EC433 Test 1

LOOK OVER PROBLEMS FROM 2ND HALF OF PRACTICE SHEET

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.........France ...Indonesia Machines.....3 .........1 Cloth (yards) .....15 ......7 a. Which country has an absolute advantage in producing machines? in producing cloth? Explain with numbers.

*France* has absolute advantage in both machines (b/c 3>1) AND cloth (b/c 15>7)

If international trade isn't causing the widening wage gap, what is?

*Technological change*: Technology progresses faster in industries that use skilled labor, like software development. Causes: - increase in demand for skilled labor-intensive goods - higher demand for (and therefore a higher wage for) skilled labor

"Once we recognize that product differentiation is the basis for much international trade, there are likely to be more winners and fewer losers in a country when the country shifts from no trade to free trade." There may be several reasons why this statement is true. What are the reasons? Explain each briefly.

- Product differentiation provides the foundations for international trade as consumers demand different products and so consumer choice increases when imports are allowed. - International trade allows consumer surplus to increase as other countries may experience lower wages and lower other factor costs, reducing the cost of production for firms, allowing for these lower costs to be passed on to the consumer. These cheaper products are then exported to other countries.

Why does the Heckscher-Ohlin theory predict that most research and development (R&D) activity is done in the industrialized countries?

- R&D is a production activity that is intensive in the use of highly skilled labor (scientists and engineers) - Heckscher-Ohline model states that a country should specialize in and export the good which uses its abundant factor of production. - Since industrialized countries are more capital abundant than non-industrialized countries, the industrialized countries should specialize in and export capital-intensive goods which include R&D

What is the Leontief Paradox?

- Tested truthfulness of Heckscher-Ohlin theory - Proved the theory right, the US was a net exporter of products that use factors intensively

Consumer surplus:

- The difference between what a buyer is willing to pay for a given amount of a good or what he or she pays for that amount of the good. - Consumers are left with a net gain when they pay the market price instead of what they valued the product at.

What is clustering? What kind of economy is it an example of?

- When export opportunities provide an advantage to firms in a given industry clustered in a particular location. Knowledge spillovers and pooling of labor reduce their costs of production. - Example of external scale economies

What do these global organizations do? - World Bank - International Monetary Fund - World Trade Organization

- World Bank = lends funds to developing countries - International Monetary Fund = work w countries on financial issues - World Trade Organization = work with countries on trade issues

Explain why: product differentiation the basis for much international trade, there are likely to be more winners and fewer losers in a country when the country shifts from no trade to free trade

- consumer choice will increase when free trade is implemented. - Consumers buy from other countries that make goods that aren't available in their country - International trade opens markets to levels unreachable by only domestic trade, demand increases due to the product differentiation that takes place among different countries

.........France ...Indonesia Machines.....3 .........1 Cloth (yards) .....15 ......7 b. Which country has the comparative advantage in producing machines? in producing cloth? Explain with numbers. (Divide other number by the number ur looking at) FOR COMPARATIVE ADVANTAGE, YOU WANT THE # TO BE LOWER

...........................France ...........................Indonesia Machines......*5* (15/3)........................*7* (7/1) Cloth (yards)...*1/5* (3/15).............*1/7* (1/7) So, *France* has comparative advantage in Machines b/c 5 is less than 7 *Indonesia* has comparative advantage in Cloth b/c 1/7 is less than 1/5

5 entry modes to foreign markets: - Exporting - Licensing - Franchising - Joint ventures - Wholly-owned subsidiaries

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Heckscher-Ohlin model

A country will tend to export those goods that use intensively its abundant resources; it will tend to import those goods that use intensively its scarce resources. When an industrialized country gets good at producing a good, eventually it does not need skilled labor to produce it. This is when they begin importing the good instead because they can utilize the cost benefits associated with importing the good

Consider our standard model of the economy, with two goods (wheat and cloth) and two factors (land and labor). A decrease now occurs in the relative price of wheat. What are the short-run and long-run effects on the earnings of each of the following: Labor employed in the wheat industry? Labor in the cloth industry? Land used in the wheat industry? Land in the cloth industry.

A decrease in the relative price of wheat leads to decrease in production of wheat. This also leads to increase of relative price in cloth and production. With a lower price of wheat and lower production, there is less demand for land and labor in the wheat industry. With a higher price of cloth and efforts to expand cloth production, there is more demand for both land and labor in the cloth industry. In the long run, factors are mobile between industries. The shrinking of wheat production releases a relatively large amount of land and relatively little labor, while the expansion of the cloth industry requires a relatively large amount of labor and relatively little land. Thus, labor benefits from strong demand for its services. Land experiences weak demand.

Stolper-Samuelson Theorem

As a country liberalizes its international trade, its *abundant factors tend to gain* from trade and its *scarce factors tend to lose* from trade

The United States exports a substantial amount of scrap iron and steel to Turkey, China, Canada, and other countries. Why do some U.S. users of scrap iron and steel support a prohibition of these exports?

Because a country exports goods and services if the world price is higher that the domestic price. So U.S. users would want to prohibit this trade because with this trade agreement, U.S. users are paying more for scrap metal than they would if there was no trade.

As a result of the North American Free Trade Agreement (NAFTA), the United States and Canada shifted toward free trade with Mexico. According to the Stolper-Samuelson theorem, how did this shift affect the real wage of unskilled labor in Mexico? In the United States or Canada? How did it affect the real wage of skilled labor in Mexico? In the United States or Canada?

Because there is more unskilled labor in Mexico, and more skilled labor in the US and Canada, free trade will help both. With free trade, Mexico will import skilled-labor and export unskilled labor. The US and Canada will do the opposite by exporting skilled labor and importing unskilled labor. So this, will reduce the wage of unskilled labor in the US/Canada and increase the wage of unskilled labor in Mexico. Vice versa, the wage of skilled labor will decrease in Mexico and increase the wage of skilled labor in the US/Canada.

"According to the Heckscher-Ohlin theory, two countries that have the same production technologies for the various products that they produce are unlikely to trade much with each other." Do you agree or disagree? Why?

Disagree - as this theory suggests that even though production is the same, each country will have different resources at their disposal, causing them to have different abilities to make certain products. These countries may still trade with each other frequently if depending on their abundance of the resources needed to produce said product.

Scale economies are important in markets that are not perfectly competitive. What is the key role of scale economies in the analysis of markets that are monopolistically competitive? What is the key role in oligopoly?

In monopolistic competition, scale economies are found small or moderate. The key role of scale economies in the analysis of markets that are monopolistically competitive is to provide an incentive for larger production levels of each variety of the industry's products. A large number of firms and product varieties can exist and compete in the market. The key role of scale economies in the analysis of oligopoly is that they drive firms to become large so that a small number of firms come to dominate the market.

If a firm encounters significant up-front costs before production of a product begins, the more of the product that the firm produces, the lower the average cost of the product will be because those up-front costs will be spread over a larger number of products than if the firm produced less of the product. This effect is an example of a(n):

Internal Scale Economy (because it is just inside one org/country)

Marginal Cost Equation

Marginal Cost = change in total cost / change in quantity

The country of Pugelovia has an endowment (total supply) of 20 units of labor and 3 units of land, whereas the rest of the world has 80 units of labor and 7 units of land. Is Pugelovia labor-abundant? Is Pugelovia land-abundant? If wheat is land-intensive and cloth is labor-intensive, what is the Heckscher-Ohlin prediction for the pattern of trade between Pugelovia and the rest of the world?

Pugelovia is land-abundant as in this scenario they hold 30% of the land in this world, and only 20% of the labor in this world. Because of this, in the Heckscher-Ohlin prediction, Pugelovia will export land-intensive wheat and import labor-intensive cloth.

What do scale economies mean?

Refers to the lowering of per unit costs as a firm grows bigger.

Producer surplus

The difference between the price at which producers are willing to sell their goods and the price they actually receive.

A tropical country can produce winter coats, but there is no domestic demand for these coats. Explain how this country can gain from free trade in winter coats.

This country can gain by exporting these coats so long as the world price is greater than the costs incurred by local producers to make the coats. This creates a market opportunity in which producers are able to have a surplus.

What is autarky?

When a country has economic self-sufficiency

Assume the standard trade model with one country, Alpha, and the rest of the world. There are two goods (food and cloth) and two factors of production (land and labor). Further, assume that Alpha is labor abundant; the rest of the world is land abundant; cloth is labor intensive; and food is land intensive. When trade opens, Alpha exports cloth. Which of the following is most likely to happen in Alpha following the opening of free trade between Alpha and the rest of the world *in the long run* when land and labor are mobile between the two industries? (The result is consistent with the Heckscher-Ohlin model of trade.) a. All labor will gain while all the landowners will lose. b. All labor will lose while all the landowners will gain. c. Labor and landowners in the food industry will gain while labor and landowners in the cloth industry will lose. d. Labor and landowners in the food industry will lose while labor and landowners in the cloth industry will gain.

a. All labor will gain while all the landowners will lose. In the *LONG RUN* = ALL WIN & ALL LOSE

A monopolistically competitive industry exists in both Pugelovia and the rest of the world, but there has been no trade in this type of product. Trade in this type of product is now opened. a. Explain how opening trade affects domestic consumers of this type of product in Pugelovia. b. Explain how opening trade affects domestic producers of this type of product in Pugelovia.

a. Pugelovian consumers of this product now have more variety and lower costs. The well-being of Pugelovian consumers has increased because they have more options and pay less. b. Domestic producers lose because there are now more options for product substitution. Because of this increased substitution, producers must compete with the lower prices of imported products. However, producers now have the potential to increase their sales since they have access to a market of foreign customers who may prefer the Pugelovian product.

Looking at the product cycle, __________countries are more apt to export newer non-standardized products at ____________ stages of the product cycle. a. developed; earlier b. developed; later c. developing; earlier d. developing; later

a. developed; earlier

Since the late 1970s, China has been a strong __________ of manufactured goods and __________ of land-intensive products such as wheat. The trade pattern is ____________ with what happened in Japan, Korea, Taiwan, and Hong Kong previously. a. exporter; importer; consistent b. exporter; importer; inconsistent c. importer; exporter; consistent d. importer; exporter; inconsistent

a. exporter; importer; consistent

Comparing inter-industry trade with intra-industry trade, inter-industry trade is____________________________, while intra-industry trade is __________________________. a. more consistent with the Heckscher-Ohlin model of international trade; more likely to take place between developed countries b. more consistent with the Heckscher-Ohlin model of international trade; more likely to take place between a developed country and a developing country c. more likely to take place between developed countries; more consistent with the Heckscher-Ohlin model of international trade d. more likely to take place between a developed country and a developing country; more consistent with the Heckscher-Ohlin model of international trade

a. more consistent with the Heckscher-Ohlin model of international trade; more likely to take place between developed countries

Suppose the amount of exports of textile machinery from Italy to the rest of the world equals 60 billion tons. The amount of imports of textile machinery into Italy from the rest of the world is 40 billion tons. Therefore, the intra-industry trade share for machinery is a. 0.2 b. 0.8 c. 1.5 d. 0.67.

b. 0.8 T = 1 - |X - M| / X + M T = 1 - |60-40| / 60+40 T = 0.8 (highest is 1)

Specialization and International trade allow a country to ___________ beyond its production frontier. a. produce b. consume c. produce and consume d. neither produce nor consume

b. consume

If the dollar-pound exchange rate changes from $1.50 per £ to $2 per £, the dollar has _________against the pound (£) and the pound (£) has against _____________the dollar. a. appreciated; appreciated b. depreciated; appreciated c. appreciated; depreciated d. depreciated; depreciated

b. depreciated; appreciated

After doing his test, Leontief discovered that the U.S. was ____________ labor-intensive goods and ______________ capital-intensive goods. After this realization, Leontief concluded that there are different kinds of labor, natural resources, and capital, which is why his results were ______________ the original Heckscher-Ohlin model. a. exporting; importing; the same as b. exporting; importing; different from c. importing; exporting; the same as d. importing; exporting; different from

b. exporting; importing; different from

U.S intra-industry trade is _____for-high tech products (such as semiconductors and electrical generating machinery) which the U.S exports and imports in similar values mostly from advanced countries and leading emerging market economies. Intra-industry trade is_____ for some low-tech, labor-intensive products (such as apparel and household goods) which the U.S mainly imports from developing countries. a. high; high b. high; low c. low; low d. low; high

b. high; low

What is arbitrage?

buying something in one market and reselling the same thing in another market to profit from a price difference.

Adam Smith explained the benefits of trade in terms of ___________ advantage, and David Ricardo explained the benefits in terms of ____________ advantage. a. absolute; absolute b. comparative; comparative c. absolute; comparative d. comparative; absolute

c. absolute; comparative

"Many computer companies are clustered in California's Silicon Valley, and financial institutions and banks are concentrated in New York City." An explanation of this clustering and concentration is: a. increasing returns; i.e. economies of scale within a given firm in the industry. b. perfect competition within the industry. c. knowledge spillovers among employees within the industry interacting outside of the workplace.

c. knowledge spillovers among employees within the industry interacting outside of the workplace.

Assume the standard trade model with one country, Alpha, and the rest of the world. There are two goods (food and cloth) and two factors of production (land and labor). Further, assume that Alpha is labor abundant; the rest of the world is land abundant; cloth is labor intensive; and food is land intensive. When trade opens, Alpha exports cloth. Which of the following is most likely to happen in Alpha following the opening of free trade between Alpha and the rest of the world *in the short run* when land and labor are immobile between the two industries? a. All labor will gain while all the landowners will lose. b. All labor will lose while all the landowners will gain. c. Labor and landowners in the food industry will gain while labor and landowners in the cloth industry will lose. d. Labor and landowners in the food industry will lose while labor and landowners in the cloth industry will gain.

d. Labor and landowners in the food industry will lose while labor and landowners in the cloth industry will gain. (Food industry contracts in demand, in cloth industry there are gains because it is the good that is intensive... if *short run*, then one of the longer 2 options)

Which of the following is true of mercantilism? Mercantilists believed that: a. free trade is beneficial for the trading nations. b. under free trade each of the trading countries benefit equally. c. a nation does not benefit directly from its exports. d. national well-being was based on national holdings of gold and silver.

d. national well-being was based on national holdings of gold and silver.