Reference no: EM133078175

1. Consider a small country like Canada which produce two goods: manufacturing and food products. Assume it exports manufacturing products (the capital intensive good) and imports food.

(i) Using a graph with production possibility frontier and community indifference curves, represent the free trade equilibrium. Make sure to identify production and consump-tion. Briefly justify your answer.

(ii) Suppose now that the Canadian government would like to increase the share of laborused in the manufacturing sector (i.e. decrease K/L used in manufacturing) while keeping full employment of the factors of production, what should the governmentdo? Should it find a policy that contributes to increase, to decrease or to do nothing regarding the production of manufacturing goods? Explain your reasoning and usegraph as appropriate.

(iii) To achieve its goal, the government can choose among three types of policies: (a)to subsidize wage payment in manufacturing (for each worker in manufacturing, the government pays a share α of the wage rate so that manufacturing firms effectively pay(1 - α)w); (b) to tax or to subsidize the production of manufacturing; or (c) to tax or to subsidize the exports of manufacturing products. Identify precisely what each of(a), (b) and (c) does on the allocation of resources and for the government's goal. It does not matter whether you consider a tax or a subsidy for (b) and (c) as long as youexplain carefully and precisely what either the tax or the subsidy does.

(iv) Considering the goal of the government and the effect of each policy on overall welfare,rank three policies that you consider as the most appropriate ones from the most efficient to the least efficient. That is indicate for (b) whether a tax or a subsidyshould be selected, idem for (c), and indicate a ranking among these three policies from best to less best. Explain your reasoning.