ECON 1535 Final Exam PART THREE
n the absence of wage di§erences across countries, there would not be multinationalÖrms in the world.
False. For example, if there exists transportation cost that are increasing in distance, there still could be horizontal FDI due to internal economies of scale
In horizontal models of multinational activity, foreign direct investment flows between neighboring countries are particularly appealing.
False. Horizontal FDI replicates production abroad, and tends to take place between similar countries when transport costs make exporting costly. Vertical FDI is a fragmentation of the production process, and tends to take place in countries with disimilar factor endowments.
In perfectly competitive environments without externalities, an import tari§ can only increase welfare if it generates positive tari§ revenue. (6 points)
False. Import quota raises the domestic price of sugar for consumers, so consumer surplus decreases, and consumers are worse off (see slides 23-24, Lecture 19; and slide 23,Section 10).
If factors are freely mobile across sectors, opening up to trade has no distributional consequences
False. In a Heckscher-Ohlin framework, opening to trade changes factor rewards. In particular, relatively scarce factors have high rewards in Autarky. When a country opens to trade, the good intensive in the abundant factor is exported, raising the relative reward of the abundant factor.
(H-O Model) What, besides trade, could be generating those trends in relative employment levels?
One alternative theory for the wage premium increase is skill-biased technical change: technology favoring the employment skilled workers creates increased demand for skilled labor. Increased demand for skilled labor would result in higher employment. Secular increases in supply through education or migration would have the opposite effect on wages but would also result in increases in skilled labor employment.
The anti-globalization movement is responsible for the stalling of the Doha round.
[FALSE - FARMERS AND OTHER STUFF...]
There exists little evidence that multinational Örms generate positive productivity spillovers in their host countries.
[FALSE - VERTICAL SPILLOVERS]
The gravity equation is flawed because the U.S. trades much more with Mexico than with Germany even though Germany's GDP is much larger than Mexico's
[FALSE ó distance]
Barack Obama is preparing his inauguration address. In his speech, he would like to discuss the situation of the U.S. auto industry, but he is a bit confused about which policies should be used to prop up U.S. auto makers. Mr. Obama Önds 2 your contact information on Facebook and decides to give you a call to seek your advice. Would you advise him to use trade policy to protect U.S. producers against foreign competition? Would it work? What alternative policies might work? Brieáy describe your recommendations.
[Say trade policy is only second-best solution. Also, ideally, mention FDI so that it is not obvious the policy would work since most foreign competition actually produces in U.S. or Mexico]
Reciprocal dumping between Canada and the United States is more likely to increase welfare than reciprocal dumping between Japan and the United States.
[TRUE BECAUSE OF PRO-COMPETITIVE EFFECT AND LOW TRANSPORT COSTS WITH CANADA]
In the two-good, two-country Ricardian model, the larger one country is, the less likely it is that it will beneÖt from free trade.
[TRUE ñ MORE LIKELY THEYíRE INCOMPLETELY SPECIALIZED]
The use of voluntary export restraints (VERs) is hard to justify in perfectly competitive models.
[TRUE ñStraight from class]
Economic growth in the rest of the world may be welfare-enhancing for the U.S.
[TRUE ñTERMS OF TRADE EFFECT]
Weak intellectual property right protection in the developing world does not necessarily reduce world welfare.
[TRUE]
Paul Krugman once wrote: ìThere is no generally accepted label for the theoretical underpinnings of GATT. I like to refer to it as ëGATT-thinkí ñ a simple set of principles that is entirely consistent, explains most of what goes on in negotiations, but makes no sense in terms of economics. [...] To make sense of international trade negotiations, one needs to remember three simple rules about the objectives of negotiating countries: 1). Exports are good. 2). Imports are bad. 3). Other things equal, an equal increase in imports and exports is good. In other words, GATT-think is enlightened mercantilism.î Do you agree with Krugman? Or can we make sense of GATT/WTO negotiations in terms of economics?
[Terms-of-trade theory and so on
International trade and Foreign Direct Investment are complements.
[UNCERTAIN - HORIZONTAL VS. VERTICAL]
Preferential trade agreements should be encouraged because they provide a partial approachment towards global free trade.
[UNCERTAIN - TRADE CREATION/DIVERSION]
Which of the following are potentially valid arguments for tari§s or export subsidies, and which are not (explain your answers)? 1. ìThe more oil the United States imports, the higher the price of oil will go in the next world shortage.î 2. ìThe growing exports of o§-season fruit from Chile, which now accounts for 80 percent of the U.S. supply of such produce as winter grapes, are contributing to sharply falling prices of these former luxury goods.î 3. ìU.S. farm exports donít just mean higher incomes for farmers ñthey mean higher income for everyone who sells goods and services to the U.S. farm sector.î 4. ìSemiconductors are the crude oil to technology; if we donít produce our own chips, the áow of information that is crucial to every industry that uses microelectronics will be impaired.î 5. ìThe real price of timber has fallen 40 percent, and thousands of timber workers have been forced to look for other jobs.î
The correct answers for this section depend mostly on your assumptions and your stated reasoning. There are no a priori right or wrong answers and if you have doubts about your answers you should come talk to me during oce hours.
There exists little evidence that multinational firms generate positive productivity spillovers in their host countries.
There exists little evidence that multinational firms generate positive productivity spillovers in their host countries. (5 points) From lecture 19: False. Aitken and Harrison (1999) estimate the productivity effects of inward FDI on a sample of Venezuelan manufacturing plants in the period 1976-1989. Although the average effect of FDI on plant productivity is positive, domestic firms in sectors with larger foreign presence actually record lower productivity levels. So average effect is purely coming from foreign firms being more productive. Other authors have found positive horizontal spillover effects in other countries. Smarzynska (2004) argues that spillovers from FDI are more likely to be vertical than horizontal in nature; finds that the positive effects of FDI take place mostly through backward linkages, with a negligible effect of FDI through either horizontal or forward linkages. So local suppliers become more productive when MNEs enter a country
Both tariffs and export subsidies increase the price of a good inside the country relative to the world price
True. A tariff obviously increases the price of imported goods. With an export subsidy, in order for the producer to be indifferent between selling domestically and abroad, the domestic price must be higher than the export price by the magnitude of the subsidy.
In models of trade with monopolistic competition, consumers gain access to an overall larger number of varieties, but may end up with a lower number of domestically produced (or local) varieties.
True. First note that when opening to trade, the total number of firms increases. When no barriers to trade exist, there is no difference from the firm's perspective between selling domestically and exporting. In this case, the effect of opening to trade on the total number of goods available to consumres is isomorphic to the analysis of an increase in country size. Greater demand per firm puts downward pressure on average cost and upward pressure on average revenue. For the two to balance in equilibrium, the total number of firms must rise. Next, note that the number of domestic firms may decrease. To see this, we can decompose the effects on the domestic firms into the effect of import competition, whcih decreases overall demand for domestic goods, and the effect of opening to exports, whcih increases demand for domestic goods. The net effect will depend on the demand function specified in the model.
In models of trade with monopolistic competition, consumers gain access to an overall larger number of varieties, but may end up with a lower number of domestically produced (or local) varieties.
True. For example, with the setup in section notes on monopolistic competition, when two symmetric countries trade with each other, total variety increases from pS/bF to p2S/bF. However, local variety decreases from pS/bF to 1 2 p2S/bF .
Free trade agreements are more likely to be widely supported by the population when they entail a large amount of intraindustry trade between the signing countries.
True. In a model with two industries, one homogenous good on differentiated good, intra- and inter-industry trade happens. The former happens only in the industry with differentiated products, due to love of varieties, and the latter, as in the H-O model, happens due to differences in factor prices. As in any H-O model, free trade agreements could come under fire in this setup because factors that are scarce and protected in autarky or under a tariff regime might lose from trade as their relative factor rewards decrease (due to factor price convergence). However, when countries that enter into free trade agreements are more similar (in terms of factor abundance) relatively less inter-industry and relatively more intra-industry trade takes place. In this case, it is more likely that all individuals gain overall, with the gain from consumption (due to increased variety) outweighing loss from factor price convergence for the scarce group.
Import quotas may be welfare-improving.
True. In a small open economy, import quotas don't affect the terms of trade, and create deadweight loss. In a large economy, if quota licenses are held domestically, then the gain to domestic producers and the quota license fees or profits on a quota can outweight the loss in consumer surplus. This is because the reduced consumer demand changes the terms of trade, making imports cheaper. That the net effect is positive is only the case with a "small enough" effect (i.e. one equivilant to a small enough tariff); as the quota becomes more restrictive, the loss in CS outweights the gains in terms of trade, tariff rent, and PS.
There exists some evidence that productivity spillovers tend to operate through vertical linkages rather than within industries.
True. In particular, empirical studies covered in lecture identify FDI as a primary method of technology transmission between countries, as domestic firms share their production techniques with foreign affiliates.
There exists some evidence that productivity spillovers tend to operate through vertical linkages rather than within industries.
True. Smarzynska shows that spillover happens mainly through backward vertical linkages (i.e. local suppliers become more productive). There is little evidence for spillovers through horizontal or forward vertical linkages.
Export taxes are not often observed in the real world because they are opposed bydomestic Örms, who often are able to ináuence politicians.
True. The producer surplus will decrease under export taxes, which may leads lobbyist for domestic exporting firms to oppose the policy.
Trade liberalization causes more productive firms to increase their market shares.
True. This is a prediction of the Melitz model.
The more dissimilar in their relative factor endowments two countries are, the more likely that any bilateral FDI activity between them will be vertical rather than horizontal in nature. (6 points).
True. Trade costs make vertical FDI more costly by increasing the price of foreign inputs for domestic firms. On the other hand, large trade costs favor horizontal FDI by making exporting more costly, so firms prefer to set up a plant in the foreign country to avoid these trade costs. See slides 25-37 of Lecture 17.
In models of trade with monopolistic competition, consumers gain access to an overall larger number of varieties, but may end up with a lower number of domestically produced (or local) varieties.
True. While we know that the overall number of varieties available consumers must always increase when opening to trade, the resulting number of domestic varieties available is ambiguous. If the equilibrium number of varieties increases one-for-one with population size, then opening to trade (which in a simple model of intra-industry trade would be equivalent to an increase in domestic population), would not result in a decrease in domestic varieties. Alternatively, the number of domestic varieties can go up less than 1-for-1 with the population size, in which case opening to trade would result in a decrease in the number of domestic firms even while overall number of good available to consumers increases.
Import quotas may be welfare-improving.
True. You could provide a graph similar to slide 13 in the Review Section and argue about the terms-of-trade effect. It was also important to write that this is not true for a small open economy and that the effect depends on who collects the revenue from quotas (see slide 24 in the Lecture 19).
A first possibility is for the firm to start exporting in a given foreign market, where you are told that there is likely to be demand for the firms' products. Discuss how certain characteristics of your firm (its size, productivity or quality), certain characteristics of the products it manufactures (weight-to-price ratio), and certain characteristics of the foreign market (the size of the demand there, its distance to the U.S., etc.) are particularly relevant to assess the profitability of this decision. How do each of these factors impact the profitability of exporting?
When the firm accesses the foreign market through export, the main variables that determine profit are trade cost, productivity, foreign market size, demand elasticity and competition. (For example, in the linear demand example in lecture 17, the profit of the exporter is Sb[1/(nb) (1/2)t] 2 FE FD.) • When the the product has a high weight-to-price ratio or when the destination is far from the U.S., the trade cost will be high (t high), which drives down profit. • When the foreign market is larger (S large), the profit will be higher. • Given foreign demand, higher productivity leads to higher profit. • If the quality of the good is such that demand elasticity is low or foreign competition is low, then the profit will also be higher. • How about the size of the firm?
What is the optimal trade policy? How is it different from the actual trade policy?
Discuss the rationale behind trade policy (terms-of-trade and correction of distortions) Discuss the political economy of trade policy
Discuss the (partial equilibrium) welfare implications (on consumer and producer surplus) of restrictions to international trade in a world with dynamic economies of scale. In particular, explain whether a country may Önd it optimal to restrict imports for a period of time, and if so, why and for how long? Are there preferable policies that achieve the same goal? No need to use math or graphical analysis, but feel free to do so if it helps you.
Dynamic (external) economies of scale mean that average costs of firms fall with the increase in the cumulative output (in the industry) over time. In this environment, if a country is more efficient (in a particular industry) relative to other countries for each level of output but initially produces less than other countries, then trade restrictions might increase welfare (consumer and producer surplus) if they allow the industry to become larger over time. Restrictions should be in place up to a point where the industry achieves 1 enough output to outperform other countries. However, to correct external economies of scale it is preferable to use domestic policy instruments (e.g., subsidies) rather than tariffs.
Define the collective action theory of policy determination, and explain whether it isrelevant to the theory of trade policy determination. Justify your answer. (8 points)
Lecture 20 Notes
Discuss the partial-equilibrium e§ects of trade liberalization in a setting in which ini-tially there is a monopolist at Home and one Abroad with identical marginal costs.What are the implications for consumer welfare and producer welfare? And for aggre-gate welfare? Consider the following four scenarios (No need to use math or graphicalanalysis, but feel free to do so if it helps you):1 (a) Firms compete in prices and there is free trade after the trade liberalization. (4points)(b) Firms compete in quantities and there is free trade after the trade liberalization.(4 points)(c) Firms compete in prices and there are trade costs even after the trade liberaliza-tion. (4 points)(d) Firms compete in quantities and there are trade costs even after the trade liber-alization. (4 points
(a) From a monopoly to a Bertrand duopoly, the price will be suppressed to marginal cost. This will increase the consumer welfare, suppress the producer surplus to 0, and the total surplus increase (b) From a monopoly to a Cournot duopoly, the price will be suppressed. This will increase the consumer welfare, suppress the producer surplus domestically, (even when firms will earn foreign profit, its aggregate profit will decline under certain assumption)and the total surplus increase (c) The price will becomes the min{c+t, p^m}. If c+t < p^m, then CS increase, PS decrease domestically compared to monopoly, firms earn zero profit oversea. aggregate welfare increases. (d) ?
In 2006, Proctor and Gamble (P&G), one of the largest American multinational consumer goods companies opened a new manufacturing plant in Lodz, Poland, to produce Gillette blades and razors. 1. Hypothesize on the potential rationale for opening a manufacturing plant in Poland and relate it to the location decision models of FDI developed in class. (10 points) 2. Why do you think that P&G decided to internalize that production transfer rather than subcontracting it to an independent manufacturer of blades and razors? (10 points) 3. The Polish government subsidized part of the investment necessary to build the plant in Lodz. Why would the Polish government use public funds to subsidize P&Gís foreign investment? Discuss potential reasons in light of the evidence discussed in Lecture 19 on the economic impact of multinational Örms. (10 points)
1. Broadly, there are two types of multinational activity, vertical and horizontal. P&G may be seeking to build a plant closer to an export market (let's say, EU countries) in a way which will allow it to circumvent trade costs, including transportation costs from a US factory to the EU, and tariffs on goods coming from the US into the EU. If the Polish plant produces final goods that are shipped locally, we suspect this horizontal FDI is due to P&G trading off the additional fixed cost of foreign plants for variable cost savings. Alternatively, P&G may be trying to exploit lower local factor prices (perhaps a lower cost of labor in Poland). This vertical FDI would imply the Polish plant sends on its intermediate or final goods back to the home country for sale. Potentially, both rationales can be at play, where P&G want to set up an EU factory to decrease variable trade costs but choose Poland instead of larger richer countries where final goods are destined for (UK, Germany) to exploit its lower local factor prices. 2. The decision to internalize production is a result the tradeoff f P&G's faces between the costs and benefits associated with different levels of control over the production process. It may be less costly to transfer production methods and technology to foreign affiliates instead of independent foreign firms. If P&G's production process includes a lot of trade secrets, for example, it may be beneficial to keep control over the production process abroad. Additionally, contracting difficulties and the importance of P&G's headquarter services in their production process may lead P&G to internalize production. If P&G is sourcing parts from the Polish plant, and these parts are not standard but specific to P&G's final product, P&G may have trouble ensuring quality standards and getting an independent foreign producer to enter into an agreement to produce specific parts that are not resaleble. P&G may thus have decided to internalize production to resolve these bargaining issues. 3. For the Polish government to want to subsidize P&G, there must be some positive benefit to producers or consumers in Poland that isn't captured by market forces, i.e. some externality on Poland of P&G's decision to locate production in Poland. Empirical studies of FDI have shown that FDI leads to technology spillover and increased local productivity. In addition, the subsidy has to lead P&G to locate in Poland where otherwise they would choose another location for production. While FDI raises domestic wages, this would only enter into the decision to subsidize P&G's investment if these wages were rents captured by Polish workers at P&G or were accounted for by spillovers to local worker productivity. Foreign multinationals usually higher, better quality (more skilled, experienced) workers, which make it appear as though foreign companies pay higher wages. Controlling for these kinds of worker characteristics, we still find local wages increase when FDI is present. However only if this is due to a productivity spillover would Poland want to entice P&G to come, and then only if Poland's subsidy shifted P&G's decision would it be worth it
Consider the standard Heckscher-Ohlin model, with two goods: computers and t-shirts. The two goods are produced with two factors of production skilled labor and unskilled labor, and the production of computers is skilled-labor intensive relative to the production of t-shirts. All countries in the world have access to the same production technologies for producing these goods. 1. Without the need to provide any mathematical details, discuss the effects that a move to free trade will have on the wages paid to skilled and unskilled workers in a country (call it Home) with a large endowment of skilled labor relative to unskilled labor (a skilled-labor-abundant country). Feel free to appeal to any theorems you know, without needing to prove them. Discuss the same effects from the point of view of an unskilled-labor-abundant country (call it Foreign). (10 points) 2. What is the effect of trade integration on the incentives for skilled workers to migrate across countries? (10 points) 3. If trade is not free, from which country to which country would the model predict skilled workers should be migrating to? Do you find this realistic? If not, what assumptio
1. By the Heckscher-Ohlin theorem, we know that a country with a large endowment (relative to other countries) of skilled labor will have comparative advantage in the skill-intensive indusry. We therefore know that when this country trades, it will export the good that is skill-intensive, and the price of that good will go up in equilibrium. By the Stolper-Samuelson Theorem, we know that an increase in the price of the skill-intensive good increases the relative factor reward of skilled labor. The same holds true for unskilled labor in the unskilled-labor intensive country. 2. Skilled workers will want to migrate if the receive higher wages in the foreign country. The incentive to migrate is positively related to the difference in wages. We know that trade has an equalizing effect on factor rewards, therefore it will lessen the incentive to migrate. 3. If trade is not free, skilled labor will have higher reward in the country where skills are relatively less abundant. In the real world, we sometimes see this kind of migration for unskilled labor moving to skilled countries, but we also often see "brain drain" where skilled labor flows out of countries where skilled labor is relatively rare. One reason for this might be that the returns to skill are still higher in skill-abundant coutnries. One way to reconcile that hypothesis with the model is to introduce differences in technology. If skill-abundant countries have technologies that increase the productivity of skilled workers, skilled workers may still have higher wages in skill-abundant countries. [If the rewards to skill are determined by technology differences and a heterogenous workforce chooses whether or not to invest in human capital based on the rewards to skills, then this positive relationship between the reward to skills and the abundance of skills in an economy arises endogenously].
For each of the following example, explain whether this is a case of horizontal FDI, vertical FDI, or a combination of both: 1. Fordís decision to produce certain models (such as the Ford Fiesta) in Spain. 2. Gilleteís plant producing razors in ×Ûd¥z, Poland. 3. BMWís plant in Spartanburg, South Carolina, producing the X series. 4. Western Digitalís harddisk assembly plant in Malaysia. 5. Johnson and Johnsonís plant in Geel, Belgium.
1. Horizontal or a combination of both 2. Vertical 3. Horizontal or a combination of both 4. Vertical 5. Vertical Points could be given if argument is solid.
Discuss the (partial equilibrium) welfare implications (on consumer and producer surplus) of moving from autarky to trade in a world in which a sector features only two Örms worldwide (one in each of two countries). Overview the Bertrand and Cournot cases, with an without trade costs. No need to use math or graphical analysis, but feel free to do so if it helps you. (8 points)
1. In Bertrand competition, firms compete in prices. With symmetric firms and free trade, trade leads to marginal cost pricing. With symmetric firms and costly trade, the most efficient domestic firm will serve the market by undercutting the competitor. In both cases trade leads to (weakly) lower price and markup for the domestic monopolist. Consumer surplus goes up because of the lower prices and producer surplus (profits) goes down. Overall, total welfare goes up because competition induced by trade reduces distortions 1 caused by monopolies (it brings allocation closer to the point where marginal costs are equal to the demand). In Cournout competition, firms compete in quantities. With symmetric firms and free trade, trade leads to lower prices (but still higher than marginal costs) and lower markups for firms. With symmetric firms and costly trade, both firms will serve the market (comparing to Bertrand case) but domestic firm will have higher market share. There will be reciprocal dumping where a foreign firm charges lower price (net of trade costs) comparing to its own domestic market. Consumer surplus goes up because of lower prices. In contrast to Bertrand case, producer surplus consists of domestic surplus/profits (goes down because of competition from foreign firm) and foreign surplus/profits (goes up because of the access to new market). Total welfare might increase (because of the lower monopoly distortion) or decrease for high trade costs (because of the replacement of domestic production with high cost importing). See slides 24-41, Lecture 15; and slides 5-8, Section 8.
In a small open economy, a tari§ will induce similar changes (changes in the same direction) for both consumer and producer surplus
False. A tariff raises the domestic price, so producers who previously produced at the world price reap additional surplus, and producers who were on the margin now produce, adding additional surplus, so producer surplus increases. Consumer surplus decreases since fewer consumers purchase the good and those that do pay a higher price. Due to the In a small open economy, world price is fixed, though this information is not necessary to answer the question.
The Stolper-Samuelson theorem predicts that trade liberalization will increase wageinequality in less developed countries.
False. After trade, the relative price of unskilled-labor-intensive product will increase. According to Stolper-Samuelson Theorem, this will increase the relative real wage of unskilled workers, therefore, shrinking the wage inequality in less developed countries.
The Heckscher-Ohlin model is useless because it predicts factor price equalization and we observe large factor price differences in the world.
False. All models are simplified versions of the real world. If some of the model's predictions are not observed in the data it does not mean that the model is useless. Instead we need to focus which assumptions of our theory are crucial and not observed in the world. For example, to ensure factor price equalization (FPE) in the HO model we assume zero trade costs, a small difference in capital-labor ratios and identical technologies between countries. Relax one of these assumptions and FPE will not be satisfied but we will still have useful predictions. For example, HO model have good predictions if we introduce technological differences between countries, for more on this see Trefler (1995).
In perfectly competitive environments, export subsidies may be beneficial when applied by sufficiently large countries.
False. Export subsidies are never beneficial. Export subsidies decrease consumer surplus and increase producer surplus, but with the government expenditure, they're always net negative. In addition, when large countries impose export subsidies, they flood foreign markets with their exports, reducing the cost of their exports. Thus export subsidies by large economies deteriorate the country's terms of trade, adding to the welfare loss.
An export tax on chicken may decrease welfare, but since most people consume chicken, this tax makes the vast majority of society better o§. (6 points)
False. Export subsidy raises the domestic price of corn for consumers, so consumer surplus decreases, and consumers are worse off (see slides 25-26, Lecture 19; and slide 24, Section 10).
Export taxes are welfare reducing and that is why they are only used by populist governments.
False. Export taxes do lower the domestic price, reducing producer surplus and raising consumer surplus. When the economy is a small open economy, the additional government revenue from the tax is insufficient to cover the difference between the lost consumer surplus and the gained producer surplus, and there is deadweight loss. However, large producers (like Saudi Arabia as an oil exporter) are able to manipulate the world price using an export tax. In particular, the decrease in domestic production (and the increase in domestic consumption) act as a negative shift in world supply of exported oil, increasing the world price. This attenuates the effect of the tax overall. Importantly, the affect on exports is lower than before. For a small tax, the additional government revenue (above and beyond the government revenue without the manipulation of world price) is first order to the deadweight loss, so a small tax can be welfare enhancing.
Economies of scale are inconsistent with perfect competition Similar countries mostly have inter-industry trade Capital abundant country does not import capital-intensive goods
False. External Economies of Scale are consistent with perfect competition False. Intra-industry False. In the presence of intra-industry trade capital abundant country is a net exporter of the capital intensive goods. It still imports capital-intensive varieties
Imposing tariffs can become a first-best policy if unemployment is large enough
False. First-best policies address market failures and problems directly, not via trade policy. Trade policy may be considered a 'second best' if such first-best policies are unavailable and if it is possible to identify the source of market failure.
Intra-industry trade between two countries requires differences in relative factor endowments across these countries.
False. In a simple model of intra-industry trade, monopolistically competitive firms need only use one factor to produce and trade goods. Because firms produce unique varieties using that single factor, and because consumers enjoy added variety, demand exists domestically for foreign varieties even though their factor content is identical to domestic varieties (in this case, because the same factor was used to produce both goods).
Trade policy choices of governments usually try to cater to the median voter.
False. In real world, many trade policies benefit very few voters. The problem of collective action is a more plausible explanation.
Intra-industry trade between two countries requires differences in comparative advantage.
False. Intraindustry trade can happen with love for variety preferences even when the two countries are symmetric (have the exact same technology and endowments
Exporters are larger than non-exporters in comparative advantage sectors, but they are smaller than non-exporters in comparative disadvantage sectors.
False. On average, exporters are larger than non-exporters in all sectors. The idea is that more productive firms can pay fixed cost of exporting while less productive firms cannot. Notice that in models with monopolistic competition and differentiated products all sectors can export because of the love of variety. So, the argument that firms from comparative dis-advantage sector will not export is not valid in this environment.
Preferential trade agreements should be encouraged because they provide a partial approach towards global free trade
False. Preferential trade agreements 1 that lower tariffs between only two countries can lower welfare. If differentially lower tariffs make expensive goods from one country relatively cheaper than from another country that doesn't have a preferential trade agreement but that was producing the good cheaply, imports will rise from the former and fall from the latter, and government revenue will fall. The net effect on welfare may be negative
Reciprocal dumping is always welfare-reducing
False. Reciprocal dumping only emerges when price ¿ MC, which happens in the presence of market power. If there are two natural monopolies (one in each country), reciprocal dumping improves welfare by reducing markups and increasing competition.
The WTO should let China tax its exports of rare earth metals because China only harms itself by imposing such taxes, while the rest of the world is made better off.
False. The argument is wrong because if China is large open economy that can affect world prices, export tariff can be beneficial to China (see slide 15 in the Review Section).
The law of comparative advantage does not work in the HO theory because countries have the same technologies. Factor unit requirements do not depend on factor prices. We see an increase in skilled to unskilled wage ratio in the developing countries. Trade theories cannot explain this.
False. The law of comparative advantage is about the differences in autarky and trade relative prices. These differences might come from the differences in technologies (Ricardian model), relative endowments (HO model), etc. False. It is true only for Leontief technology. False. Standard HO theory cannot explain this but offshoring can explain it.
The anti-globalization movement is responsible for the stalling of the Doha round.
False. The potential trade agreements to be reached at the Doha round would have lowered agricultural subsidies in developed nations in exchange for reduced tariffs on industrial products in developing nations. Gains were modest, it was difficult to reach Pareto improvements, and agriculture subsidies are politically sensitive in developed nations.
Intra-firm trade is quite rare in practice; In the data, on average, more productive firms engage in horizontal FDI; Increase in trade (e.g., transportation) costs has a negative impact on Horizontal FDI; Increase in trade costs has a negative impact on Vertical FDI.
False. The share of intra-firm trade is quite large (about 50%); True; False. It is more likely to increase Horizontal FDI; True. With higher transportation costs we have lower benefits of fragmentation;
mport quotas are preferred to import tari§s because they do not require that thegovernment collects tari§ revenue.
False. The welfare impact of import quota depends on who owns the license. If the license belongs to the foreign countries, the domestic total welfare will be worse off.
Import tariffs always decrease welfare? Export subsidies generate gains for our economy because they improve our terms-of-trade? Export taxes can increase welfare.
False. There might be terms-of-trade gains but true for small open economy False. Export subsidies (weakly) deteriorates terms-of-trade True. If ToT effect dominates distortions from tax
Trade policy choices of governments usually try to cater to the median voter.
False. Trade policy often deviates from what one would expect under the theory of the median voter because of collective action problems; trade policy effects a small number of people a great deal, while the gains from trade are often distributed very widely. This makes it easier for those benefiting from a tariff or quota, e.g., to organize and influence policy.
There are no good reasons for trade protection, even for developing countries.
False. When external economies of scale exist, trade protections can defend infant industries and allow domestic firms to capture market share. Also, trade policy can be used strategically to capture market share as in the Boeing/Airbus example from class. More geneerally, production may have positive spillovers, thus protection of positive-spillover industry may have welfare-enhancing overall effects.
Suppose that you are CEO of a big company. What would affect your decision regarding the organization of production? If you want to move some production abroad, will you do it within firm or contact with another firm?
Horizontal FDI: trade costs, fixed costs, proximity-concentration trade-off, etc; Vertical FDI: factor prices, trade costs, communication costs, contractual environment;
(H-O Model) What happens to the relative wage of skilled workers (relative to the wage of unskilled workers) in the developing country? Is this consistent with the empirical evidence on 2 wage inequality for developing in the last half-century?
In skill-scarce countries, the HO model predicts the opposite to be true: wages of unskilled labor should increase since that is the relatively abundant good. This is inconsistent with the evidence on wage inequality which shows a growing wage premium for skills in developing nations as well.
(H-O Model) What happens to the relative employment levels of skilled/unskilled workers in both sectors (high tech and low tech)? Is this consistent with the empirical evidence for the US? Feel free to consider the case of no factor substitution or the case with factor substitution.
In the case without factor substitution, the relative amounts of each input are fixed, and there can be no change in the relative employment of skilled vs unskilled labor in each industry. When factor substitution is allowed, the increase in wages of skilled workers means that firms choose to substitute to the cheaper factor of production, unskilled labor. [In the HO model, full employment is guaranteed via changing industry composition in favor of the skill-intensive good but] therefore the relative employment of skilled workers in each industry should be decreasing. This is not supported by empirical evidence. Most of the increase in skilled-labor employment comes from within-industry shifts.
President Trump is frustrated at how little his international trade advisors have achieved this year. He fires them all and, impressed by your performance in Economics 1535, he hires you and asks you to give him a crash course on international trade policy. In particular, he has the following questions for you: 1. How would an increase in tariffs vis-a-vis Mexico affect U.S. producers, consumers, and U.S. tax revenue? 2. What is the balance of these effects assuming no retaliation from Mexico? 3. What if Mexico were to retaliate? 4. Is an increase in tariffs within NAFTA countries consistent with WTO rules? 5. If NAFTA was dismantled, under what conditions would such an increase in tariffs with Mexico be consistent with WTO rules? 6. Should the U.S. leave the WTO?
In this problem, I focus on partial equilibrium analysis with perfect competition as in lecture slides. 1. Since the U.S. is likely to be a large country relative to Mexico, import tariff can lead to improvement in terms-of-trade. Producers are better of, consumers are worse off, tax revenue goes up. 2. Here you need to discuss the effect of the tariff on total surplus: consumer surplus, producer surplus, terms-of-trade effect. For extra points you could also briefly discuss how this sum varies depending on the elasticities/slopes of import demand and export supply curves (see Section 10). 3. It would (weakly) negatively affect the U.S. The answer depends on whether Mexico can affect the U.S. prices or not. If Mexico is a small open economy relative to the U.S., then Mexico's tariff will have no impact on the U.S. On the other hand, if Mexico's tariffs can affect U.S. prices, then U.S. terms-of-trade will deteriorate. 4. No. It is not consistent within NAFTA because according to WTO rules preferential trade agreements should have zero tariffs. 5. It would be consistent if it is not discriminatory (MFN should apply). 6. I think that no. Otherwise, we might have a trade war where many countries will raise tariffs on the U.S. products. Also, the WTO provides a mechanism to solve trade disputes.
Discuss why standard HO theory cannot explain the rise of inequality?
Inconsistency with the data: Relative price of skill-intensive products to unskilled intensive products, PC PF , goes down (not up); Relative wage, wh wl , goes up in developing countries too; Skill-intensity rises mostly within industries;
DeÖne the concept of intraindustry trade, explain how it is computed and why it is relevant to the theory of international trade. (8 points)
Intra-industry trade is a two-way trade within the same industry between countries. It is measured using the following formula: VI−I = 1 − |Export − Import| / Export + Import A large share of trade is intraindustry trade between similar countries. "Old" trade theories based on perfect competition could not explain this (these theories could explain interindustry trade between countries different in factor endowments and technologies). "New" trade theory pioneered by Paul Krugman can explain intra-industry trade. See Lecture 14.
Define the median voter theory of policy determination, and explain whether it is relevant to the theory of trade policy determination. Justify your answer
Median voter theorem of policy determination is the following. Suppose people have different preferences over some policy (e.g., tariffs), and we order them along this dimension (e.g., some prefer small tariffs while others prefer large ones). Also, assume that preferences are single-peaked, that is all people have their preferable policy and the further away we are from this policy, the less they like it. Then median voter theorem predicts that political parties will converge to the policy of the median voter in order to increase their support. We can apply this theory to trade policy determination. However, it seems inconsistent with the actual trade policy: quite often there are small groups of people that have large benefits from a trade policy while others have small costs.
Suppose finally that a foreign company approaches you with an interest to license the technology for producing your firm's products. More specifically, the firm offers you a fee for the rights to produce and sell the products in their local market in the next calendar year, with the possibility of renewing the contract if sales are high and both parties are in favor of extending the contract. Assess the pros and cons of this o§er.
One benefit of having a local firm is that the local firm may have lower operation costs due to their knowledge of the market. For example, they may find buyers more easily and deal with local regulations more efficiently. Thus, the technology may lead to higher profit and the licensing fee can potentially be higher than the original FDI profit. Meanwhile, licensing out the technology can help the company avoid some agency problem by giving local managers higher incentive. One drawback is contractibility. For example, when the licensing fee depends on the sales of the product, but the sales reported by the local firm is hard/costly to verify. Or when the quality of the product is hard to verify, the local producer may produce low quality goods that hurts your reputation. Another drawback is costly technology transfer. For example, when intellectual property protection is weak, the local firm may steal your technology and never pay the licensing fee again after the first year
Discuss the extent to which the recent escalation of trade tensions between U.S. and China is happening through the legal umbrella of the WTO, and to which extent it is not. (8 points)
One of the major WTO principles is MFN (most-favored-nation) treatment: countries cannot discriminate their trading partners, a country receives the minimum tariff applied 2 to all trading partners. Tariffs imposed by Trump administration violate this rule. However, there are some exceptions to this rule. According to section 232, unilateral tariffs might be imposed based on national security threats (this section was used for steel and aluminum); according to section 201 tariffs can be imposed to give temporary relief to injured domestic industries (was used for solar panels and washing machines); and according to section 301 tariffs can be imposed based on unjustified, unreasonable, or discriminatory practices by foreign government that burdens or restricts U.S. commerce (was applied to different goods). Eventually, all these exceptions will be review by WTO. See slides 31-34 Lecture 21.
1. For each of the following example, explain whether this is a case of external or internal economies of scale. a) Most musical wind instrument in the USA are produced by more than a dozen factories in Elkhart, U.S. b) All Hondas sold in the United States are either imported or produced in Marysville, Ohio. c) All airframes for Airbus (Europeís only producer of large aircraft) are assembled in Toulouse, France. d) Hartford, Connecticut, is the insurance capital of the northeastern United Stat
Part I It is key for you to remember that internal economies of scale occur when the average cost of producing a certain product decreases as a firm produces more of it. External economies of scale occur when the average cost of producing a certain product is decreasing as the size of the industry increases. 1. External economies of scale. 2. Internal economies of scale. 3. Internal economies of scale. 4. External economies of scale.
Evaluate the relative importance of economies of scale and comparative advantage in causing the following: a) Most of the worldís aluminum is smelted in Norway or Canada. b) Half of the worldís large jet aircraft are assembled in Seattle. c) Most semiconductors are manufactured in either the United States of Japan. d) Most Scotch whiskey come from Scotland. e) Much of the worldís best wine comes from France.
Part II 1. Comparative advantage first, and then probably economies of scale. 2. Economies of scale. 3. Comparative advantage in skilled labor first and then economies of scale. 4. Comparative advantage first, and then probably economies of scale. 5. Comparative advantage.
Discuss the extent to which the recent loss of manufacturing jobs in the U.S. can be ascribed to increased trade with China. Discuss the evidence for and against such a link.
Several papers (e.g., Autor, Dorn, Hanson (ADH) and Pierce and Schott (PS)) documented that an increased competition with China after 2000 led to the decline in manufacturing employment in the U.S. The key idea behind ADH paper is that in the medium run labor is immobile across space, so there has been a decline in the manufacturing employment in the locations with high concentration of industries that competed with China. The key idea behind PS paper is the following: once China joined the WTO, this removed uncertainty regarding the potential tariff increases. They showed that industries more exposed to this change experienced higher employment loss. The key counter-argument to the trade hypothesis is that there might be other reasons behind the decline in manufacturing employment, for example automation of production.
(H-O Model) What happens to the relative wage of skilled workers (relative to the wage of unskilled workers) in the developed country? Is this consistent with the empirical evidence on wage inequality for the US in the last half-century?
Skilled labor is relatively abundant in the US. The HO model predicts that increased trade integration will increase the wage of the relatively abundant resource, so wages of skilled labor in the US should increase. This is consistent with the rise of the college wage premium in the US over the last half-century.
There exists little evidence that multinational firms generate positive productivity spillovers in their host countries.
Uncertain. The evidence is mixed. It seems that there are no horizontal spillovers although there are positive vertical spillovers. See slides 27 and 28 in the Lecture 18.
The Stolper-Samuelson theorem rationalizes the increase in the skill wage premium observed worldwide in the last 30 years. (6 points)
Uncertain/False. It is true with perfect competition and no economies of scale, but it is false with external economies of scale or in models with imperfect competition. See Lecture 13, Lecture 14 and Section 7
Suppose that the demand for the firms' products is particularly large and the goods are relatively expensive to ship. Can you think of an alternative strategy that might be more profitable than exporting? Which other factors are likely to make this second strategy particularly successful?
When the foreign demand is large and trade cost is high. The firm may choose to service the foreign market through horizontal FDI instead of exporting. Related to large demand, when productivity is high, sales is large and FDI is more attractive than exporting. Meanwhile, horizontal FDI is also more desirable when firm level economy of scale is high and plant level economy of scale is low. (i.e. FE large and FD small in the Lecture 17 example).
Discuss the effect of trade liberalization on the industry with monopolistic competition and internal economies of scale;
With firm heterogeneity this leads to within industry reallocation. Most productive firms expand, less productive firms shrink, so the average productivity rises, etc.
