Econ 340 - Chapter 1
1.4 What are some of the simplifying assumptions made by international economic theorist?
two nations two commodities two factors perfect competition Factors are made locally Transport costs are zero
1.17 Which commodity will the US import and export if the exchange rate between the dollar and pound is $0.50 per pound? 1 pound = $0.50 (US - 6W & 3C | UK - 1W & 2C)
1 pound = $0.50 In the UK Pw = 1.8 pounds = $0.90 Pc = 0.9 pounds (1.8/2) = $0.45 In the US Pw = $1 Pc = $2 The US would import both commodities and trade would be unbalanced in favor of the UK. This is because the exchange rate is so low that the US comparative advantage in both does not show. (Especially in wheat)
1.20 Determine which commodities will be exported and imported by the US if 1 pound = $2 Commodity Price in the U.S Price in the U.K. A 1 9 B 4 7 C 6 6 D 8 4 E 12 1
1 pound = $2 Commodities A B C D E Price in the UK 18 14 12 8 2 In this case, the US will export commodities A, B, and C to the UK and import E
1.17 Which commodity will the US import and export if the exchange rate between the dollar and pound is $3 per pound? 1 pound = $3 (US - 6W & 3C | UK - 1W & 2C)
1 pound = $3 In the UK Pw = 1.8 pounds = $5.40 Pc = 0.9 pounds (1.8/2) = $2.70 In the US Pw = $1 Pc = $2 Since both Pw and Pc (in $) are lower in the US than the UK, the US will export both commodities to the UK. Trade is unbalanced in the favor of the US. Thus the exchange rate between the dollar and the pound is so high that England's comparative advantage does not show.
1.2 How can we measure the degree of economic interdependence of a nation with the rest of the world?
1. A rough measure of economic interdependence of a nation with the rest of the world is given by the value of its imports as a percentage of its GNP (Gross National Product) 2. Small developed nations such as Belgium, Netherlands, Switzerland, Denmark, Sweden, etc. range from 30-60% 3. For larger developed nations such as Germany, England, France, Italy, etc. ranges from 20-30% 4. The US is about 9%
1.6 Why did mercantilism advocate the accumulation of gold?
1. Gold was seen as a stable and universally recognized form of currency during the era of mercantilism. (Until 1971). 2. Monarchs could equip the army's, buy the supplies, and maintain the navies that they need to consolidate power and acquire colonies.
1.6 How does the mercantilist concept of national wealth differ from today's view?
1. Mercantilist concept of nation wealth was measured by the stock market of precious metals (Gold & Silver) that is processed. 2. Today we measure a nation's wealth by the stock of human and natural resources that it uses in production.
1.3 Why does the US rely much less on international trade than any other noncommunist developed country?
1. The US is a nation of continental size. Immense natural and human resources. 2. The US can produce with relative efficiency
1.1 Why do we study it? (International economics)
1. To understand international economics primarily in order to analyze the effect of the international flow of goods, services, and factors of production on the welfare of domestic consumers. 2. As individuals and notes we study international economics in order to be able to form intelligent opinions on these matters.
1.13 With reference to Table 1.6, what quantities of C for 6W represent the limits within which mutually advantageous trade between the US and UK can take place? (US - 6W & 3C | UK - 1W & 2C)
12 C < 6W < 3C
1.12 With reference to Table 1.6 indicate what happens if 6W and exchanged for 3C. (US - 6W & 3C | UK - 1W & 2C)
6W for 3C the us gains nothing. All of the gains accrue to the UK. The US is indifferent and may not be willing to trade.
1.18 State the implicit assumptions on which Ricardo based his law of comparative advantage.
All resources are fully employed. There are no economies of scale. There are no barriers to entry or exit in industries. Factors other than labor, such as capital or natural resources, are not considered.
1.18 State the implicit assumptions on which Ricardo based his law of comparative advantage and explain why we must reject the assumption of The Labor Theory of Value.
Assumptions can be easily relaxed, but this assumption's purpose of the modern theory of international trade is to explain the law of comparative advantage on the basis of acceptable theory of value to relax most of the assumptions made by Ricardo to explain the basis and gain from trade.
1.2 In what way are they similar? How do both differ from the rest of economics? (International vs Interregional)
Both involve the overcoming of space and distance
1.15 With respect to problem 1.14, If Pc/Pw is stabilized at 1 with trade, how can you show the gains from trade for the US and UK?
If Pc/Pw = 1 with trade, the US gains by being able to import clothes from the UK. At a smaller relative price that the US could provide for itself [Pc/Pw = 2 in the US] Put differently, this means that the US can import 1 Clothes by giving up 1 Wheat. While to provide clothes domestically, the US would have to give up 2 Wheat for 1 Clothes. Since with trade Pc/Pw = 1 | The inverse Pw/Pc is also 1 for the US.
1.7 With reference to Table 1.3 (US - 6W & 1C and UK - 1W & 3C) indicate how much the US and UK gain if 6W were exchanged for 3C?
If the US exchanges 6W for 3C, the US gains 2C or would save 2 labor hours. (since the US can only exchange 6W for 1C domestically). The 6W which the UK receives from the US is equivalent or equivalent to or would require 6 labors hours to produce in the UK. The UK gains 15C or saves 5 labor hours.
1.9 With reference to Table 1.4 (US - 6W & 4C and UK - 1W & 3C) indicate the gains to the US and UK if they exchange 6W for 6C?
If the US exchanges 6W for 6C, the US gains 2c (since the US can only exchange 6W for 4C domestically). The UK would have required 6 labor hours to produce 6W itself. The UK uses these 6 hours to produce 18c. By then, exchanging 6 of the 18c for 6w, the UK gains 12c.
1.7 With reference to Table 1.3 (US - 6W & 1C and UK - 1W & 3C) indicate how much the US and UK gain if 6W were exchanged for 6C?
If the US exchanges 6W for 6C, the US would gain 5C or would save 5 labor hours. Since 6W requires 6 hours to produce in the UK, the UK could produce 18C. The UK will then gain 12C or 4 labor hours.
1.17 When will trade be balanced in the US and the UK? (US - 6W & 3C | UK - 1W & 2C)
If the exchange rate between the dollar and the pound is free to fluctuate and wheat and clothes are the only commodities produced and traded. The exchange rate will settle at the point at which the value of US export of wheat to the UK is balanced. If the exchange rate is fixed by international agreement, then the wage rate in each nation will have to change. Wage rate in the nation in the export surplus and fall in the nation with the import surplus until trade is balanced.
1.10 If a Lawyer earns $100 per hour at practicing law but can also type faster than her secretary who receives $10 per hour, does it pay for the lawyer to fire her secretary and do her own typing?
If the laywer can be fully occupied at practicing law, it would not pay for her to do her own typing. For each hour of typing that she does, she would save $20, since she can type twice as fast as her secretary, who recieves $10/hour. However, in order to type for one hour, the lawyer would have to give up $100. The lawyer would lose $80 for each hour typing.
1.20 Determine which commodities will be exported and imported by the US if 1 pound = $1 Commodity Price in the U.S Price in the U.K. A 1 9 B 4 7 C 6 6 D 8 4 E 12 1
In order to answer this question we must first express the price of all commodities in terms of the same currency and then compare the price in the two nations. For example, the dollar price of commodities in the UK when 1 pound = $1 1 pound = $1 Commodities A B C D E Price in the UK 9 7 6 4 1 In this case, the US will export commodities A and B to the Uk and import D and E
1.17 Which commodity will the US import and export if the exchange rate between the dollar and pound is $1 per pound? 1 pound = $1 (US - 6W & 3C | UK - 1W & 2C)
In the UK Pw = 1.8 pound = $1.80 (1.8 * 1) Pc = 0.9 pound = $0.90 In the US Pw = $1 Pc = $2 Therefore the US exports wheat to the UK and imports clothes. As this occurs Pw will rise in the US and fall in the UK. Until Pw will be the same in both countries.
1.16 Given table 1.8, express the limits for mutually advantageous trade in terms of Pc/Pw. What does this result indicate? (US - 4W & 2C | UK - 2W & 1C)
In the UK with the absence of trade Pw/Pc = 2. Thus, the UK also gains from trade because it imports Wheat at the relative price of 1 while to produce 1 Clothes domestically, it would have to pay the relative price of 2. This means that the price of clothes relative to the price of wheat is the same in both. Thus, there is no comparative cost or price advantage or disadvantage. No mutually advantageous trade is available.
1.19 In the absence of trade Pw / Pc = ½ in the US and 2 in the UK. The US has a comparative advantage in and should export wheat to the UK. While the UK has a comparative advantage in and should export clothes to the US. If we now add a third nation, Germany, where in the absence of trade Pw / Pc = 1, explain how multilateral trade among these three nations can take place?
In the US Pw/Pc = ½ In the UK Pw/Pc = 2 In Germany Pw/Pc = 1
1.14 If labor is the only factor of production and is homogenous (all of one type), as Smith and Ricardo assumed, express Pc relative to Pw for both the US and UK in the absence of trade. (US - 6W & 3C | UK - 1W & 2C)
In the absence of trade, the US can produce 1 Wheat with half the labor hours required to produce 1 Cloth. (⅙ is one half of of ⅓). This means that in the US, the cost of producing 1 Wheat or Pw (Expressed not in dollars but in labor content) Pw = Pc/2 or Pw / Pc = ½ The US in absence of trade. This read: Pw relative to Pc or ½ which is what we asked to find. Turning to the UK, we find that in the absence of trade the UK requires twice as much labor time to produce 1 Wheat as 1 Cloth. Pw = 2Pc or Pw / Pc =2 The Uk in absence of trade. It is this difference in relative commodity prices between the US and the UK that is the basis for naturally advantageous trade.
1.21 Why must we reject it? (The labor theory of value)
Labor is neither the only factor of production nor it is used in the same fixed position in the production of all commodities (such as steel, uses much less labor per unit of capital than others). Labor is obviously not all of one type (such as doctors, anybody much more skilled are more productive and receive much more salary. For this reason, the labor theory of value must be rejected. The modern theory of value overcomes these shortcomings and can be used to explain comparative advantage. Specifically, we can use the opportunity cost of theory and the production possibility curve.
1.2 How do international economic relations differ from interregional economic relations?
Nations impose restrictions on the free international flow of goods, services, and factors. Differences of languages, customs, and laws. International flows may involve receipts and payments in different currencies.
1.8 Why do nations usually impose restrictions on the free flow of trade?
Since Smith believed that free trade leads to maximum world welfare, it may seem paradoxical that nations invariably impose some restrictions on free flow of goods, services, and factors. In reality, they are advocated by and imposed to protect those industries that would be hurt by imports.
1.16 Given table 1.8, express the cost of producing Wheat and Clothes in the US and in the UK in terms of labor content. (US - 4W & 2C | UK - 2W & 1C)
Since the US produces 4 bushels of wheat by using 1 labor hour, cost of wheat in the US in terms of labor = 1/4 labor hour. Similarly, cost of wheat and cloth n terms of labor is calculated in the table: US UK Cost to Produce 1 Wheat (Labor Hour) 1/4 1/2 Cost to Produce 1 Cloth (Labor Hour) 1/2 1
1.8 How did Adam Smith explain his contention that all nations engaged in trade can benefit from trade?
Smith explained that if each nation specialized in the commodity in which it was more efficient, and exchanged this excess for the commodity in which is t was less efficient, the output of all commodities entering trade would increase. This increase would be shared by all nations that voluntarily engaged in trade. This is simply an extension to the international setting of the gains from specialization or division of labor. These gains would be maximized when the government interfered as little as possible with the oppression of the domestic economy (laissez-faire) and with international trade (free-trade).
1.6 How do mercantilists views on trade differ from those of Adam Smith?
Smith focused his attention on the internal administration of a nation, mercantilists focused in the external (geopolitical) competition between nations.
1.9 With reference to Table 1.4 (US - 6W & 4C and UK - 1W & 3C) indicate the commodity in which the US and UK have a comparative advantage?
The AA which the US has over the UK is greater in wheat than in cloth. The US has a CA in wheat and comparative disadvantage in cloth. This is always so in a two nation two commodity world.
1.12 With reference to Table 1.6 indicate what happens if 6W and exchanged for 12C (US - 6W & 3C | UK - 1W & 2C)
The US gains (12C - 3C) = 9C or 3 Hours The UK gains (6W - 6W [12/2]) = 0 or nothing The UK may be unwilling to trade.
1.12 With reference to Table 1.6 indicate what happens if 6W and exchanged for 9C (US - 6W & 3C | UK - 1W & 2C)
The US gains (9C - 3C) = 6C or 3 Hours The UK gains (6W - 4.5W [9/2]) = 1.5W or 1.5 Hours
1.11 With respect to each part of Table 1.5 indicate which commodity the US has an absolute and comparative advantage with respect to the UK and which commodity the US should export to England? (c. US - 4W & 2C | UK - 2W & 1C)
The US has AA in both. The advantage is the same in wheat as in cloth. The US is twice as efficient in both wheat and cloth. We cannot speak of CA or CDA and there can be no mutually advantageous trade.
1.11 With respect to each part of Table 1.5 indicate which commodity the US has an absolute and comparative advantage with respect to the UK and which commodity the US should export to England? (b. US - 4W & 1C | UK - 1W & 1C)
The US has AA in wheat. But equally as productive as the UK in cloth. The US has CA and should export wheat to the UK in exchange for cloth.
1.9 With reference to Table 1.4 (US - 6W & 4C and UK - 1W & 3C) indicate whether the US has an absolute advantage or disadvantage in wheat and clothes?
The US has the AA in both products. Trade under these circumstances cannot be based on AA.
1.1 What does international economics deal with?
The economic relations interdependence among nations. This influences the political, social, cultural, and military relations among nations.
1.10 Your answer for this question (If a Lawyer earns $100 per hour....) is an example of what principle?
This is an application of the law of comparative advantage to everyday life. The lawyer has an absolute advantage over her secretary in typing and the practice of law. However, her absolute advantage is greater in the practice of law than in typing since the secretary cannot practice law. It pays for the lawyer to specialize in law and leave typing to secretary. The secretary gains by not having to find a new job and possibly get paid less.
1.4 What is the purpose of theory?
To predict and explain.
1.18 State the explicit assumptions on which Ricardo based his law of comparative advantage.
Two nations and two commodities Free Trade Perfectly mobile labor within a nation completely immobile labor internationally Constant costs of production No transport costs No technological change
1.7 With reference to Table 1.3 (US - 6W & 1C and UK - 1W & 3C) indicate in which commodity the US and UK have an absolute advantage.
US - 1 Wheat cost ⅔ Cloth Thus, in the US should specialize in making Wheat (Lower Opportunity Cost) UK - 1 Wheat cost 3 Cloth Thus, the UK should specialize in making Cloth (Lower Opportunity Cost)
1.14 If labor is the only factor of production and is homogenous (all of one type), as Smith and Ricardo assumed, express the cost in terms of labor content of producing wheat and clothes in the US and UK as implied in table 1.6. (US - 6W & 3C | UK - 1W & 2C)
US UK Cost to Produce 1 Wheat (Labor Hour) 1/6 1 Cost to Produce 1 Cloth (Labor Hour) 1/3 1/2
1.11 With respect to each part of Table 1.5 indicate which commodity the US has an absolute and comparative advantage with respect to the UK and which commodity the US should export to England? (a. US - 4W & 3C | UK - 2W & 2C)
US has AA in both. But since AA is greater in wheat than in cloth, the US has the CA in wheat. The US should export wheat and specialize in it and import cloth.
1.4 What do they (international economist) seek to accomplish?
Using these assumptions international economists seek to predict and explain the composition and volume of the international flow of goods and services. International economists also seek to assess their impact on domestic welfare. They also seek to predict how national policies affect these flows and domestic welfare.
1.17 Assuming that the wage rate per labor hour is $6 in the US and 1.8 pounds in the UK. Express Pw and Pc in the US in terms of dollars and the UK in terms of pounds, in absence of trade. (US - 6W & 3C | UK - 1W & 2C)
1 labor hour receives $6 thus and produces 6 wheat. Pw = $1 ($6/6W) Similarly, 1 labor hour receives 1.8 pounds and produces 1 wheat. Pw = 1.8 pounds
1.20 Determine which commodities will be exported and imported by the US if 1 pound = $0.50 Commodity Price in the U.S Price in the U.K. A 1 9 B 4 7 C 6 6 D 8 4 E 12 1
1 pound = $0.50 Commodities A B C D E Price in the UK 4.5 3.5 3 2 0.5 In this case, the US will export commodities A to the Uk and import B, C, D, and E
1.16 Given table 1.8, Find Pc/Pw for both the US and the UK in the absence of trade. (US - 4W & 2C | UK - 2W & 1C)
For US, Pc/Pw = (1/2)/(1/4) = 2 For UK, Pc/Pw = 1/(1/2) = 2
1.13 With reference to Table 1.6, Would the UK be willing to exchange more than 12C for 6W? Why? (US - 6W & 3C | UK - 1W & 2C)
For the US to trade 6 W we must trade less than 12C but greater than 3C 12 C < 6W < 3C
1.13 With reference to Table 1.6, would the US be willing to exchange 6W for less than 3C with the UK? Why? (US - 6W & 3C | UK - 1W & 2C)
For the US to trade 6 W we must trade less than 12C but greater than 3C 12 C < 6W < 3C
1.1 How can we justify international economics as a special branch of economics?
On the ground that international economic relations differ from interregional relations.
1.14 If labor is the only factor of production and is homogenous (all of one type), as Smith and Ricardo assumed, express the cost or price of Wheat (Pw) in terms of labor content relative to the cost or price of Clothes (Pc) for the US and UK in the absence of trade. (US - 6W & 3C | UK - 1W & 2C)
Pc relative to Pw can be rewritten as Pc/Pw | Pw/Pc is the inverse or reciprocal of Pw/Pc. Since Pw/Pc = ½ in the US -> Pc/Pw = 2 also in the US. For the UK we found that Pw/Pc = 2. Therefore in the UK Pc/Pw = 2. Hence, the UK has the comparative cost or price advantage while the US has a comparative advantage in wheat.
1.17 Which commodity will the US import and export if the exchange rate between the dollar and pound is $2 per pound? 1 pound = $2 (US - 6W & 3C | UK - 1W & 2C)
Pw = 1.8 pound = $3.60 (1.8 * 2) Pc = 0.9 pound = $1.80 In the US Pw = $1 Pc = $2 Now Pw (in $) is lower and Pc (in $) is higher in the US than in the UK. The difference in relative commodity prices is reflected in a difference in absolute prices in the US and the UK. Thus, the US would export wheat to the UK and import clothes.
1.15 With respects to problem 1.14, express the limits for mutually advantageous trade in terms of Pw/Pc and Pc/Pw.
Pw/Pc = ½ in the US. Pw/Pc =2 in the UK. Thus, the limits of mutually advantageous are ½ < Pw/Pc < 2 In problem 1.14 c. we saw that in the absence of trade Pc / Pw = 2 in the US and Pc / Pw = ½ in the UK. Thus, the limits of mutually advantageous trade are ½ < Pc/Pw < 2. These results show that the US has a comparative cost or price advantage over the UK in Wheat and that the UK has a comparative advantage in clothes.
1.22 Figure 1-1 shows the result of an empirical test of the Ricardian trade model. The scales are logarithmic (so that equal distance refers to equal percentage changes). The vertical axis measures the ratio of the productivity of the U.S. Labor to that of U.K labor. The horizontal axis measures the ratio of U.S exports to U.K exports to the rest of the world in 20 industries. Does the figure tend to support or reject the Ricardian trade model? Why?
The figure supports the Ricardian trade model. That is the higher productivity of US labor in relation to UK labor, the higher the ratio of US-to-US export.
1.3 What would happen to its standard of living if the US withdrew completely from international trade?
The impact would be minimal. We would lose luxury items such as coffee, champagne, foreign automobiles.
1.21 What does the labor theory of value state?
The labor theory of value or price of a commodity is equal to or can be inferred from the amount of labor time going into the production of the commodity. This implies: Either that labor is the only factor of production or that labor is used in the same fixed proportion in production of commodities. Labor is homogenous (i.e one type) Based on these assumptions we were able to say that (in exercise 1.14) since only ⅙ of labor time is required to produce 1 unit of wheat while ⅓ of labor time is required to produce 1 unit of clothes in the US in the absence of trade, then Pw = Pc/2 in the US.
