ECO 4704 Final Exam

An industry pollution that is not taken into account by firms. Which of the following must be true about social and private costs and benefits for this industry in the market equilibrium? - SMC < SMB and PMC > PMB - PMB > SMB and PMC = PMB - SMC < SMB and PMC = PMB - none of the above

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In the ideal world of first best, in which of the following case will a country never gain from a tariff? - A small country levying a small tariff - A small country levying a large tariff - A large country levying a small tariff - Both a and b above

- A small country levying a large tariff chapter 10

the principles of WTO

- Liberalization of trade - no discrimination or most favored nation status - no unfair encouragement to export (Notes 5 I think)

trade diversion

- The shift of trade from low-cost outside producers to higher-cost bloc-member producers - Trade diversion results in a loss to the country that is part of or joining a trade bloc as it is now forced to buy its existing imports at higher prices.

HO Theorm

- a country exports the good that uses its abundant factor intensively & - imports the good that uses its scarce factor intensively

Label a graph for a small country imposing a quota

- change in producer surplus: g - change in consumer surplus: (g+h+i+j) - deadweight loss: (h+j) - Government rev (if quota licenses are auctioned off).: i - If import licenses are allocated based on a resource-using application procedure, the loss to the economy will be equal to the area: (h+j+ part of i) - If import licenses are allocated based on fixed favoritism, which area will be captured by importers?: i

FBE Theorm

- laborers earn equal wage rate (w) in both countries - units of land earn equal rental return (r) in both countries - Factor price equalization theorem states that, under certain, conditions, returns to similar factors are equalized across countries. In this case,it implies that wage earned by labor will be equalized across countries. The same will be true for the return to land across countries. The theorem says nothing about what will happen to the wage in one country relative to the land rent in that country.

S-S Theorem (Long Run)

- raises real return to factor used intensively in price rising industry - lowers real return to factor used intensively in price falling industry - i.e. abundant factor gains in real terms in the long run

comparative advantage

- the country with the lower relative pre trade price - one country cannot have have the comparative advantage in both goods - countries will export the good they have the comparative advantage in - countries will specialize in the good that they have the comparative advantage in

trade creation

- the new volume of trade created as a result of formation of a trading bloc due to lower tariff among members. - delivers usual gains from the production and consumption effect as tariff on imports with bloc-member countries is reduced.

Formula for ITT (Intra-industry trade) Share

1 - [ |X - M| / (X + M) ] X- exports of goods of an industry M- imports of goods of the same industry

IIT share formula to find overall intra-industry trade share

1 - Σ [ |X - M| / Σ (X + M) ]

a single firms innovations in production technology often benefit the production of other firms because these other firms learn about the technology and can use some of the ideas in their own production A) is there an externality here? B) how would an economist rank the following 2 policies in this situation and why? 1. a tariff on imports to make sure that domestic production using the new technology occurs & 2. a subsidy to domestic production, to make sure that domestic production using the new technology occurs C) what third policy would the economist recommend as even better than these two?

A) Yes, there are external benefits, a positive spillover effect. The benefits to the entire country are larger than the benefits to the single firm innovating the new technology. Other firms that do not pay anything to this firm receive benefits by learning about and using the new production technology B) The economist would say that the production subsidy is preferable to the tariff. Both can to used to increase domestic production, but the tariff distorts domestic consumption, leading to unnecessary DWL (the consumption effect) C) The economist would use the specificity rule. The actual problem is that innovating firms do not have enough incentives to pursue new production technologies (because other firms get benefits without paying). The economist would recommend some form of subsidy to new production technology as better than a production subsidy or tariff. The technology subsidy could be a subsidy to undertake research and development, or monetary awards or prizes for new technology once it is developed.

"a tariff on imports of a product hurts domestic consumers of this product more than it benefits domestic producers of the product" do you agree or disagree? Why?

Agree. Note that in the standard diagram representing the effect of tariff, loss to consumer is areas (a+b+c+d) which represent the decrease in consumer surplus as a result of increase in domestic price due to imposition of tariff. On the other hand, gain to producers is only area a which represents increase in producer surplus. Thus, we see that a tariff hurts domestic consumer more than it benefits the domestic producers.

in which of the following case is a country expected to lose at least as much or more than a quota with licenses distributed through resource-using procedures?

An equivalent tariff

What other gains may arise in a country that chooses to join a trade bloc?

By joining a trade-bloc a country can also gain from increase in competition which will reduce prices by reducing monopoly power of the firms which is a source of inefficiency. Competition also lowers costs of production by providing incentive for innovation and implementation of new technologies. It can also gain as its firms can now exploit economies of scale due to access to larger markets. Finally, it can also increase foreign business investments which increases growth and allows access to new technology, management techniques and marketing capabilities.

(Fully) economic union

Common Market + common economic policies. Example: Eu-ropean Union

common market

Customs union + free flow of factors such as labor and capital. Ex-ample: European Common Market (prior to formation of EU)

A friend in your study group tells you, "The import quota and the voluntary export restraint have exactly same effect of welfare of a country except that the VER is imposed by the foreign government (at the request of domestic government) and the import quota is imposed by the domestic government. So, you only need to study the import quota and remember that little difference." Do you agree or disagree? Explain why.

Disagree they do not have the same effect, the VER cannot produce any national benefit, whereas the quota has the potential to if a large country imposes a small quota

in a monopolistically competitive market, as the market size increases, the price curve _______ and the unit cost curve ________.

Does not move; decreases

"In presence of intra-industry trade, there are likely to be more losers than winners in a country when it shifts to free trade." Is this statement true or false? Give arguments in support of your answer.

False. There are likely to be more gainers than losers. In presence of intra-industry trade, consumers gain not only from reduced price but also from an increase in number of varieties available for consumption. More importantly, intra-industry trade does not lead to large changes in factor prices like inter-industry trade where by virtue of Stolper-Samuelson Theorem one factor loses and real terms and another gains in real terms.

THe different types of trade blocks

Free-trade area Customs union Common market (Full) economic union

What is the gain/loss to it from a subsidy per good on domestic production of goods? formula

In case of production subsidy, there is no consumption effect and overall welfare effect is: t - r

Which factor(s) will gain in absolute terms in the short run?

In short-run, exporting sector gains as the price of the good it produces rises due to exports.

Which factor(s) will gain in the long run in absolute and relative terms?

In the long-run, the abundant factor gains both in absolute (nominal) and relative terms.

Which of the following is a principle of GATT or WTO?

Liberalization of trade (pg.187 last paragraph)

customs union

Members remove trade barriers among themselves as in a free-tradearea and also adopt a common set of external barriers. Example: MERCOSUR

Free-trade area

Members remove trade barriers among themselves but keep their separate national barriers against trade with non-members. Example: NAFTA, CAFTA. - If some countries are negotiating to form a new trade bloc, they are likely to start with the formation of a free trade area, because it requires minimum degree of policy coordination across countries.

The presence of large amount of intra-industry trade in the world trade data is consistent with

Monopolistic competition model of international trade

In which of the following case will the resulting trade be primarily intra-industry trade? - The trading countries differ in endowments. - The trading countries differ in technology - Both a and b - None of the above

None of the above

Bhutan, a small country, has recently doubled its tariffs to raise more revenues for the government. As a result, it is currently losing an estimate $320 million due to tariffs. How much was Bhutan was leaving before the doubling of the tariffs?

Not enough information, we need to know how tariff amount either before or after doubling

a small price taking nation imports a good that it could not possibly produce itself at any finite price. can you describe plausible conditions under which that nation would benefit from an import tariff on the good?

One such set of conditions described in this chapter is the developing government argument if the government is so underdeveloped that the gains from starting or expanding public programs exceed the costs of taxing imports, then the import tariff brings net national gains by providing the revenue so badly we needed for those programs. i.e. tax imports if our consumption of the product brings external cost.

What conditions must be in place in order for a firm to be a persistent dumper?

Persistent dumping occurs when a firm with market power uses price discrimination between markets to increase its total profits. The firm will maximize its profits by charging lower price to foreign buyers and hence engage in persistent dumping 1. if it has less monopoly power (more competition) in the foreign market than it has in its home market, and 2. if buyers in the home country cannot avoid the high home prices by buying the good abroad and importing it cheaply.

"Intra-industry trade can be explained by the Heckscher-Ohlin (HO) Theory." Defend or reject this statement by explaining the basis of intra-industry trade.

Reject because in the theories of comparative advantage (HO or Ricardian), the trade arises due to differences in the production-side either technology or factor endowments. Thus, according to these theories countries that are similar in their production-side (technology and endowments) should trade, little if at all, with each other. & intra industry trade is the trade of similar products

"The basis of intra-industry trade is the difference in endowments or technology between the two trading countries." Defend or reject this statement with reference to basis of trade in different theories of trade.

Reject because in the theories of comparative advantage (HO or Ricardian), the trade arises due to differences in the production-side either technology or factor endowments. Thus, according to these theories countries that are similar in their production-side (technology and endowments) should trade, little if at all, with each other. For example, consider the industrialized countries of Europe and North America that are similar in both technology and factor endowments (i.e. production side)

"Your friend says that tariffs are always bad for the country imposing the tariff. It does not matter if this country is 'small' or 'large'." Is your friend correct?

She is incorrect. Although a small country cannot benefit from tariff, a large country can. A large country can possibly benefit from tariff as it also has terms of trade gains represented by area e besides losses due to production distortion (area b)and consumption distortion (area d) as shown in figure below. The gain is definitely larger than the loss when tariff is small though it turns into a loss when tariff gets too large as evident from the following diagrams. However, in a small country there are only loss from production distortion (production effect) and consumption distortion (consumption effect).

internal scale economies

The actions and decisions of the individual firm itself

Terms of trade effect

The change in the ratio of international prices of a large country's exports to the interna- tional price of the large country's imports resulting from the imposition of a tariff in the country leads to a welfare gain to the large country

Explain why import tariffs are probably very important to small developing countries

The explanation lies in the public revenue argument for protection. The country considers tariffs very important to be very important as, being a small developing country, they area very important source of government revenues that it can use to provide vital government services such as health, education, and safe drinking water to its population.

what is the infant industry argument for putting up barriers on imports? what are its merits and weaknesses

The infant industry argument justifies temporary tariff on import so that domestic infant industry can learn to produce at lower cost. However, if indeed domestic industry canlearn and become efficient over time, it can borrow from the market to cover its losses during initial period when it learns just like any other business. This is the weakness of the infant industry argument for justifying temporary tariff. However, if there are imperfections in the financial markets so that a firm in the industry cannot borrow to cover initial losses during learning phase, a temporary tariff to provide protection to the industry while it learns isvalid. It is also a valid argument if benefits from learning do not accrue to the firms that make initial investment. Although, government intervention is justified in both situations mentioned above, tariff (or protection in general) is not the best government policy. Typically,production subsidy is better than tariff as it avoids the loss due to consumption effect. Ofcourse, one may counter argue that a developing country may find it difficult to raise resources to finance the production subsidy whereas tariff instead raises revenue for the government.In any case, there is the final question: will the infant industry really grow up?

how to determine a possible international price of a good after trade opens(ex: oil)

The international equilibrium price of oil after trade opens has to be between the relative price of oil in U.S. and Norway before trade Ex: relative price of oil in US: $3 relative price of oil in Norway: $1 A possible international price of oil after trade would be $2

specificity rule

The specificity rule states that it is usually more efficient to use the government policy tool that acts as directly as possible on the source of incentive distortion that separates private and social benefits. In short, specify the specific source of the problem and intervene as close to the source as possible.

"Trade blocs always good as they lead to freer trade among the member countries." True or False, explain

The statement is not correct as it stands. Creation of trade blocs has two opposing effects on the welfare of member countries. On one hand, there is freer trade as mentioned in the quote. This leads to trade creation or new volume of trade among member countries.Trade creation delivers usual gains from the production and consumption effect as tariff on imports with bloc-member countries is reduced. But, creation of trade bloc also leads to trade diversion which is the shift of trade from low-cost outside producers to higher-cost bloc-member producers. Whether creation of trade bloc is good or not depends on which effect dominates. However, one can say that if the different between the costs of productionbetween members and non-members is small relative to tariff in place before formation of the bloc, trade creation is likely to dominate and member countries will gain.In addition to gains from trade creations, there as other sources of gain from formation of trade blocs that are important but harder to quantify. [See answer to problem 3 below]. If those benefits are also taken into consideration, the likelihood of gaining from formation of a trade bloc is even higher. Thus, the statement while not always true, it is quite likely to be true

consumption effect

The welfare loss to consumers in the importing country that results from them reducing their consumption after the tariff is imposed

production effect

The welfare loss to the economy that results from consumers shifting from imports to more expensive domestic production

Why would a small developing country be unwilling to convert its import tariffs to production subsidies or quotas?

They would be extremely unwilling to convert its import tariffs into production subsidies or quotas as in that it will lose an important or perhaps the only major source of public revenue. In case of production subsidy, in fact, it will find impossible to find resources to pay such subsidy.

In the first best world, a large country gains both from a small import tariff and a small export subsidy." Is this statement true or false? Explain.

This statement is false. While a large country does gain from a enough small tariff, it always loses from an export subsidy whether large or small.

Inter-industry trade (IIT)

Trade between countries in goods from different industries IIT = (X + M) - [X - M] X- exports of goods of an industry M- imports of goods of the same industry

can you describe plausible conditions under which a nation would benefit from subsidizing imports of a good?

Yes, think about distortions and ask how a nation could have too little private incentive to buy imports. The most likely case is one in which buying and using foreign products could bring new knowledge benefits throughout the importing country, benefits that are not captured by importers alone. To give them an incentive matching the spillover gains to residents other than the importers, the national government could use an import subsidy.

monopolistic competition

a type of market structure in which a large number of firms compete vigorously with each other in producing and selling varieties of the basic product. this happens if scale economies are modest, then there is room in the industry for a large number of firms.

A friend in your study group tells you, "A tariff and an equivalent quota can have identical effect on the welfare of a country." Do you agree or disagree? Support your stance with suitable explanation.

agree

A friend in your study group tells you, "Free trade is always the best policy for a small country. It always loses from a protectionist policy, whether it is a tariff, quota, or a VER." Do you agree or disagree? Explain why.

agree, because small countries are price taking firm. The tariff or NTB will cause the domestic price to rise because the foreign price will rise to compensate for the tariff or NTB and the imported quantity will decrease. The only benefits a small country will receive from a tariff/NTB is the gain in producer surplus (graphically area a) and/or the government revenue collected from the tariff/NTB (graphically represented area c) , and they will lose significantly more in consumer surplus (graphically area a + b + c + d), resulting in a net national loss.

Label a graph for a large country imposing a tariff

change in producer surplus: m change in consumer surplus: (m+o+q+s) production effect: o consumption effect: s Government rev.: (q+r) net efffect of the tariff on economic welfare is calculated by: [r - (o + s)]

in a monopolistically competitive market, if currently P < AC, to restore the equilibrium, the number of varieties will have to _______. As a result the price will _______ and average cost will ________.

decrease, increase, decrease when the number of varieties decreases then price will increase because with less options competition is not as fierce and price is driven up & AC of producing a unit decreases as output increases (and production will increase when the price rises) in scale economies which have to be present to create monopolistic competition

"according to the HO theory, countries should engage in a lot of intra-industry trade." do you agree or disagree? why?

disagree. the HO theory indicates that countries should export some products and import others. HO theory predicts the pattern of interindustry trade. it does not predict that counties would engage in a lot of intra-industry trade, which involves both exporting and importing products that are the same

If the expansion of the size of an industry is responsible for a decline in average cost, then _______ are present.

external economies of scale

external economies of scale

external scale economies are based on the size of an entire industry within a specific geographic area. the typical firm producing the product in this area declines as the output of the industry (all the local firms producing this product) within the area is larger

Label a graph for a small country imposing a tariff

gain in producer surplus: c loss in consumer surplus: (c+d+e+f) production effect: d consumption effect: f Government rev.: e

What is the gain/ loss to the country from the imposition of tariff on import of goods formula

he imposition of tariff results in both a production and a consumption effect creating a loss of (r+s) which is offset by the additional social side benefits of domestic production t resulting in overall welfare effect of: + t - (r + s)

in a monopolistically competitive market, if currently P > AC, to restore the equilibrium, the number of varieties will have to _______. As a result the price will _______ and average cost will ________.

increase, decrease, increase- when the number of varieties increase then price will decrease because with more options competition increases and price is driven down & AC of producing a unit increases as output decreases (and output will decrease as price decreases) in scale economies which have to be present to create monopolistic competition

In the monopolistic competition model of international trade, when two countries move from autarky (no trade) to free trade, the number of varieties available (for consumption) in each country ________ and the price in each country ________.

increases; decreases (book pages 97-99) The number of varieties produced in world as a whole has declined after trade. However, since number of varieties produced in the world is greater than the number of varieties produced in either country initially and all varieties are available in both countries, number of varieties available to consumers in each country has increased. This in turn shows that welfare of consumers has increased as they have access to more varieties and at a lower cost. The world production has also become more efficient at average cost of production has fallen as each firm now sells more due to access to a larger market. Or, looking at it in another way, as some varieties are not longer produced, fixed resources used to produce those varieties (such as plant and machinery and land) can be used to produce other goods in the economy.

If the expansion of the size of the firm is responsible for a decline in average cost, then _______ are present

internal economies of scale

Which of the following is not an example of a non-tariff barrier? - quota - VER - product standards - none of the above

none of the above

The firms in computer industry fail to take in account social benefit of skills of its workers. Which of the following must be true about social and private costs and benefits for this industry in the market equilibrium? - SMC < SMB and PMC > PMB - SMB > PMB and PMC = PMB - SMB < SMC and PMC = PMB - none of the above

none of the above correct answer: SMB > SMC & PMC = PMB (Notes 7)

Which effect on the welfare of a country is absent when a large country levies a tariff on imports? - consumption effect - production effect - terms of trade effect - none of the above

none of the above, all are present

in a monopolistically competitive market, as the market size increases, the price curve _______ and the unit cost curve _______.

price curve does not shift and average unit cost decreases

Which effects on welfare of a country are present when a large country levies a tariff on imports?

production, consumption, and terms of trade effects

In the monopolistic competition model of international trade, when two countries move from autarky (no trade) to free trade, the number of varieties available (for consumption) in each country ________ and the number of varieties produced in the world as a whole ________.

rises; falls it rises because domestic consumers can purchase foreign products The number of varieties produced in world as a whole has declined after trade. However, since number of varieties produced in the world is greater than the number of varieties produced in either country initially and all varieties are available in both countries, number of varieties available to consumers in each country has increased. This in turn shows that welfare of consumers has increased as they have access to more varieties and at a lower cost. The world production has also become more efficient at average cost of production has fallen as each firm now sells more due to access to a larger market. Or, looking at it in another way, as some varieties are not longer produced, fixed resources used to produce those varieties (such as plant and machinery and land) can be used to produce other goods in the economy.

Which of the following is a basis for trade in a monopolistically competitive market?

scale economies- monopolistic competition happens if scale economies are modest, then there is room in the industry for a large number of firms

net trade

the difference between exports and imports of that product. it shows the product's importance in the country's inter-industry trade, in which some products are net exported and other products are net imported net trade for an industry = X - M

South is considering two trade liberalization policies: (i) opening trade with North in wheat and cotton;(ii) opening trade with North in cars and pharmaceuticals. There is a lot more support for policy (ii) compared to policy (i). Why that might be so? Explain.

the opening of trade with wheat and cotton is an example of intra-industry trade (two-way trade by a country in a very similar product); whereas, the trade of cars and pharmaceuticals is inter-industry trade. According to the HO theorm If the south uses it abountdent factor intensively in the production of cars then it should export cars, and if pharmaceuticals use their scare factor intensively then they should import pharmaceuticals this will maximize the benefits of trade for both the south and the north

intra-industry trade

two-way trade by a country in a very similar product Ex: Toyota and Mercedes, US imports the same amount of cosmetics that it exports

absolute advantage

when a country can produce more of the good per labor hour than the other country

scale economies

when output quantity goes up by a larger proportion than does total cost, as output increases. if output quantity expands faster than total cost increases, then the average cost of producing a unit of output decreases as output increases (there are not constant returns to scale)

Bhutan, a small country, is facing revenue shortfall and is planning to double its tariffs. Currently, it loses an estimated $20 million due to tariffs. How much will it lose after reduction of tariffs? What would be its loss if it tripled its tariffs?

yo no sé my guy