ECO 4704 Exam 3 PS 7, 8, & 9
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.
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.
THe different types of trade blocks
Free-trade area Customs union Common market (Full) economic union
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)
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
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.
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.
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.
"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
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.
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)