PROBLEM 1 (25 points): Assume there are only two countries, Kiribati and Belize. Further, assume there are only two goods in the world, fish and sugar. Finally, assume that the only input to production is labor.

a.) (5 points) Suppose that there are 120,000 hours of labor available on Kiribati. 12 labor hours are required to produce fish and 48 labor hours are required to produce sugar. Graph Kiribati's production possibility frontier (PPF), putting fish on the X-axis. Remember to fully label your graph.

1. b.)(14 points) Assume that the post-trade relative price of fish is one. On your graph for part a, draw Kiribati's terms of trade line. In addition, draw Kiribati's autarky production, autarky consumption, post-trade production, and post-trade consumption. Finally, draw appropriate indifference curves. Remember to fully label your graph. (note: you should know the exact location of post-trade production. Post-trade production, autarky consumption, and autarky production need to be consistent with the model, but precise locations are not necessary.)
2. c.)(3 points) Based on your answer to part b, does Kiribati have comparative advantage in fish or sugar? Explain.

d.) (3 points) Where do the gains from trade come from in the classical model of trade? What does this say about who benefits the most when large countries trade with small countries?

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PROBLEM 2 (35 points): Assume that the Aruba is a small, open economy with respect to motorcycles. In addition, assume Aruba' demand and supply for motorcycles are given by:

1 6

: = 1 2

where denotes the price of a motorcycle, denotes the quantity demanded of motorcycles, and denotes the quantity supplied of motorcycles. Remember to show all work.

1. a.)(5 points) Calculate the autarky equilibrium price and quantity of motorcycles in Aruba.
2. b.)(5 points) Assume the world price of a motorcycle is $300 and Aruba allows free trade.
3. Calculate Aruba's levels of domestic production, domestic consumption, and imports/exports of
4. motorcycles.
5. c.)(7 points) Assume that Aruba instead imposes a 100% ad valorem tariff on motorcycles.
6. Calculate the post-tariff price, domestic consumption, domestic production, and
7. imports/exports of motorcycles in Aruba.
8. d.)(3 points) Calculate the government revenue created by the tariff.
9. e.)(7 points) Assume that instead of a tariff, Aruba imposes a quota on motorcycles, limiting the
10. country to 2,000 imported motorcycles. Calculate the post-quota price, domestic consumption,
11. domestic production, and imports/exports of motorcycles in Aruba.
12. f.)(3 points) What ad valorem tariff would result in the same domestic production as the quota
13. from part e?
14. g.)(5 points) Assume that quota rents accrue to the Aruban government. Which policy is better for
15. Aruba, the tariff from part c or the quota from part e? Explain. (Note: based on the information provided in this problem this question can be answered with certainty.)

: = 1,000

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PROBLEM 3 (15 points): Answer each of the following questions about preferential trade agreements.

1. a.)(2 points) Define trade creation.
2. b.)(2points)Definetradediversion.
3. c.)(4 points) How might a preferential trade agreement be welfare-increasing for a country?
4. d.)(4 points) How might a preferential trade agreement be welfare-decreasing for a country?
5. e.)(3 points) Are preferential trade agreements ever more efficient than free trade? Explain.

PROBLEM 4 (25 points): Answer each of the following questions about the foreign exchange market.

1. a.)(2 points) Define the spot exchange rate.
2. b.)(2points)Definetheforwardexchangerate.
3. c.)(3 points) Mathematically define the relationship between the spot exchange rate, the forward
4. exchange rate, and the two countries' interest rates.
5. d.)(5 points) Intuitively explain why the equation you defined in part c must be true.
6. e.)(5 points) Assume that on May 21st, 2021, the exchange rate between the U.S. dollar (USD) and
7. British pound (GBP) was 1.415 USD per GBP. On the same day, the exchange rate between the USD and the euro (EUR) was 1.218 USD per EUR. Use the cross rate to calculate GBP per EUR on May 21st, 2021.
8. f.)(5 points) Assume that on May 28th, 2021, the exchange rate between the U.S. dollar (USD) and British pound (GBP) was 1.419 USD per GBP. On the same day, the exchange rate between the USD and the euro (EUR) was 1.219 USD per EUR. Use the cross rate to calculate GBP per EUR on May 28th, 2021.
9. g.)(3 points) Using your answers to part e and f, did the EUR appreciate or depreciate relative to the GBP. Explain.