AQA A-Level Economics: International Economics and Development

Read the following extract and answer the question that follows.

The following extract was written for this exercise.

Solandia is a medium-sized open economy whose long-established steel industry employs many thousands of workers in a small number of towns. In recent years a wave of low-priced imported steel, produced in larger economies that enjoy lower costs, has pushed several Solandian mills to the brink of closure, and the volume of imports has climbed steeply. Domestic steel output has fallen and unemployment in the steel towns has risen. The government is under pressure to act and is considering a tariff on imported steel to protect the industry and the jobs that depend on it. Supporters argue that a tariff would give Solandia's mills breathing space to modernise and would safeguard communities with few alternative employers. Critics warn that a tariff would raise the price of steel for the many Solandian firms that use it, that trading partners might retaliate against Solandia's other exports, and that propping up high-cost mills would simply preserve inefficiency. The price of imported steel before any tariff is well below the price at which Solandian mills can profitably operate.

Solandia: steel market	Two years ago	Last year
Steel imports (thousand tonnes)	400	620
Domestic steel output (thousand tonnes)	900	720
Steel-industry employment (thousands)	45	36
Trade balance in steel (£m)	-120	-260
Proposed tariff rate on imported steel	none	25%

Question: Evaluate whether the Solandian government should impose a tariff on imported steel to protect its domestic steel industry. [25 marks]

An economy with a current-account deficit experiences a sharp depreciation of its currency. A government adviser notes that the trade balance is likely to get worse before it gets better.

Explain how a depreciation of the currency is likely to affect the current account of the balance of payments over time, with the help of a diagram. [15 marks]

A country can use its limited resources to produce two types of good: agricultural goods and manufactured goods. Producing more of one means giving up some of the other.

Analyse how the opportunity cost shown by a production possibility frontier underlies the law of comparative advantage, with the help of a diagram. [9 marks]

The economy of Arvonia publishes index numbers for the average price of its exports and the average price of its imports. Both indices are set equal to 100 in the base year. The table below shows the indices for two later years.

Price index (base year = 100)	Year 1	Year 2
Export price index	100	105
Import price index	100	120

Calculate Arvonia's terms of trade index for Year 1 and for Year 2, and state whether the terms of trade have improved or deteriorated between the two years. (6 marks)

The government of Lentaria has recently developed a new domestic electronics industry, while a flood of cheap foreign electronics threatens to overwhelm it.

Explain two reasons why the government of Lentaria might impose import tariffs on electronics. (5 marks)

Two countries, Velora and Tarsia, can each use one unit of resource to produce either wheat or steel. The table below shows the maximum output of each good that one unit of resource can produce in each country.

Maximum output per unit of resource	Wheat (tonnes)	Steel (tonnes)
Velora	80	40
Tarsia	30	30

Calculate each country's opportunity cost of producing one tonne of steel, and identify which country has the comparative advantage in steel and which in wheat. (4 marks)