Home and Foreign produce two goods, flowers and soybeans. Home exports the labor

Question

Home and Foreign produce two goods, flowers and soybeans. Home exports the labor intensive flowers and Foreign exports the land intensive soybeans. Suppose that Home provides an export subsidy to its domestic flower producers. The provision of an export subsidy to flower producers by Home will cause

A. an improvement in Foreign's terms of trade. B. the relative demand for flowers to increase. C. the relative supply of flowers to decrease. D. Home's terms of trade to improve.

The provision of the export subsidy by Home on flowers, in the absence of Metzler's paradox, will have which of the following income distribution effects?

A. It worsens Home's terms of trade but aids its exporting sector as the internal relative price of flowers declines. B. It improves Home's terms of trade and aids its exporting sector as the internal relative price of flowers increases. C. It worsens Home's terms of trade but aids its importing sector as the internal relative price of flowers increases. D. It worsens Home's terms of trade and harms its exporting sector as the internal relative price of flowers declines.

Explanation / Answer

For the first question, it is D. Home's export susbsidy will encourage more export of flowers, which means the export index will be higher than the import index, leading to a favourable economic condition given the ToT formuala: (Index of Export Prices/Index of Import Prices)*100. The relative supply of flowers will not decrese, since the producers will be producing more. The relative demand of flowers will not increase, because the prices are bound to rise according to the Heckschler-Ohlin theory, which implies a shift in the consumption of flowers. Foreign's terms of trade will not improve, since he will end up importing more flowers, leading to a higher import index.

[If you cannot understand ToT, do not worry, It is not easy. However, placing figures and referring to the formula mentioned in bold will help you get a clearer picture, and answer objectively]

For the second question, the Metzler's paradox does not exist, which means the price of flowers cannot decline. This rules out options B and C, since the price of flowers cannot increase, and Home's terms of trade cannot improve. Now, it cannot be D since the exporting sector cannot be harmed by export subsidies, considering all other factors remain stable. Hence, by process of elimination, we are left with A. This complies with the absence of Metzler's paradox, and the rule of thumb that export subsidies aids exports, considering all other factors remain unchanged.

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