International Econ Midterm 2
For trade to take place, a country must face a world relative price that is
different from the relative price that would prevail in the absence of trade.
Within each country that opens itself to international trade,
some factor owners gain, but other factor owners lose.
During the time period 1945-1970 the U.S. exported more
technologically-intensive goods.
In each sector of a specific factors economy, profit-maximizing employers will demand labor up to the point where
the marginal product of labor times the price of the product equals the wage rate.
What is the slope of the budget constraint?
-Pc/Pf (Relative price of cloth)
Arguments for Free Trade
-Protected markets limit gains from external economies of scale by inhibiting the concentration of industries. The scale of production becomes inefficient. -Free trade offers more opportunities for learning and innovation than are provided by a system of managed trade. -A move to free trade makes the economy as a whole more efficient by shifting the industrial mix toward firms with higher productivity
What are the three main reasons that economists do not generally stress the income distribution effects of trade?
1. income distribution effects are not specific to international trade (i.e. unemployment from new technology) 2. It is always better to allow trade and compensate those who are hurt by it than to prohibit it. (Unemployment benefits) 3. Those who stand to lose from increased trade are typically better organized than those who gain (because they're more concentrated within regions and industries)
Political Argument for Free Trade
A political commitment to free trade may be a good idea in practice even though there may be better policies in principle. Economists often argue that trade policies in practice are dominated by special interest politics rather than by consideration of national costs and benefits. Economists can sometimes show that in theory, a selective set of tariffs and export subsidies could increase national welfare, but that in reality, any government agency attempting to pursue a sophisticated program of intervention in trade would probably be captured by interest groups and converted into a device for redistributing income to politically influential sectors.
What does a rise in the price of cloth do in terms of the relative earnings of labor and capital?
A rise in the price of cloth raises the purchasing power of labor and lowers the purchasing power of capital.
Why is abundance defined in relative terms?
Because no country is abundant in everything
Customs Union
Countries must agree on tariff rates
What did the Uruguay Round do
Cut tariff rates around the world Liberalized trade in two important sectors: agriculture and clothing
Suppose a specific factors economy produces two goods: X and Y. Given that the economy is open to trade, and assuming that D is consumption, Q is production, and P is price, the budget constraint can be defined as
DX−QX=PYPX×QY−DY
Why does trade exist in the Heckscher-Ohlin theory?
Differences in resources The country that is abundant in a factor exports the good whose production is intensive in that factor.
The quantity of direct foreign investment by the United States into Mexico has increased dramatically during the last decade. How would you expect this increased quantity of direct foreign investment to affect migration flows from Mexico to the United States, all else being equal?
Direct foreign investment has increased the amount of capital per worker in Mexico. This will increase the marginal product of labor and increase the real wage, which should slow the flow of labor from Mexico.
Free trade area
Each country's goods can be shipped to each other without tariffs, but the countries set tariffs against the outside world independently
What kind of trade agreement is NAFTA
Free trade area
What kind of trade agreement is the EU
Full customs union
What does it mean if Home is Labor abundant and Foreign is Capital abundant?
Home has a higher ratio of labor to capital than foreign Foreign has a higher ratio of capital to labor than home. This is in terms of ratio and not absolute quantities.
What does Df - Qf = (Pc/Pf) x (Qc - Dc) show us?
How much a country can afford to import based on the amount it exports. It is known as a budget constraint.
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.
Give an intuitive explanation for the optimal tariff argument.
In a large country, a tariff can favorably shift the terms of trade such that the tariff revenue exceeds the welfare loss.
Terms of Trade Argument for a Tariff
In some cases, the terms of trade benefits of a tariff outweigh its costs. If it is a sufficiently small tariff, the terms of trade benefits outweigh the costs.
Question content area Part 1 Recently, computer programmers in developing countries such as India have begun doing work formerly done in the United States. This shift has undoubtedly led to substantial pay cuts for some programmers in the United States. Answer the following two questions: Part 2 How is this possible when the wages of skilled labor are rising in the United States as a whole?
In the short run, programmers with specific skills that compete with Indian workers may face wage cuts, while, in the long run, programming in general becomes more efficient, which can increase wages for others in the industry.
If governments make trade policies based on national economic welfare, is the problem of trade warfare still represented by a "Prisoner's dilemma" game? What is the equilibrium solution to the game if governments formulate policy in this way? Would they ever choose the strategy of protectionism?
In this case, it would no longer be a Prisoner's dilemma game; each country's dominant strategy would be to engage in free trade and there would be no incentive to switch to protectionism.
Who does trade benefit and who does it hurt in the Specific Factors Model?
It benefits the export sector of the country It hurts the import-competing sector of the country It has ambiguous effects on mobile factors
Why does trade benefit a country?
It expands an economy's choices. This means that we can redistribute income in such a way that everyone gains from trade.
Which of the following arguments would trade economists make against seeing these wage cuts as a reason to block outsourcing of computer programming?
It is possible for those who gain from outsourcing to compensate those who lose. Allowing programming to be done more cheaply expands the production possibilities frontier of the US, making the entire country better off on average. The income distribution effects from outsourcing are not specific to international trade.
The United States' imports from 1945 through 1970 were more capital-intensive than its exports. One would have expected that the United States would have imported more labor-intensive goods and exported capital-intensive goods during this period. Part 2 This phenomenon that occurred in the United States is known as the
Leontief paradox.
Which group has more political power to change trade policies?
Organized groups, ie the ones who lose from trade. They are typically more concentrated and informed on the matter.
What must be equal to each other if a country is not part of international trade?
Output of a good and its consumption
What is the general conclusion about income distribution effects of international trade in the long run in the Heckscher Ohlin model?
Owners of a country's abundant factors gain from trade, but owners of a country's scarce factors lose
What happens in Country Home (who is labor intensive in cloth) when the relative price of cloth rises?
People who get their incomes from labor gain, but people who get their income from capital lose. (laborers v capital owners)
What is the main reason explaining why agriculture enjoys protective tariffs in the U.S.?
Producers (who gain) are well organized, while consumers (who lose) are not.
Factor Abudance
Relative abundance of factors of production
How is abundance determined in Heckscher-Ohlin?
Relative quantity, not absolute
What's the difference between the Specific Factors Model and Heckscher Ohlin in regards to the income distribution effects?
SFM: The specificity of factors to particular industries is often only a temporary problem. Over time, laborers can shift from industries. HOM: the effects of trade on the distribution of income among land, labor, and capital are more or less permanent.
What policy would terms of trade argument dictate for export sectors?
Since an export subsidy worsens the terms of trade, and therefore unambiguously reduces national welfare, the optimal policy in export sectors must be a negative subsidy, that is, a tax on exports that raises the price of exports to foreigners. This optimum tax is positive but less than the prohibitive tax hat would eliminate exports completely
Limitations to terms of trade argument against free trade
Small countries have little ability to affect the world prices of either their imports or their exports For big countries, the problem is that they could use this power at the expense of other countries. This could anger other large countries and start a cycle of tariffs.
According to the model, the establishment of trade between Home and Foreign will ultimately bring
an equalization of both the relative prices of goods and factor prices.
What happens if there is an increase in Pc/Pf in the Specific Factors Model?
The economy will produce more cloth. Consumers will demand more food. The economy will export cloth and import food.
What happens if there is a decrease in the relative price of cloth in the Specific Factors Model?
The economy will produce more food Consumers will demand more cloth. The economy will import cloth and export food.
What does Df - Qf yield? What does (Pc/Pf) x (Qc - Dc) yield?
The economy's food imports, the amount by which its consumption of food exceeds its production. The economy's cloth exports, the amount by which production exceeds consumption.
Where is national welfare maximized (Tariff rates) for terms of trade?
The optimum tariff, t0. It is always positive but less than the prohibitive rate (tp) that will eliminate all imports.
Assume a specific factors economy produces two goods, cloth and food, and that when representing the output of this economy graphically, cloth is on the x-axis and food is on the y-axis. When the price of cloth increases by 9% and the price of food increases by 9%,
The real income of landowners remain the same
What must be equal to each other if a country is to be part of international trade in a Specific Factors Model?
The value of consumption must be equal to the value of production. Df - Qf = (Pc/Pf) x (Qc - Dc)
In Heckscher-Ohlin, what is the only difference between countries?
Their resources. Technology is the same Demand is the same
Why are international organizations important in order to reduce tariff rates worldwide?
They help avoid trade wars
Although trade creates gains for some and losses for others, economists do not, generally, stress the income redistribution effects of international trade. Which of the following is NOT a reason why economists tend to de-emphasize the impact of international trade on the distribution of income?
Those that lose from trade tend to be marginally impacted by trade, poorly organized, and largely devoid of political influence.
Empirical Evidence of HOM and the income distribution effect
US is abundantly endowed with highly skilled labor while low skilled labor is correspondingly scarce. This means that international trade has the potential to make low skilled workers in the US worse off on a sustained basis.
The U.S. labor movement—which mostly represents blue-collar workers rather than professionals and highly educated workers—has traditionally favored limits on imports from less-affluent countries. Is this a shortsighted policy or a rational one in view of the interests of union members? How does the answer depend on the model of trade?
Using the Ricardian model, this policy would not be rational. However, considering the Heckscher-Ohlin model, which specifically addresses income distribution, unskilled labor, the scarce resource, loses from trade.
How do you calculate real wages?
W/P W= nominal wages, P = price
In the United States where land is cheap, the ratio of land to labor used in cattle raising is higher than that of land used in wheat growing. But in more crowded countries, where land is expensive and labor is cheap, it is common to raise cows by using less land and more labor than Americans use to grow wheat. Can we still say that raising cattle is land-intensive compared with farming wheat? Why or why not?
Yes. As long as the ratio of land to labor for cattle production exceeds the ratio in wheat production in that country.
Theory of the Second Best
a hands-off policy is desirable in any one market if all other markets are working properly. If they are not, a government intervention that appears to distort incentives in one market may actually increase welfare by offsetting the consequences of market failures elsewhere.
Suppose the United Colonies (a hypothetical country) happens to be the world's most capital-abundant country. According to the factor-proportions (aka Heckscher-Ohlin) model, the U.C. would be expected to
export capital-intensive goods and import labor-intensive goods.
Who stands to lose in the short run in the Specific Factors Model?
immobile factors in the import-competing sector
Rent seeking example with quotas
individuals and companies incur substantial costs, effectively wasting some of the economy's productive resources, in an effort to get import licenses
In the context of the "2 by 2 by 2" idealized factor-proportions model, assume the following facts about the world: In each country (Home and Foreign) coal is the labor-intensive good; Home is the labor-abundant country. From these few facts, it can be asserted that before trade
in Home, workers earn less, land earns more, and the relative price of coal is lower than in Foreign.
In 1986, the price of oil on world markets dropped sharply. Since the United States is an oil-importing country, this was widely regarded as good for the U.S. economy. Yet in Texas and Louisiana, 1986 was a year of economic decline. Why? Part 2 In Texas and Louisiana, 1986 was a year of economic decline because in these two states,
oil production was reduced.
When an economy is open to trade, the relative price of a good is determined by the
relative supply and demand for the world.
Assume a specific factors economy produces two goods, cloth and food, and that when representing this economy graphically, cloth is on the x-axis and food is on the y-axis. For a trading economy,
the budget constraint is tangent to the production possibility frontier at the chosen production point.
