ECONOMIC PRINCIPLES

Department of Economics, School of Business Word Limit (1500 words) Basic Version This basic version is worth 18 marks total. There are three other challenging versions, each of which is worth 4 bonus marks. You only have to complete one (1) assignment. This version is worth 45 points, reweighted to 18 marks. Submit your assignment via Cloud Deakin in the appropriate assignment dropbox by 11:59 p.m. on Monday 21 September 2015. Hard copies will NOT be accepted. Please note the new, later, due date. Extensions can only be granted by the Unit Chair (Dr Randy Silvers, randolph.silvers@deakin.edu.au). This is an individual assignment; the work that you submit must be your own. Plagiarism will incur penalties. 1 Background Currently, Australia and China are implementing a bilateral trade agreement that the leaders of the two countries signed recently; known in the press as the ChinaAustralia Free Trade Agreement.1 For some background, see: http://business.nab.com.au/wp-content/uploads/2014/11/china-australia-freetrade-agreementhighlights-no vember-2014-economic-report.pdf and http://dfat.gov.au/trade/agreements/chafta/Pages/australia-china-fta.aspx As you have learned in MAE101, economics is about allocating scarce resources among competing uses. One of the core principles is that voluntary trade benefits all participants to the trade. If this principle is so basic and intuitive, why then have governments resisted trade between countries?In what ways do governments restrict trade? Why is trade between countries different from trade within a country — such as, workers moving from one state to another for employment, or goods being manufactured in one state and sold in another? In this assignment, you will use the economics that you have learned in MAE101 to assess who gains and who loses when trade restrictions are relaxed. 1 2 This is separate from the TransPacific Partnership, which is a trade agreement that Task 1: Opportunity Cost and Trade (a) Use an example from your own life in which two individuals (you can be one of them) can produce two different “goods.”2 (i) Describe the example. Who are the individuals, what can they produce, what do they actually produce. (ii) Generate a table showing how much each individual can hypothetically produce in a given period of time — define the period of time.3 (iii) On one graph, show the production possibilities frontiers for each individual and the joint production possibilities. (6 Points) (b) Using your example: (i) Define opportunity cost, absolute advantage, and comparative advantage. (ii) Derive the opportunity costs for both individuals, for both goods. (iii) State who, if either, has the absolute advantage in each good; state who, if either, has the comparative advantage in each good. Describe how both individuals gain by trading. (6 Points) (c) Notice that you have not expressed any costs in dollars. What is the “real cost” of a good? (2 Points) 2 Do not use examples referenced in the textbook, lectures, or videos. You may use examples from your household, your studies, your work, and your extracurricular activities — such as a sport team or video production. 3 You do not need to do research. Just generate reasonable numbers. 3 Task 2: Supply, Demand, and Changes in the Equilibrium Choose an industry for which China currently has a tariff and that is affected by the new trade agreement — see the first page after the title page of the NAB link. Assume for parts (a) and (b) below that the market for your chosen industry is perfectly competitive. (a) For the market you’ve chosen, draw two demand-and-supply graphs side-byside — one for Australia, one for China. Show the effects of the tariff in both markets. (2 Points) (b) Reproduce the graphs without the tariffs. On each graph, identify: (i) the old and new equilibrium price; (ii) the old and new equilibrium quantity; (iii) the old and new amounts of exports or imports, as appropriate; and (iv) the changes to consumers’ surplus and producers’ surplus. Also, explain each effect. That is, explain the change to the price, quantity, imports/exports, and consumers’ and producers’ surpluses in both markets. (4 Points) (c) Suppose that either: (i) the demand for this industry’s product in Australia, or (ii) the supply for this industry’s product in Australia, is more inelastic than what you have drawn above. You may choose which comparison to make. State which comparison you consider. Then, for each of the effects in (b), explain whether the effect becomes larger, smaller, or there is no change to the effect. For example, if you choose option (i) and stated that the new price in Australia is greater than the old price, then for this part, you should state, and explain, either “the price rise becomes greater the more inelastic the demand in Australia” or “the price rise becomes smaller the more inelastic the demand in Australia” or “the price rise is unaffected by the elasticity of demand in Australia.” (4 Points) (d) List the three defining characteristics of a perfectly competitive market. For the market you’ve chosen, state whether or not each condition applies. Do you think that the market is perfectly competitive, monopolistically competitive, oligopolistic or monopolistic? State your reasoning. (3 Points) 4 Task 3: Cost Structure and Effects in Short and Long Run Regardless of your answer to Task 2 (d) above, assume that the industry in Australia is perfectly competitive. (a) Consider the current market, in which China imposes tariffs on Australian goods, to be in long-run equilibrium. Graph a typical firm’s cost curves and production decisions. (2 Points) (b) Show on your graph and explain what happens in the short run to this typical firm after the tariff is eliminated. (2 Points) (c) Explain what will happen in the long run to the market and to this typical firm. What is the long-run equilibrium price? (3 Points) (d) Who gains and who loses in this market from the elimination of tariffs? Be sure to consider consumers and producers in both countries, and distinguish between the short run and the long run. (3 Points) 5 Task 4: In this task, you are to complete part (a); you then complete either part (b) OR part (c) – this is your choice. (a) Professor Ricardo, a leading economist, was interviewed recently about the Free Trade Agreement with Australia. Professor Ricardo stated that it didn’t really matter what the specifics of the agreement were. Said Professor Ricardo, “what is really important is to lower and preferably eliminate all of China’s tariffs so that China can have a level playing field”. Explain what Professor Ricardo meant by a level playing field. (4 Points) (b) In both China and Australia, there has been some opposition to the Free Trade Agreement. In Australia, for example, some have feared that this will destroy jobs. Some groups have lobbied their governments to modify the agreement or even stop it. Lobbying involves the use of scare resources. Is this a productive activity or a dead weight loss? Explain your reasoning. (4 Points) (c) Regarding both working conditions and environmental pollution standards, Australia imposes stronger restrictions on its domestic producers than China does on its domestic producers. If China were to impose similarly stringent restrictions on its domestic producers, what would happen to the cost (marginal cost and average total cost) of a typical Chinese firm? What effect(s) would that have on Chinese exports to Australia and on Chinese imports from Australia? (4 Points)

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