China – Australia Free Trade Agreement; ssess who gains and who loses when trade restrictions are relaxed.

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-agreement-highlights-november-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.

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)

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)

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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