ECON 340 Exam 1

1.3 a) How can we measure the degree of economic interdependence of a nation with the rest of the world? b) Why does the U.S. rely much less on international trade than any other non-communist developed nations? c) What would happen to its standard of living if the U.S. withdrew completely from international trade?

a) A rough measure of the degree of economic interdependence of a nation with the rest of the world is given each time by the value of its imports as a percentage of its GDP. For small nations such as Belgium, the Netherlands, Switzerland, Denmark, and Sweden, the figure ranges from 30 to 60%. For large developed nations such as Germany, England, France, and Italy, the figure ranges from 20 to 30%. For the U.S., the figure is about 9%. b) The U.S. relies only to a small extent on foreign trade, a significant part of its high standard of living depends on it. For one thing, there are certain commodities such as coffee, tea, cocoa, scotch, and so on that that U.S. cannot produce at all. In addition, the U.S. has no deposits of certain minerals which are important for industrial production. However, the U.S. could probably survive without drastic consequences from withdrawing from world trade.

1.6 How does the mercantilist concept of national wealth differ from today's view? b) Why did mercantilism advocate the accumulation of gold? b) How do the mercantilists' views on trade differ from those of Adam Smith?

a) According to the mercantilists, the wealth of a nation was measured by the stock of precious metals (gold) that is possessed by the nation. Today, we measure a nation's wealth by the stock of human and natural resources that it uses in production. The greater a nation's wealth, the greater the flow of goods and services that can be made available to each person, and the higher the standard of living in that nation. b) Mercantilism advocated the accumulation of gold because gold was regarded as the real wealth of the nation. At a more sophisticated level of analysis, there were more rational reasons why they prefer gold. With gold, monarchs could equip the armies, buy the supplies, and maintain the navies that they needed to consolidate power and acquire colonies. More gold meant gold coins in circulation and also greater business activity. c) The mercantilist advocated strict control by government, they tried to show that the mains of nations were basically in conflict and they preached economic nationalism. On the other hand, Adam Smith (and other classical economists) advocated free trade as the best policy for nationals of the world, Only few exceptions to this policy of free trade were to be allowed. One of these, was the protection of industries important for national defense.

1.10 If a lawyer earns $100/hour practicing law but can type faster than her secretary who makes $10/hour, does it pay for the lawyer to fire her secretary and do her own typing? b) The reasoning you employed in answering part a is an example of what principle?

a) 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. b) 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.

1.2 a) How do international economics differ from interregional economic relations? b) In what way are they similar? c) How do both differ from the rest of economics?

a) International economics and interregional economics both involve the overcoming of space or distance. They both arise from the problems created by distance. This distinguishes them from the rest of economics, which treats a single point in space where production, exchange, and consumption take place.

1.1 a) What does international economics deal with? b) Why do we study it? c) How can we justify international economics as a special branch of economics?

a) International economics deals with the economic relations and interdependence among nations affected by political, social, cultural, and military relations between nations. b) We study international economics in order to analyze the effect of international flow of services/goods and factors of production on the welfare of domestic consumers. We also wish to examine or forecast how national policies directed at regulating these international flows affect domestic welfare. As individuals and voters, we need to study international economics in order to be able to form intelligent opinions on these matters. c) We can justify international economics as a special branch of economics on grounds that international economic relations differ from domestic economics and require different tools of analysis from those used to analyze a domestic economy. It was developed by Smith, Ricardo, Mill, Marshall, Keynes, and Samuelson.

1.8 a) How did Adam Smith explain his contention that all nations engaged in trade can benefit from trade? b) Why do nations usually impose restrictions on the free flow of trade?

a) 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). b) 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.

1.7 a) From table 1.3, indicate in what commodity the U.S. and the U.K. have an absolute advantage. b) How much would the U.S. and the U.K. gain if 6W were exchanged for 3C? c) What if 6W were exchanged for 6C? Nation US UK Wheat 6 1 Cloth 1 3

a) The U.S. has an absolute advantage in the production of wheat, while the UK has the absolute advantage in cloth. b) 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 to or would require 6 labor hours to produce in the UK. These same 6 hours can produce 18C in the UK. By exchanging 3C (one hour to produce) for 6W, the UK gains 15C or saves 5 hours. c) If the US exchanges 6W for 6C, the US would gain 5C or would save 5 hours. Since 6W requires 6 hours to produce in the UK, the UK could produce 18C. need only give up 6C for 6W, it gains 12c or 4 hours.

1.12 Table 1.6, indicate what happens if a) 6W is exchanged for 9C, b) 6W are exchanged for 3C, or c) 6W are exchanged for 12C.

a) The US gains 6c or 2 hours. The UK gains 3C or 1.5 hours. b) 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. c)

1.9 From table 1.4 indicate a) Where the US has an absolute advantage or disadvantage in wheat and cloth, b) Th commodity in which the US and the UK have a comparative advantage and c) the gains to the US and the UK if they exchange 6W for 6c. Nation US UK Wheat 6 1 Cloth 4 3

a) The US has the AA in both products. Trade under these circumstances cannot be based on AA. b) 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. c) 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.

1.5 Why are the pure theory international trade and the theory of commercial policy referred to as the microeconomic aspects of international economics? b) Why are the study of the balance of payments and the process of adjustment to disequilibria in the balance of payments referred to as the macroeconomic aspects of international economics?

a) The pure theory of trade examines the basis for and also the gains from trade. The theory of commercial policy studies the reasons for and the results of obstructions to the free flow of trade. Since these topics are discussed by treating each nation as a single unit and by dealing with individual commodity and factor costs and prices, we are in the field of microeconomic analysis. b) In the real world, nations exchange many goods, services, and factors with other nations. The balance of payment summarizes the total receipts and payments resulting from all of these international transactions and as such it is macroeconomic concepts.

1.4 a) What is the purpose of theory? b) What are some of the simplifying assumptions made by international economic theorists? c) What do they seek to accomplish?

a) The purpose of theory is to predict and explain. A theory abstracts from the details of an event and focuses on one of two relationships deemed most important in order to predict and explain the event. b) International economics usually assume a two-nation, two-commodity, and two-factors of production. They assume that there is perfect competition that also factors are perfectly mobile domestic level, but immobile internationally. There are no obstructions to free international flow of goods and services and that transportation costs are zero. c) Using these simplifying assumptions, international economists seek 3 things. 1. To predict and explain the composition and volume of international goods and services. 2. To assess their impact on domestic welfare, and 3. to predict how national policies affect this flow and, through them, domestic welfare.

1.11 With respect to each part of table 1.5, indicate in which commodity the US has an absolute advantage and CA and which the US should export to the UK.

a) 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. b) 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. c) 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.