1. Section 4
Diagrams

2. Free trade in Corn
Price of corn ($ per tonne)
D
S(domestic)
Pe
Pw
S(world)
Quantity of corn (000s tonnes)
Q2
Qe
Q1
3. Explanation
Before trade, Qe corn is produced domestically at a price of Pe. When free trade takes place, Q1Q2 of corn is imported at the world price of Pw, and Q1 of corn is produced domestically.
4. A tariff on corn imports
Price of corn ($ per tonne)
D
S(domestic)
Pw + tariff
S(world) + tariff
Pw
S(world)
Quantity of corn (000s tonnes)
Q2
Qe
Q1
Q4
Q3
5. Explanation
The imposition of a tariff upon imported corn means that the price will rise from Pw to Pw + tariff. Imports will fall from Q1Q2 to Q3Q4 and domestic production will increase from Q1 to Q3.
6. A subsidy on domestic wheat production
Price of corn ($ per tonne)
D
S(domestic)
S(domestic)+ subsidy
Pw
S(world)
Quantity of corn (000s tonnes)
Q2
Q3
Q1
7. Explanation
When the government gives a subsidy to domestic producers, the domestic supply curve shifts downwards from S(domestic) to S(domestic)+ subsidy. The price to consumers remains the same, but imports fall from Q1Q2 to Q3Q2 and domestic production increases from Q1 to Q3.
8. The J-Curve
Current account surplus
Z
Time
X
Current account deficit
Y
9. Explanation
The country has a current account deficit and is at X on the diagram. The exchange rate of the currency is lowered to rectify this. In the short term, because of existing contracts and imperfect knowledge, the deficit worsens to Y. However, in the long term, if the Marshall-Lerner condition is fulfilled, export revenue will begin to increase and import expenditure will start to fall. The current account deficit will get smaller, moving in the direction of Z on the diagram
10. Price of Pound in Euro)
A floating currency
S(of pound from UK)
1 pound=1.26
D(for pound from EU)
Q
Quantity if pound
11. Explanation
The exchange rate of the pound against the Euro is being determined solely by the demand for the pound and the supply of it. In this case, the exchange rate will be1 pound=1.26 euro
12. An increase in the demand for the pound
Price of pound in Euro
S
1.37
1.26
D2
D1
Quantity of pound
13. Explanation
The demand for the pound has increase from D1 to D2. this may have been caused by an increase in the UK interest rates, increase demand for UK products, speculation that the pound will increase in value, or a more favourable investment climate in the UK. In all cases, EU citizens will want more pounds, thus increasing the demand for the pound on the foreign exchange market. The exchange rate of the pound will rise to 1pound=1.37euros
14. An increase in the supply for the pound
Price of pound in Euro
S1
S2
1.26
1.15
D
Quantity of pound
15. Explanation
The supply of the pound has increased from S1 to S2. This may have been caused by an increase in foreign interest rates, increased demand for foreign products, speculation that the pound will decrease in value, or a more favourable investment climate in foreign countries. In all cases, UK citizens will want more foreign currency, thus increasing the supply of pounds on the foreign exchange market. The exchange rate of the pound will fall to 1pound=1.15euro
16. Shoes (pairs)
Production possibilities curves (PPCs) to show comparative advantage
3
2
China
India
12
Cloth (metres)
5
17. Explanation
China has an absolute advantage in the production of both shoes and cloth. It can produce more of both than India with the same factor inputs, however, India has a comparative advantage in producing shoes, since they only give up 2.5 meters of cloth for each pair, whereas China gives up 4 meters of cloth. China should specialize in cloth and India should specialize in shoes.