ECON 491 - International Trade: Midterm 1

Autarky

A situation in which a country does not trade with other countries

Heckscher-Ohlin Theorem

An economy exports goods that are relatively intensive in its relatively abundant factors of production and imports goods that are relatively intensive in its relatively scarce factors of production.

Which one of the following is a conclusion of the Ricardian Model?

Consumers benefit from free trade by having access to cheaply (efficiently) produced goods.

opportunity cost

Cost of the next best alternative use of money, time, or resources when one choice is made rather than another

Ricardian Model: What goods does each country export?

Countries EXPORT goods in which they have a comparative advantage

Rybczynski Theorem

If you hold output prices constant as the amount of a factor of production increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases.

In what way does the specific-factors model add to the conclusions of the Ricardian model?

In the Ricardian model, a country is better off with free trade. In the specific-factors model, some of a country's resources will be worse off with free trade. -- SOLUTION: The specific-factors model adds the income distributions effects of trade to the Ricardian model.

In the specific-factors model, which of the following is treated as the mobile factor? a. labor b. land c. capital d. food

LABOR

H-O model: What does the model predict about factor prices, wages and rental rates?

Relative output prices and factor prices will equalize, neither of which occurs in the real world.

Ricardian Model: In autarky (no trade), what would the relative prices be?

Relative prices would be equal to the opportunity costs in each country.

gravity model of trade

SIZE (GDP) and DISTANCE matter to int'l trade: • The size of an economy (GDP) is directly related to the volume of trade •The distance between two countries is inversely related to the volume of trade. Tij = (AYiYj) / Dij

comparative advantage

The ability of an individual, a firm, or a country to produce a good at a lower opportunity cost than another producer

absolute advantage

The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources

Leontief Paradox

The empirical finding that, in contrast to the predictions of the Heckscher-Ohlin theory, US exports are less capital intensive than US imports.

Specific Factors Model (SFM)

The model to analyze the effect of a change in commodity price on the returns of factors in a nation when at least one factor is not mobile between industries. • Allows for trade to affect the income distribution of the countries.

relative price

The price of a specific good or service in comparison to the prices of other goods and services.

Ricardian Model: What can we say about the value of relative prices after trade?

The relative price settles in between what the relative prices were in each country before trade (the opportunity costs).

Stolper-Samuelson Theorem

The theory that protection benefits the scarce factor of production. If a country imports goods that make intensive use of its scarce factor, then limiting imports will help that factor. In a labor-scarce country, labor benefits from protection and loses from trade liberalization.

Which of the following statements better capture the idea of the Border effect?

There is much more trade between pairs of Canadian provinces than between Canadian provinces and U.S. states, even when holding distance constant. -- SOLUTION: The trade barrier generated by the border is called the Border effect. The best way to characterize it is with the example we discussed in class on the US-Canada trade. In this example we found that there is much more trade between pairs of Canadian provinces than between Canadian provinces and U.S. states, even when holding distance constant.

Ricardian Model: Who benefits from trade?

Trade benefits all countries and everyone in them. • Income for workers who produce exports rises. • Imported goods become less expensive.

SFM: Which are larger, gains or loses?

Trade produces overall gains that exceed the losses. • Those who gain could in principle compensate those who lose while still remaining better off than before.

Ricardian Model

Uses the factor of differences in LABOR PRODUCTIVITY due to differences in TECHNOLOGY

issue with Ricardian Model

We don't observe full specialization in reality as the model predicts • Complete specialization prevented by transportation costs and other barriers to trade.

Whenever a nation has a lower opportunity cost of producing a good or service relative to another country, that nation is said to have:

a comparative advantage -- SOLUTION: According to the Ricardian Model, a country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than in other countries.

Heckscher-Ohlin model

a model of international trade in which a country has a comparative advantage in a good whose production is intensive in the factors that are abundantly available in that country.

In the specific-factors model, the effects of trade on welfare are _______ for mobile factors, _______ for fixed factors used to produce the exported good, and _______ for fixed factors used to produce the imported good

ambiguous (based on consumer preferences); positive (EX); negative (IM)

The United States requires 15 hours of labor to produce 1 ton of steel and 30 hours of labor to produce 1,000 board feet of lumber. In Canada, 20 hours of labor are required to produce 1 ton of steel and 25 hours of labor to produce 1,000 board feet of lumber. Under free trade, the wages in Canada relative to wages in the US must be (wCanada ) must be:

between 0.75 and 1.2 The wages in Canada relative to wages in the US (wCanada / wUS) must be between the relative efficiency in each industry. Canada is (15/20 = ) 0.75 as productive as the US in the steel industry, and it is (30/25 = ) 1.2 times more productive than the US in the lumber industry. Therefore, (wCanada / wUS ) must fall between 0.75 and 1.2.

In the specific-factors model with two goods (cloth and food), and with diminishing returns to labor, we assumed that capital was specific to the cloth industry and land was specific to the food industry. In this model, the production possibility frontier has a _______ shape. This implies that the opportunity cost of cloth in terms of food _______ as the relative production of cloth increases.

concave; increases. -- SOLUTION: According to the specific-factors model, diminishing returns to labor explain the concavity of the production possibility frontier, implying that the opportunity cost of cloth in terms of food increases as the relative production of cloth increases.

The Heckscher-Ohlin Model assumes that:

consumer tastes and technologies are the same in the two countries

The Heckscher-Ohlin model of international trade uses _______ and _______ to explain trade patterns.

factor abundance; factor intensity

Which of the following is the MOST likely explanation for the high volume of trade between the U.S. and Canada?

geographic proximity -- SOLUTION: The U.S. - Canada trade flow is a typical example of the Gravity Model to show that neighboring countries are more likely to trade with each other.

In the Heckscher-Ohlin model, suppose the production of cloth is relatively labor intensive while the production of food is relatively capital intensive. ***Holding the prices of cloth and food constant, if the amount of capital available for production decreases relative to the amount of labor, then the supply of cloth ________ and the supply of food _______.

increases; decreases -- SOLUTION: According to the Rybczynski theorem, if you hold output prices constant as the amount of a factor of production increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases.

The Ricardian model explains trade based on:

labor productivity differences across countries -- SOLUTION: According to the Ricardian Model, differences in the productivity of labor (technology) across countries generate comparative advantage.

The Gravity Model of Trade implies that _________ increases trade between two countries while _________ decreases trade between two countries.

one economy growing larger; greater distance between two countries

In the Heckscher-Ohlin model, suppose the production of cloth is relatively labor intensive while the production of food is relatively capital intensive. ***(Stolper-Samuelson theorem) If the relative price of food falls, the wage-rental ratio must

rise -- SOLUTION: According to the Stolper-Samuelson theorem, if the relative price of a good increases, then the real input price (wage or rental rate) of the factor used intensively in the production of that good increases, while the real input price (wage or rental rate) of the other factor decreases.

According to the gravity model, the volume of trade existing between two countries is affected by:

their size (GDP) and distance -- SOLUTION: The gravity model predicts that the distance between two countries is inversely related to the volume of imports and exports between them and the size of an economy (GDP) is directly related to the volume of imports and exports.

The specific-factors model concludes that if international trade increases the relative price of one industry, the owners of the factor specific to that industry:

will experience an increase in their real income

Suppose Germany and Belgium only trade with each other. Each produces wine and beer. The production of beer is relatively capital intensive, and the production of wine is relatively labor intensive. Germany is relatively abundant in capital, while Belgium is relatively abundant in labor. According to the Heckscher-Ohlin theorem, Belgium will export _______ and Germany will export ________

wine; beer -- SOLUTION: According to the Heckscher-Ohlin theorem, the country that is abundant in a factor exports the good whose production is intensive in that factor.

H-O Model: What happens to input factor prices if relative prices change?

• An increase in the relative price of a good causes the price (real wage or real rental rate) of the factor used intensively in the production of that good to increase • The price of the other factor of production decrease

H-O Model: What explain trade patterns in the Heckscher-Ohlin Model?

• Differences in the relative abundance of factors of production across countries. • Production processes use factors of production with different relative intensity.

SFM: Who gains and who loses with trade?

• Factors specific to export sectors in each country GAIN from trade • Factors specific to import-competing sectors lose. • Mobile factors that can work in either sector may either gain or lose.

H-O Model: Who gains and who loses with trade?

• Owners of abundant factors gain • Owners of scarce factors lose Does the gains exceed the loses? • Yes! A country as a whole is better off with trade, so winners could in theory compensate the losers

H-O model: Does the model find empirical support?

• Weak empirical support • Exception: Cases involving trade between high-income countries and low/middle- income countries OR when technology differences are included.