GS 29281 Fall 2014

International Trade Professor Bae

Problem Set 1
Solution

1. The central reason for outsourcing to China or other countries is that

firms believe they can earn a higher profit in the process. Outsourcing
to China or countries isn’t risk-free. In most cases, the entrepreneur has
no guarantee that the costs of outsourcing (payments to the workers plus
costs of arranging things and supervising from a distance, for example)
will be lower than the costs of production with domestic workers whose
productivity and quality of workmanship may be much higher. However,
many firms use all relevant information available to them and believe
that the benefits of oursoucing outweigh the costs. In the sense, they are
rational.

2.

a. Setting M N B(Q) = 100 − 4Q − 2 = 0 and solving, we see that the

net benefits of recycling are maximized when Q = 24.5.
b. N B(Q) = B(Q) − C(Q) = [100Q − 2Q2 ] − 2Q = [100(24.5) −
2(24.5)2 ] − 2(24.5) = $1, 200.5.
c.
With Q = 20, N B = [100(20) − 2(20)2 ] − 2(20) = $1, 160.

With Q = 40, N B = [100(40) − 2(40)2 ] − 2(40) = $720.

So, the optimal level of recycling is 24.5. At this level, the net
benefits are maximized.

3. The production possibility frontier shifts outward. The y-intercept is

unaffected, however. At the y-intercept, the country would be producing
all cars and no corn and the new technology would have no effect.

1
4. N/A.

5.

a. Yes, the statement is correct. The value of trade between Sweden

and Germany in 2012 was $ 44.665 billion, while the value between
Sweden and Spain was only $ 4.714 billion in the same year. The
gravity model explains why the trade between any two countries
diminishes with distance. Sweden is closer to Germany than to
Spain. Therefore, the trade value between Sweden and Germany is
greater than the value between Sweden and Spain. (Data Source:
http://wits.worldbank.org/)

b. Yes, the statement is correct. We can easily find evidence from

data. For instance, the trade value between China and U.S. is a
lot greater than the value between Korea and Canada. Please find
other examples too.

c. Yes, the statement is correct. The two neighbors of the U.S. are
Canada and Mexico. Their GDPs in 2012 were about $ 1.8 and
$ 1.3 trillion respectively. Two European countries of similar size
are the U.K. and Spain. Theirs were about $ 2.5 and $ 1.4 trillion
respectively. Their trade values are as follows:

Neighbor Countries European Countries

$ 619.157 billion (Canada) $ 110.803 billion ( U.K.)
$ 496.348 billion (Mexico) $ 21.717 billion (Spain)

Thus, the U.S. trades with its neighboring countries a lot more than
with European trading partners. There are several reasons. They
include distance, barriers, and geography.
(Data Source: http://wits.worldbank.org/)