by GDP. Thus social interest is reduced to GDP. 3- How does pursuit of self interest can lead to maximization of social interest? Contribution of each individual to GDP is equal to his/her income. Adam Smith argues that when individuals maximize their income by pursuing their self interest then social interest (GDP) is also maximized. 4- Under what conditions pursuit of self interest can lead to the maximization of GDP? a- have competitive markets b- self interest is followed within rules of the game c- have good rules 5- What is the main problem with measuring social interest with GDP? If we accept the level of consumption as an economic measure of national interest, the main problem with GDP is a measure of social interest is that this does not ell us anything about the distribution of income in the society. A society can be very wealthy (high income per capita) and yet a great many members of its citizens live in poverty. 6- How does Adam Smith generalize the conclusion he gets from his example of Domestic trade between individuals to gains from trade between nations?