GS 29281 Fall, 2013

International Trade Professor Bae

GS 29281
Midterm Exam 1
Solution
< Total points: 50 >

Part 1. (10 points) Multiple Choice. Each question is worth 1 point. Write
down the letter corresponding to the correct answer.

1. (d)

2. (a)

3. (b)

4. (c)

5. (a)

6. (d)

7. (c)

8. (c)

9. (a)

10. (b)

Part 2. (20 points) Short questions. Each question is worth 5 points. Explain
them clearly and logically.

1. This question cannot be easily answered. This is rather a matter of

empirical issues.

The reason that the number of accidents could increase is probably be-
cause of this economic reasoning: The threat of being killed in an acci-
dent is a powerful economic incentive to drive carefully. But, a driver

1
 may believe that they will face less of a threat from risky defects if re-
calls remove the defects. Because people respond to incentives, drivers
could be less careful. The result may cause more accidents. This expla-
nation seems very reasonable. However, an interesting question remains.
The regulations tend to reduce the number of driver deaths by making
it easier to survive an accident. At the same time, the regulations tend
to increase the number of driver and pedestrian deaths by encouraging
reckless behavior of drivers. Which effect is greater?

An economist, Sam Peltzman of the University of Chicago quantified

those effects for the first time and found that the two effects were of ap-
proximately equal size and therefore canceled each other out(known as
Offsetting Effect). (I met him and we discussed this issue in an Interna-
tional Industrial Organization Conference in 2005 in Chicago.)

Since then, many economists, including me, have tried to discover what
the outcome would be. I have challenged the effects, using one of my
current research papers. Once this paper is published in top Economics
journal, authors in many economics textbooks should change their cor-
responding contents in their books.

2.
dT R dT C
= 4, 000 − 2q and = 4q.
dq dq

If q = 500, then the derivatives are $ 3,000 and $ 2,000 respectively. If the
firm produced and sold its 501th unit, the additional revenue earned from
it would exceed the extra cost of producing that extra unit. Therefore,
the firm’s profits would increase.

3. If the economy is currently at point A, the opportunity cost of producing

an additional 10,000 bushels of wheat is 5,000 rugs. If the economy is
currently at point B, the opportunity cost of producing an additional
10,000 bushels of wheat is 10,000 rugs. If the economy is currently at
point D, the opportunity cost of producing an additional 10,000 bushels
of wheat is 20,000 rugs.

2
 4.
Cotton
Initial PPF

PPF with genetically

modified soybeans
*


PPF with drought 

0 Soybeans

Part 3. (20 points) Long questions. Each question is worth 10 points. Display
your working.

1. a. Chile has an absolute advantage in the production of both hats and

beer.
b. Chile has a comparative advantage in the production of hats, and
Argentina has a comparative advantage in the production of beer.
Chile’s opportunity cost of producing one hat is three-fourths of a
unit of beer, but Argentina’s opportunity cost of producing one hat
is 2 units of beer. Thus, Chile’s opportunity cost is lower and it has
the comparative advantage in hat production.
c. Chile should specialize in producing hats, and Argentina should
specialize in producing beer. By specializing, Chile can produce
8,000 hats per hour, and Argentina can produce 2,000 barrels of
beer per hour. If Chile trades 600 hats to Argentina for 600 barrels
of beer, the countries will end up with:

Hats Beer
Chile 7,400 600
Argentina 600 1,400

Both countries are better off than they were before specializing and
engaging in trade.

2. Please see your lecture note.