ECON 4520 Final End of Chapter Questions (conceptual)

Ch.7 If countries are behaving rationally, they should always be willing to export more at a higher export price. Thus, one would not expect to see "backward bending" offer curves. discuss.

"Behaving rationally" occurs even with a "backward-bending" offer curve. The underlying economic purpose of exports is to obtain imports for enhancing utility, and a rise in the relative price of exports constitutes a fall in the relative price of imports. With this fall in the price of imports, there will rationally be a rise in the quantity of imports purchased, and the exporting country will export a smaller quantity if the demand for imports is inelastic. Alternatively, the rise in the price of exports would lead to the export of a smaller quantity if the "income effect" (or "terms-of-trade effect") of the price increase outweighs the "production effect" and the "substitution effect."

Ch.8 If the K/L ratio for Belgium is higher than France, What kind of products might Belgium export to France? Why?

According to the H-O theorem, countries should specialize in and export the product that uses relatively intensively the relatively-abundant factor. Therefore, Belgium should export capital-intensive goods to France because, by the physical definition, Belgium is the capital-abundant country.

Ch. 18 Why might the static gains from trade for the developing country differ from those experienced by industrialized countries?

According to trade theory, countries should specialize in and export those goods and services that use relatively-intensively their relatively-abundant factor. Because the LDCs are often labor/land-abundant, the static gains from trade would result from their expanded production and trade in goods intensive in these factors. Their trading partners, the industrialized countries (ICs), would, on the other hand, be specializing in goods that are relatively intensive in capital. Thus, the gains from trade and the relative income distribution effects accompanying trade would tend to reward labor/land in the LDCs and capital in the ICs.

Ch.4 Suppose France has a trade surplus with the UK. What would you expect to happen to prices, wages, and commodity prices in France? Why? What would happen to TOT between the two countries?

As a result of the trade surplus, France experiences, under a fixed exchange rate, a net gold inflow and the United Kingdom experiences a net gold outflow. Assuming that the price-specie-flow mechanism is in operation, these gold movements will result in an increase in prices and wages in France and a decrease in prices and wages in the United Kingdom. Because the demand for traded goods is assumed to be price-elastic, this will cause the expenditures for U.K. goods by France to rise and the expenditures for French goods by the United Kingdom to fall. These adjustments will take place until trade is balanced. The changes in prices in the two countries will lead to a change in the terms of trade that will move them closer to those of the United Kingdom in autarky, i.e., the terms of trade will deteriorate for the United Kingdom and improve for France.

Ch. 8 Using the factor specific model, explain why you might expect to see certain capital owners and labor groups arguing against expanding trade in a capital-abundant country.

Assume that capital is a specific factor of production, i.e., that it cannot move from the production of one product to the production of the other. As trade opens in the capital-abundant country, the country will attempt to expand production of the capital-intensive good (and export it) and contract production of the labor-intensive good (and import it). Because capital cannot move, the change in production takes place by the movement of labor from labor-intensive production to capital-intensive production. This increases the demand for labor and hence the wage rate. Owners of capital in the contracting (labor-intensive) industry find themselves with excess capacity and a falling return to capital. In the capital-intensive industry, the productivity of capital and hence the real return to capital are rising. Although the wage rate is also rising, it is not rising as fast as the price of the export (K-intensive) good due to the declining marginal productivity of labor in the production of the K- intensive good. Consequently, workers who consume only the K-intensive good will find themselves worse off. Thus, those who unambiguously stand to benefit from trade are workers who consume only the cheaper labor-intensive good and the owners of capital used in the expanding capital-intensive industry (whose real income is rising). Those who unambiguously stand to lose are workers who consume only the capital-intensive good and owners of capital used in the production of the labor- intensive product (whose real income is falling).

Ch. 8 You read in a newspaper that the owners of capital in a particular country are urging their government to restrict trade through import quotas. What might you infer about the relative factor abundance of that country?

Assuming that the owners of capital are worried that the distribution of income will turn against them with trade, one concludes that the country in question must be a labor-abundant country. This follows from the Stolper-Samuelson theorem, which indicates that international trade will increase the real income of the owners of the abundant factor and lower the real income of the owners of the scarce factor.

Ch. 18 Why is export price instability judged to be a problem for the EDCs? Why might it seem more likely to occur for EDCs than ICs?

Basic reasons why export price (and earnings) instability is judged to be a problem are indicated in the chapter. Price instability seems more likely to occur for LDCs than for ICs because demand and supply elasticities are lower in LDCs, because shifts in the curves may be more frequent for LDCs, and because LDC exports are more heavily concentrated by commodity. These features reflect the relatively greater reliance on the export of primary products by the LDCs than by the ICs.

Ch.3 How is a country able to gain from trade if it is unable to change its production pattern?

Because the price of the import good falls and the price of the export good rises with trade, the slope of the consumption-possibilities frontier originating at the production point is now different from that of the domestic production-possibilities frontier. Trading away from the domestic production point by exporting some of the comparative advantage good and importing the comparative disadvantage good results in the country being able to consume outside the production-possibilities frontier. This is sometimes referred to as the gains from exchange.

Ch. 2 Why was regulation of the economy so important?

Because wealth was viewed in terms of holdings of precious metals, the objective of economic activity and policy was to foster increased holdings of specie. Mercantilists believed that individuals pursuing their own self interest would not accomplish this objective and that, consequently, economic activity had to be closely regulated and supervised

Ch.17 the terms trade creation and trade diversion are applied in the context of assessing the impact of developed countries' tariff preferences for the products of developing countries (GSP). How can this be useful in the GSP context?

By reducing (usually eliminating) tariffs only on developing-country goods coming into developed countries, the action is a discriminatory trade policy measure, as is the formation of an economic integration project. Trade can be "created" in that the new developing countries' exports displace previous high-cost domestic production within any given GSP-grantingdeveloped country. The GSP also diverts imports from other developed countries into any given developed country, switching imports from a lower-cost to a higher- cost source (the developingcountries) that was not exporting as much to the developed country with the uniform tariff structure.

Ch. 3 In light of the Ricardian Model, how might you evaluate the claim by developing countries that they are at a disadvantage in trade with powerful industrialized countries?

Classical comparative advantage indicates that when a small price-taking country trades with a large country, the benefits of trade go to the small country. Developing countries may not feel that this is the case due to conditions that violate the Classical assumptions. Examples of these conditions would include such phenomena as imperfect competition, economies of scale in production, different product knowledge, and trade policies such as tariffs, quotas, and production subsidies.

Ch. 16 Explain why a govts commitment to income distribution issues can cause policy to be protectionist. Is such policy inevitable if income distribution is a key target?

Concern by the government for the relative income position of a particular group or segment of the economy can foster protection in several ways. First, the government may be less willing to reduce protection on the products that are central to the income of these groups. This is particularly true if there is little support for adopting a direct form of income transfers to these groups if increased trade and the resulting structural change threaten their relative economic well-being. Further, once it is observed that the government will step in with trade restrictions, members of this group will likely become less concerned with efficiency and quality considerations and require increasing amounts of protection to maintain their relative income position.In addition, the knowledge of how the government treats one group may well foster similar behavior on the part of other groups who feel threatened by increased trade. Thus, protection based on a social objective like income distribution not only can result in a short-run policy, but also produce an environment within which continued and often increasing protection will be a necessary norm. Concern with an issue like income distribution need not result in maintaining or even increasing protection and economic inefficiency. Rather than using an indirect method such as trade restrictions to influence the incomes of the groups under consideration, it is far better to adopt policy instruments that deal directly with those in need of support. Direct income transfers to those truly in need will not only be a much more effective way to meet income needs, they would also be much less costly to the economy and consumers/ taxpayers than restricting trade.

Ch.2 What are the critical assumptions of the price-specie-flow mechanism? What happens to the trade balance in a surplus country if the demand for goods is price inelastic?

Critical assumptions of the price-specie-flow mechanism: a. a link between the money supply and the price level, (the quantity theory of money) b. perfect competition, with flexible wages and prices c. price-elastic demand for traded goods d. existence of a gold standard, with no government interference with the movement ofgold and no actions to sterilize gold's impact on the money supply. If the demand for traded goods were price inelastic, the movement of gold and prices would worsen trade balances, not correct them. This would be destabilizing, not stabilizing.

Ch.2 What were the pillars of mercantilist thought?

Critical pillars of Mercantilism: a. the zero-sum nature of international trade; b. the need for strong, powerful governments; c. the labor theory of value; d. the need to regulate economic activity; and e. the need for a positive trade balance.

Ch. 16 a.Why might an economist see virtue in the concept of trade adjustment assistance (TAA)? What difficulties might be encountered in the implementation of TAA?

From an economic perspective, TAA should facilitate the movement of resources away from comparative disadvantage industries and towards comparative advantage industries. Since this would make factors less "specific" in nature, it should enhance the short/medium-term gains from trade. The difficulties include such things as funding for the program and being able to ascertain whether the unemployment or profitability problems are due to changes in the trade environment or are simply the results of poor firm management.

Ch.16 if all interventions in agriculture were removed, what would happen to food prices? To income of farmers? to world welfare?

If all intervention in agriculture were dropped, then trade and production would reflect comparative advantage. Food prices would decline in those countries that previously had protection and rise in free-trade countries. Agricultural income would decline in the protected countries and rise in the unprotected countries. To the extent that developing countries tax farmers and developed countries subsidize farmers, a transfer of real income from developed countries to developing countries should also occur with removal of all agricultural restrictions in general. Finally, world welfare should rise with the movement to free trade.

Ch. 2 Briefly explain why the ideas of Smith and Hume were devastating to Mercantilist thinking and policy?

Hume's price-specie-flow mechanism suggested that a country could not sustain a positive balance of trade because of the effect on money and prices. The external payments position had repercussions on internal economic variables. A continual positive trade balance was thus not a viable policy target, and not a continuous source of increased wealth. Smith's concept of absolute advantage indicated that both countries could gain from trade, in direct contrast to the Mercantilist's zero-sum-game view of trade.

Ch.8 How does the existence of demand reversal complicate the predictions of the H-O?

If demand conditions are different between the two countries and sufficiently oriented toward the product using relatively intensively the physically relatively- abundant factor in at least one country, the relative autarky prices will be just opposite to what H-O would predict. That is, the price of the capital-intensive good will be relatively higher in the physically capital-abundant country and the price of the labor- intensive good will be relatively higher in the physically labor-abundant country. Consequently, the opening of trade will lead to a pattern of trade just opposite to that predicted by H-O, i.e., the physically capital-abundant country will export the labor- intensive good and import the capital-intensive good. If such extreme differences in demand are possible, then the H-O paradigm can no longer predict the pattern of trade between two countries when using the physical definition of relative factor abundance. Note, however, that the trade pattern still conforms to Heckscher-Ohlin when using the price definition of relative factor abundance.

Ch .5 Suppose the price or rental rate of capital rises. Explain how producers would respond, using the iso cost/isoquant framework. What would happen o the K/L ratio in production?

If the price of labor rises with no change in the price or rental rate of capital, w/r increases (r/w decreases). Producers in both industries would respond by using relatively less labor and relatively more capital, and the K/L ratio would rise in both industries. Note that, in this question, we do not specify the cause of the rise in the price of labor - the effects on output of each good and on total output would depend on this cause and would be different, for example, if the cause were technological change that increased the demand for labor rather than a desire on the part of labor to take more leisure time.

Ch. 8 Even though their relative factor abundances differ widely, both India and the US export similar agricultural products such as rice. What might this explain apparent contradiction of H-O?

In this case, the apparent contradiction of the Heckscher-Ohlin model could be explained by factor-intensity reversal. In the United States, agricultural production utilizes considerable capital and, thus, many agricultural commodities such as rice are relatively capital-intensive. In India, however, agricultural production uses relatively much more labor than capital and, in all likelihood, is a labor-intensive product. Since there is considerable substitutability between capital and labor in the production of, for example, rice, it would not be surprising to find that rice is a labor-intensive product in a labor-abundant country such as India and capital-intensive in a capital- abundant country such as the United States. Consequently they both end up exporting the product because it is intensive in their respective abundant factors.

Ch. 17 Why might it be argued that the development of APEC and trans pacific partnership alongside integration efforts in the western hemisphere increase the likelihood that regional agreements may be a step towards freer world trade in general?

It can be argued that the development of APEC and the Trans-Pacific Partnership alongside the efforts in the Western Hemisphere (e.g., NAFTA) represent a movement toward world free trade in that there are several members (Canada, Chile, Mexico, and the United States) that are participants in both APEC and integration efforts in the Western Hemisphere. For these countries their simultaneous participation in both movements represents a significantly greater step towards worldwide free trade and increased benefits of integration than do either of the movements alone. This follows from the knowledge that the net effects of integration are greater, the larger are the number of participants in free trade agreements and the larger the economic size of the participants.

Ch. 16 Explain 2 reasons a minority in a median voter model is able to obtain net benefits through a restrictive trade policy that clearly harms the majority group and the country as a whole.

Legislation favored by a minority may in fact be enacted if the majority simply does not actively participate in the voting process. This may occur because the costs of acquiring information and voting are sufficiently great so that a large group of voters simply chooses not to participate. A second reason this result could come about is because a large number of voters feel that their one vote does not really make a difference or "swing" the outcome and are willing to accept the political result. In either case, the non-participating voter is acting as a "free-rider," avoiding the costs of participation and accepting whatever result comes about based on those who are actively participating. Because members of interest groups in the numerical minority often have more intense interest in and/or more to gain by influencing the political outcome, it is not uncommon to see an outcome that is not consistent with the median-voter approach.

Ch. 3 Suppose Portugal requires 4 days of labor to produce 1 unit of wine and 6 days to produce 1 unit of clothing, while England requires 8 days of labor to produce 1 unit of wine and 12 days of labor to produce 1 unit of clothing. Which country would have the absolute advantage and why? What is the situation with respect to comparative advantage?

Portugal has an absolute advantage in the production of both goods because the absolute labor requirements for both wine and cloth are less than in Spain. However, since the relative labor costs are the same in both countries (4/8 = 6/12), there is no basis for trade based on comparative advantage. Consequently, trade would not take place between the two countries based on either absolute or comparative advantage.

Ch. 6 Explain the difference between "gains from exchange" (consumption gain) and "gains from specialization" (production gain).

The "gains from exchange" ("consumption gain") occur because of the opportunity to consume at different relative goods prices, even though production does not change. The higher relative price for the export good on the world market permits consumption of the now-relatively lower priced import good, and consumers will substitute toward the import good and will move to a higher indifference curve than was possible in autarky. The "gains from specialization" ("production gain") reflect the enhanced real income possible for the economy because the economy is now using resources more efficiently by concentrating its production to a greater extent on its comparative advantage good.

Ch. 9 What was the "Leontief Paradox" and why is it a paradox?

The Leontief paradox was the finding by Wassily Leontief in 1953 that the capital/labor ratio utilized in U.S. import-substitute industries when weighted by import importance was greater than the capital/labor ratio utilized in U.S. export industries when weighted by export importance. This finding suggested that the United States was importing relatively capital-intensive goods on average and was exporting relatively labor-intensive goods on average. This result was contrary to the trade pattern expected from the Heckscher-Ohlin theorem, since the United States was generally thought to be a relatively capital-abundant country.

Ch. 16 build case for use of non reciprocity principle for developing countries.

The case for nonreciprocity for the developing countries would logically be built along the lines of an infant industry argument for protection. Until the industries gain experience and sufficient scale economies, they should receive preferential treatment by the developed countries and should be able to protect their own industries until they have attained a cost of production consistent with their comparative advantage. Of course, a normative case can also be built along the lines of giving assistance to poorer countries in the world economy.

Ch. 18 How can international trade influence economic development positively over time?

The dynamic effects of trade are related to such phenomena as demonstration effects associated with exposure to new products and cultures, possible increased international investment, exposure to new technologies, economies of scale associated with enlarged production, benefits of increased competition (reduction in monopoly market leverage), etc.

Ch. 18 Why should we be concerned about long run deterioration in the commodity terms of trade of EDCs? How can such a deterioration be related to concept of immiserizing growth in Ch.11?

The long-run deterioration of the commodity terms of trade suggests that, other things equal, welfare is less for the LDCs than would otherwise be the case; for the ICs, it is greater, so there has in effect been a transfer of welfare to the ICs from the LDCs. A "worst case" of deterioration would be represented by the immiserizing-growth situation, where the outward shift of the PPF from an LDC's growth results in such a deterioration of the terms of trade that the country ends up on a lower indifference curve after growth. However, the income terms of trade might have improved.

Ch. 16 Build case against use of non reciprocity principle for developing countries.

The use of the nonreciprocity principle tends to maintain an inefficient world production structure. Developing countries, presumably for domestic policy reasons such as greater employment, will use the principle to foster production not only in their comparative advantage industries, but also in industries where they might clearly never have a comparative advantage.

Ch.8 Suppose the K/L ratio is higher in France than in Spain. What would you expect to happen to the wages in France as trade takes place? why?

The wages in the capital-abundant country should fall and the wages in the labor-abundant country should rise with trade according to the factor price equalization theorem. Therefore, French wages should fall.

Ch.9 What do you think is the major defect of the Leontief test that might have caused the paradox to occur? Why?

This is a judgmental question because several explanations involving demand reversal, factor-intensity reversals, the U.S. tariff structure, labor skills, and natural resources have been offered to account for the paradox. In general, however, the major defect seems to be that the Leontief test utilized a two-factor model, that is, it failed to differentiate labor according to various skill categories and to allow for the role of natural resources. Subsequent studies have suggested that U.S. exports might be relatively "skilled labor-intensive" or "human capital-intensive," and that imports may be relatively intensive in natural resources as well as in relatively unskilled labor.

Ch.17 What expected impacts of further integration in the EU could be detrimental to the US? What expected impacts could be beneficial? Should US be worried or enthusiastic about further integration in europe?

Trade diversion against U.S. exports could have occurred as barriers within Europe were dismantled. Further, dynamic effects such as enhanced technology and scale economies could have made the EU a more formidable export threat in third- country markets as well as in the U.S. market. However, if the EU grows more rapidly, it can be in a position to purchase more U.S. goods. Also, U.S. foreign investors expanding into Europe may source their inputs from the United States. Whether or not one should be enthusiastic or worried obviously depends on the size of the costs to the United States relative to the benefits. Certainly greater growth in Europe can potentially benefit U.S. welfare, but, if the result of the integration is the formation of two hostile trading blocs (Europe and North America), there can be overall detrimental impacts.

Ch. 2 Why did the mercantilists consider holdings of precious metals so important to nation state building?

Wealth was viewed as synonymous with holdings of precious metals. Nation- states wished to become wealthy and this meant obtaining large holdings of precious metals. It is also argued by some that the shortage of coinage constrained the growth of these nation-states and that precious metals were required to increase the supply of coinage (money) in order for the countries to grow.

Ch. 4 What do you regard as the main weakness of the Classical/Ricardian model? why?

the use of the labor theory of value - The labor theory of value obviously ignores the role of other factors of production in the determination of production cost and hence of pretrade price ratios

Ch. 17 "The countries of the world should follow the path of making nondiscriminatory reductions in trade barriers worldwide rather than path of forming selective, discriminatory econ coalitions" Build case for and against this statement.

(a) The basis for this statement is the fact that specific coalitions contain elements of both trade creation and trade diversion. The static effects of these coalitions can thus be negative if trade diversion effects are greater than trade creation effects, whereas no trade diversion effects occur with a general lowering of protection by everyone. In addition, there is the fear that once members of the coalition(s) have reduced tariffs with each other they will be less interested in further reductions in protectionwithnonmembers. Thereisalsothefearthatthenewcoalitionsmay actually raise their external tariffs to nonmembers, generating a group of trading blocs that would represent a movement away from freer trade. (b) The establishment of new trading coalitions should be encouraged because they represent a clear first step towards freer world trade. This is particularly so if the coalitions adopt common external tariffs for nonmembers which are lower than those in existence in each country prior to their integration. Further, to the extent that there are economies of scale present, the larger coalition market will allow coalition members to produce goods more cheaply and thus have less need for protection in general. Finally, experiencing both the static and dynamic economic gains that accompany the smaller coalitions will make them more open to reducing trade barriers on a worldwide basis.

Ch. 2 China has had an overall trade surplus in recent years. Economists suggest this continuing phenomenon is due to several things, including an appropriate exchange rate. How would a mercantilist view this surplus? Why might David Hume argue the surplus will disappear on their own?

A Mercantilist would view the continuing trade surplus as a very desirable outcome, since it produces a net increase in Chinese holdings of foreign exchange (claims on foreign country assets) which is similar to increased holdings of specie in Mercantilist times. To the Mercantilist, the surplus represents successful Chinese policy, not a problem. Hume would argue that the situation would be self-correcting if a fixed exchange rate system is in place as long as prices and wages are flexible and China does nothing to interfere with the flow of payment and its impact on the money supply. The increase in the money supply accompanying the trade surplus would lead to a relative increase in the prices of Chinese goods, thus reducing the trade surplus. In China's trading partners, the money supply would decrease and prices would decrease, thus decreasing their deficits. Movement to a zero trade balance would also occur under a flexible-rate system because the trade surplus would lead to an increase in the value of the Chinese currency and therefore to a relative increase in the prices of Chinese goods and services.

Ch.7 Discuss economic events that would increase a country's willing ness to trade.

A change in tastes by the home country's consumers toward greater relative preference for the import good would increase the willingness of the country to trade. In addition, a rise in income (provided that imports as a whole are not "inferior goods") would also make the country more willing to trade at each terms of trade. Other events leading to greater willingness to trade would be, for example, increased productivity in the export industry and trade negotiations that resulted in a lowering of trade barriers by the home country.

Ch. 8 It has been argued that opening a country to international trade is a great anti trust policy. What impact would the threat of imports have on a monopolist who had never before faced foreign competition? How would the monopolist respond concerning the quantity produced and the price charged in the domestic market?

Assuming that the country in question is a small country, the opening of the country to international trade will force the monopolist to become a price taker, i.e., to sell the product in question at the prevailing international price or lose its domestic sales. This will cause the monopolist to reduce price and expand output. Even if the country is not a small country, there would be downward price pressure as imports come into the country. In either case, if the international price were below the firm's shutdown point (minimum average variable cost), the firm would stop producing immediately and go out of business unless it was able to become competitive internationally (reduce its cost of production).

Ch. 16 In what respects might bilateral trade negotiations be superior to multilateral trade negotiations? In what respects might Multilateral be superior to bilateral?

Bilateral trade negotiations are superior in that there is greater likelihood of two countries reaching an agreement on reducing trade restrictions than for many countries reaching such an agreement. It is also easier to target certain commodities or policy objectives and/or tailor the trade package to the particular interests of the two countries involved. It makes equal policy reciprocity easier to put into play. On the other hand, the fact that successful multilateral negotiations represent a more significant move toward freer trade means that the potential welfare gains would be greater. There is also the possibility that certain countries might "go along" with the reduction in trade restrictions if every other member of the WTO is participating whereas they might be more reluctant on a bilateral basis, i.e., a "rules-based" trade policy is established with the multilateral negotiations.

Ch. 7 Assume that demand increases for a country's export good. Will there be a different qualitative effect on the country's TOT if the country is "large" rather than "small"?

If the demand increase for the export good is by the foreign country, the terms of trade will improve by an equal amount in either instance. If the country is large, the normal upward shift in the foreign offer curve occurs; if the country is small, the straight-line offer curve by the foreign country pivots to higher terms of trade for the home country. If the demand increase for the export good is by home country citizens, the home country's offer curve pivots inward. If the country is large, the terms of trade will improve, but, if the home country is small, there will be no impact on the terms of trade since a small country faces a foreign offer curve that is a straight line from the origin.

Ch.18 In context of external sector problems, what case can you build for the formation of common mkt among EDCs? Would you recommend such intl coalitions be created?

If the larger market size generated by an economic integration project permits scale economies and efficient production, the LDCs might consequently diversify by exporting to each other (or even to the outside world). There could also be other dynamic effects such as the attraction of direct foreign investment from the ICs. Further, if the same primary products are exported to the ICs by the member LDCs, some market power might now be exerted. With respect to static effects, trade diversion might outweigh trade creation if the LDCs began to produce some of the manufactured products formerly imported from ICs, but this may not be the result. (See the answer to End-of-Chapter Question #2 in Chapter 17 in this Instructor's Manual.) The formation of the coalition might also mean lower quality, lower-tech manufactured goods imports than had previously been the case. Whether such LDC unions should be recommended depends on a more precise assessment of the effects in each situation, but a cautionary note is provided by past experience (such as happened historically with the original East African Common Market).

Ch. 6 If the prod conditions in the US and Japan were to become essentially the same, would the neoclassical model suggest that trade between the two countries would cease?

It is not likely that trade would cease even if production conditions were to become identical (identical technologies and relative factor endowments) because there would still be a basis for trade as long as demand conditions (as reflected in the two community indifference maps) continued to be different for the two countries.

Ch. 8 Would you be surprised to learn that the composition of exports and imports of a former soviet bloc country changed with the dissolution of the soviet union and opening of trade with the west?

No. Before the upheavals in Eastern Europe and the Soviet Union, the majority of trade of most of the Eastern European countries was with each other and with the Soviet Union through a managed and negotiated framework. With the dissolution of the Soviet Union and the opening of trade with the West, prices began to reflect more accurately the true scarcity values of goods, and the Eastern European countries were also exposed more fully to a new set of potential trading partners. Hence, the relative factor endowments of the Eastern European countries vis-à-vis trading partners and the ability to respond to those endowments changed. Given the new relative scarcities, Heckscher-Ohlin analysis would tell us that new comparative advantages and hence a new pattern of exports and imports would emerge. For example, Hungary is most likely capital abundant relative to Romania but labor-abundant relative to Austria; a change in trading partners from Romania to Austria would clearly affect Hungary's trade pattern.

Ch.5 Suppose a country experiences an increase in capital stock. How would the edgeworth box change? How would the PPF change? Could the country now obtain more of both goods than before the increase in capital stock or more of only the capital intensive good?

The Edgeworth box would become "taller" because the vertical capital axes become longer and the horizontal labor axes stay the same length. The PPF will also become "taller" because the good Y intercept shifts upward by a greater percentage than the good X intercept shifts rightward. Note, however, that the good X interceptdoes shift to the right because, with a larger capital stock, more X can be obtained when all resources are devoted to X production.

Ch. 18 Chapter has indicated that diversification of the EDCs export bundles so that they contain relatively more manu goods that could potentially alleviate both the instability problem and the possible TOT problem. Why so?

The diversification could mean that the price instability would be less because demand and supply curves for manufactured goods are generally more elastic than for primary products. Also, the diversification by definition would mean less of an "eggs in one basket" phenomenon. Regarding the terms-of-trade deterioration, diversification would mean movement into products with higher income elasticities of demand in the buying countries, and perhaps a greater ability by LDCs to avert downward wage movements associated with the unorganized labor markets in the primary product sector. With respect to the terms of trade, protection against the new LDC manufactured products might arise, which could offset the favorable effects of the higher income elasticities of demand.

Ch.7 In offer curve analysis, why must an excess supply of one good be associated with an excess demand for the other good?

The excess supply of exports of one good (say good X) means that, at the given terms of trade, one country (say country I) is willing to provide a greater quantity of good X on the world market than country II is willing to purchase at those terms of trade. PX/PY (with Y being II's export good) is thus higher than the equilibrium terms of trade. Because PX/PY is "too high," this must mean that PY/PX is "too low" or below the equilibrium level. A relative price of good Y below the equilibrium level means that there is excess demand for good Y. Alternatively, because a supply of exports reflects a demand for imports in the offer curve analysis, a supply of good X from I that exceeds the demand for good X by II must be associated with a demand for good Y by I that exceeds the supply of good Y coming forth from country II at the given terms of trade.

Ch. 17 When portugal and spain entered the EC in 1986, the US threatened to place heavy duties on imports from the EC of wines, scotch whisky, and other luxury type goods unless the community permitted greater access to other US goods. What could have been the motivation behind the US action?

The motivation was that the United States feared that Portugal and Spain would, through trade diversion, switch their purchases of some agricultural goods away from the United States and toward other EC members. The threatened U.S. duties were designed to get new exports from the United States to the EC to replace the diverted agricultural goods. The action could be supported on welfare grounds since it actually led to a reduction of some other EC trade barriers and hence to gains from the additional trade. If the action had not been successful and had led to retaliatory EC measures on the United States, welfare losses would have occurred.

Ch. 7 In the past, the members of OPEC have been able to raise the relative price of petroleum by a large amount with a relatively small decrease in export volume, therefore increasing substantially the revenues they received from the buyers of petroleum exports. Describe the likely shapes of the offer curves of the importing countries - shapes that enabled OPEC countries to pursue their trade strategies successfully.

The offer curves of the oil-importing countries were likely inelastic because the rise in the price of oil exports by OPEC resulted in greater "revenue" (export quantity in the offer curve diagram) being spent on the crude petroleum imports by any given importing country. Hence, the oil importers were in the "backward-bending" portions of their offer curves.

Ch.2 What is the "paradox of mercantilism"? How was this reflected in mercantilist wage and population policies?

The paradox of Mercantilism is that wealthy countries would contain large numbers of very poor people. A second paradox is that wealthy countries had to spend great amounts of specie to protect their holdings of specie. Wages were kept low (at institutional subsistence levels) to reduce labor costs, and families were encouraged to have children through various taxes and subsidies. These actions contributed to a very large poor working class.

Ch. 8 Explain the difference between the price and physical definitions of factor abundance. When could they give conflicting answers about which factor is the abundant factor?

The physical definition of factor abundance is based on the relative physical amounts of the factors present in the country, e.g., the difference in the capital/labor ratios. The country whose K/L ratio is the largest is defined to be the capital- abundant country. The price definition is based on relative prices of the factors rather than on measurements of their presence in the country. It is hypothesized that the relatively-abundant factor in a country should be relatively cheaper compared to a second country. Thus, according to this definition, if the ratio of the price of capital to the price of labor is lower in one country (A) compared to a second country (B), country A is said to be the capital-abundant country. Under the assumptions of H-O, the two definitions should give the same result. However, if tastes differ between the two countries, then factor prices will not only reflect different supply conditions but also different demand conditions. In this instance the price definition and the physical definition could give conflicting conclusions about relative factor abundance. For example, if consumers in a physically capital-abundant country strongly prefer the capital-intensive product, this would bid up the price of the capital-intensive good and hence would bid up the price of capital. Therefore, other things equal, w/r would fall and could become lower than in the second country. Hence, the physically capital-abundant country could become labor abundant by the price definition.

Ch. 16 The number of consumers in the US exceeds the number of workers in textiles, so why do we see import restrictions on textiles and apparel despite losses to consumers?

The presence of protection on consumer goods such as textiles and clothing has continued over the years even though it has been extremely costly to the consumer. This has occurred for several reasons. First, the impact of protection on consumer prices is not transparent, i.e., not clearly apparent to the consumer. The average consumer has little idea of the higher price being paid for the merchandise because of the various instruments of protection on textiles and apparel. Secondly, not only are consumers not knowledgeable of the impact of protection, they also are not sufficiently organized as a group to influence the political process. Further, there is a strong regional aspect associated with this particular product that provides additional political leverage in Congressional negotiations. For example, the textile/apparel lobby is very well organized and strong, particularly on a regional basis. Thus, the potential winners, textile owners and textile labor, have successfully argued for protection over the years on a social objectives platform (personal and regional income) at the considerable expense of consumers at large. (Even with the formal quota removal in January of 2005, tariffs and other restrictions remain.)

Ch.17 It is said that developing countries have little to gain from econ integration projects among themselves bc they trade very little with each other. What is the reasoning behind this view?

The reasoning behind this view is that, because the developing countries produce similar products, they are not likely to be sources for each other of new, different products vital to the development effort. Even granting the questionable assumption that the developing countries are "alike," however, consideration of trade creation and trade diversion could lead to disagreement with this view of "little gain" from customs unions. Because similar items are being produced in the potential partners, there can be a likelihood of trade creation. In addition, trade diversion will be slight if the potential partners do not possess the capability for displacing the different products being supplied by the outside, developed world. Finally, there can be dynamic benefits from scale economies, etc., as well as potential collective terms- of-trade effects. All of these potential benefits assume, of course, that the developing countries can effectively agree on integration and can surmount the political and distributional difficulties associated with it.

Ch.9 Build a case for the view that increasing openness of the US economy has been the primary factor causing increased income inequality in recent decades.

The rise in income inequality in the last 10-25 years has occurred at the same time that the U.S. economy has experienced a substantial rise in its imports/GDP ratio. Because many of these imports have come from relatively labor-abundant developing countries and are relatively unskilled labor-intensive goods that were manufactured or assembled in these countries, there has been relatively less demand for domestic unskilled labor and hence downward pressure à la Stolper-Samuelson on the wages of that part of the U.S. labor force. At the same time, the United States has been exporting high-tech products that require relatively skilled labor, and thus there has been relatively increased demand for the services of this kind of labor with a consequent rise in the relative return of skilled labor. Therefore, from both the export and the import side, there has been rising inequality within the U.S. labor force. While technological change, the weakening of labor unions, and other such factors have been responsible for some of the relative factor price rise of skilled labor compared to unskilled labor, these phenomena also can be traced back to trade because the threat of global competition has induced the technological change, reduced labor union strength, and so forth.

Ch. 8 "Increasing the mobility of labor and/or capital within a country not only will reduce the internal opposition to the expansion of the countrys international trade but also will lead to greater gains in real income for the country." comment.

The specific-factors model makes it clear why, for example, if capital is immobile owners of capital in an import-competing product in a capital-abundant country would oppose the initiation of international trade. This is because owners of capital in a contracting industry unambiguously are worse off with trade. Improving the mobility of capital in this instance could enable the owners of capital in these declining industries to benefit from trade instead of finding themselves strictly worse off, as they would if their capital could not be easily adapted to production of the comparative advantage good. In graphical terms, improving factor mobility would move the factor-specific PPF (Figure 14) outwards towards the "normal" PPF. Such a change would lead to greater specialization, increased real income (a consumption- possibilities frontier "farther out" from the origin), and increased trade.

Ch. 18 Analysis in book indicated all participating countries gain from trade. If this is so, why do some observers argue that trade can actually contribute to underdevelopment of EDCs?

These arguments focus on the static effects of international trade discussed in the first question. Following the dictates of comparative advantage, many developing countries could find themselves specializing in labor/land-intensive production rather than more capital-intensive production. Such a situation could lead to several problems. First, labor/land-intensive products often have lower income elasticities of demand than do capital-intensive manufactures. Consequently, the demand for labor/land-intensive products grows relatively more slowly and the countries producing these goods find their growth in exports lagging behind export growth in the ICs. Further, the LDCs' own demand for imports may outgrow their export growth leading to balance-of-payments and debt problems. In addition, the low price elasticities of LDC export products tend to make LDC annual export revenues more erratic. Because of these production effects they may find themselves increasingly dependent upon foreign technology and international financing. Finally, by not focusing more on the effective use of capital, the consequent increase in labor productivity (and hence wages) is retarded and, relatively speaking, the gap in per capita income between the ICs and the LDCs may widen.

Ch. 9 If US tariffs and other trade barriers are placed more heavily on labor-intensive goods than capital-intensive goods because of the H-O suggestion that the scarce factor of production gains from protection, how do you explain why many developing countries also have relatively high import barriers on labor-intensive goods?

These barriers may reflect the desire to engage in import substitution, with the labor-abundant low-income developing countries in particular feeling threatened by perceived higher quality labor-intensive products from newly-industrializing countries and developed countries. There is no necessary contradiction here with Heckscher- Ohlin if the potential imports reflect product differentiation and intra-industry trade (to be discussed in Chapter 10). Also, in light of the Stolper-Samuelson theorem, the owners of capital (the relatively-scarce factor in developing countries) may be seeking protection since freer trade will reduce the return to capital. These capital owners may also have disproportionately heavy influence in the policy-making process.

Ch. 3 During the debate prior to the passage of NAFTA, opponents argued that given the relative size of the two economies, the income gains resulting from the agreement would likely be smaller for the US than Mexico. Comment on this in terms of the distribution of trade benefits in the Classical Model.

This could follow from the conclusions reached regarding the distribution of benefits from trade between countries of different economic size. If the impact of the difference in size between the two countries leads to the international terms of trade changing relatively more for the smaller country, then the smaller country will receive relatively more of the benefits of trade between the two. Because the United States is much larger than Mexico, Mexico would receive more of the gains from increased trade accompanying NAFTA as long as the relative change in its prices is greater. However, because the United States is certainly not a "large" country economically or dominant in all of the traded goods and services between the two, both countries should experience some gains from the increased trade and specialization accompanying the trade agreement.

Ch. 17 Suppose country A is considering entering a customs union with country b. Country A produces only manu goods and imports all agricultural and raw materials. Country B produces only raw materials and agricultural products and imports all manu goods. Is this union likely to be welfare enhancing?

This customs union has no possibilities for trade creation in the Viner sense because the two countries have no common domestic industries for yielding displacement of a higher-cost domestic industry by a lower-cost partner supplier. However, there are great possibilities for trade diversion. Country A may switch its imports of raw materials and agricultural goods from a low-cost outside world producer to higher-cost B producers, and B may do likewise with respect to its imports of manufactured goods. The trade diversion could still be beneficial if consumption effects are strongly positive, say because of very high preunion tariffs on outside-world products - although such tariffs would be unlikely in this situation. Of course, dynamic effects could be beneficial as the countries integrated into a larger, more diversified economic unit.

Ch.6 Suppose the US removes its long-standing embargo on trade with Cuba. Opponents of ending the embargo argue that opening trade between the US and Cuba would benefit Cuba and hurt the US by injuring US producers of goods that compete with potential Cuban exports. Evaluate.

This position reflects a misunderstanding of the nature of the gains from trade. With trade, both countries become better off in that movement can take place to a higher community indifference curve in each nation. Certainly U.S. producers in industries that would now compete with Cuban exports (principally sugar) would be injured, but U.S. consumers of sugar would gain, as would U.S. producers of new exports to Cuba (such as machine tools). As this chapter has explained, if the compensation principle is employed, those who gain from trade can fully compensate all losers and still be better off because a larger quantity of goods is available. Of course, relaxation of the embargo involves political dimensions as well as economic dimensions, and these noneconomic aspects need to be taken into account when deciding upon the most desirable course of action.

Ch.16 Some economists think TAA is discriminatory bc special assistance is given to workers displaced by imports while workers displaced by domestic competition receive no such favors. Do you think this observation rules out TAA as desirable policy?

This should not rule out the use of TAA as a desirable policy. If funds for this type of adjustment, both domestic and trade-related, are insufficient, then the funds should be allocated between the two sources of factor rigidity based on a marginal cost/marginal benefit analysis with the available funds going where the potential net gains appear to be the greatest. In addition, a case can specifically be made for TAA because trade adjustment is distinct from domestic competition adjustment in that the government has changed the "rules of the game" for trade-related firms by altering trade barriers.

Ch.16 why have tariff reductions been substantial over the years while reductions in non tariff barriers have been minimal?

This should not rule out the use of TAA as a desirable policy. If funds for this type of adjustment, both domestic and trade-related, are insufficient, then the funds should be allocated between the two sources of factor rigidity based on a marginal cost/marginal benefit analysis with the available funds going where the potential net gains appear to be the greatest. In addition, a case can specifically be made for TAA because trade adjustment is distinct from domestic competition adjustment in that the government has changed the "rules of the game" for trade-related firms by altering trade barriers.

Ch. 3 "If US productivity growth does not keep up with that of its trading partners, the US will quickly lose its international competitiveness and not be able to export any products, and its standard of living will fall." Critically evaluate.

This statement could be true if trade was based on absolute advantage. However, since trade can take place on the basis of comparative advantage, what counts is relative cost differences. Consequently a country can be less efficient or become less efficient in all goods and yet gain from trade as long as there are relative cost differences in autarky. Thus, different rates of productivity growth may change what a country exports, but it is unlikely that it would ever take away the basis for trade, i.e., its ability to export.

Ch. 8 "Within the H-O framework, complete factor price equalization cannot be achieved in the presence of transportation costs". Agree? Disagree? why?

This statement is correct because complete factor-price equalization can take place in the Heckscher-Ohlin framework only if product prices are the same in the two countries with trade. In the presence of transportation costs, the price of any good will differ between two countries by the amount of transportation costs. Hence, because product prices are not the same, factor-price equalization will not take place.

Ch.5 Evaluate the statement: If a country's production-possibilities frontier demonstrates increasing opportunity costs, this means that each of the industries within the country must be operating in a context of decreasing returns to scale.

This statement is incorrect. The discussion in the text regarding the production-possibilities frontier indicates that a PPF with increasing opportunity costs emerges when constant returns to scale exist in each industry, provided that the industries have different factor intensities. Thus, neither industry needs to be operating in a context of decreasing returns to scale in order to generate an increasing- opportunity-cost PPF.

Ch. 17 How would you explain reservations in the US about the implementation of NAFTA? Do you think NAFTA is a good thing?

U.S. workers, especially in labor-intensive industries, worried that freeing up trade with labor-abundant Mexico would cause U.S. workers to lose their jobs or receive lower wages. These results were thought to be even more likely because U.S. firms will also switch production to Mexico because of the lower wages there. Hence, fears arose and continue to arise because of the perceived increased job/wage insecurity due to NAFTA. Other concerns have been raised about inadequate environmental protection and about "unfair" trade since Mexico's labor standards are lower. In addition, with NAFTA, there is joint arbitration of some trade disputes by representatives of all three nations, and this feature led to U.S. fears of loss of national sovereignty.

Ch. 9 Build case against view

While it is clear that increased income inequality and increased U.S. openness to imports have occurred at the same time, trade is but one of several factors in today's rapidly-changing world that have led to the greater inequality. The nature of technological change seems to be the most important factor, because the increased demand for skilled labor to work with the new technology has led to a rise in the skilled labor/unskilled labor ratio in all industries, not just in traded goods industries. Further, there is little evidence that the relative prices of unskilled labor-intensive goods to skilled labor-intensive goods have fallen, which is necessary for the Stolper- Samuelson mechanism to occur. Other factors have also played a role in the increased inequality, such as a decline in the importance of unions and a fall in the real minimum wage, and these factors are likely due to the political climate and/or to the changing structure of the American economy from manufacturing to services, rather than to trade itself.

Ch.6 Ms. Jones spends the majority of her income on food. She complains that after the country became more open to trade and began to export a variety of food products, her real income was reduced. She maintains the country has been hurt by the new, expanded trade and trade restrictions should be imposed. How would you respond?

While the opening of trade improves the overall well-being of a country, it can affect thedistribution of real income and leave certain individuals less well off. This result occurs because the price of the export good is rising, the price of the import good is falling, and factor prices are changing. In this case, Ms. Jones is correct about her situation but not about the situation of the country. Also, as will be seen in Chapter 8, if Ms. Jones owns the abundant factor used intensively in food production (the export), her real income should be rising because the price of the abundant factor rises to a greater relative extent than does the price of the export good (via the Stolper-Samuelson theorem and the magnification effect). In this instance, her conclusion about her own situation is incorrect. If, however, she owns the scarce factor of production, she will be strictly worse off since she will be faced with both an increased price of food and a falling income due to the decline in the price of the scarce factor. If Ms. Jones falls into the latter category, she should lobby for "compensation" from those whose real income has clearly increased from trade rather than for the imposition of trade restrictions which would lead to a fall in real income for the economy as a whole.

Ch. 9 How might the existence of factor-intensity reversals be a reason for the Leontief paradox? How might demand reversal?

With factor-intensity reversal, suppose U.S. exports that would be produced abroad by relatively capital-intensive techniques are produced with relatively labor- intensive techniques in the United States. In addition, suppose that U.S. imports that are relatively labor-intensive in production in the supplying countries are produced in relatively capital-intensive fashion in the United States. If the United States is relatively capital-abundant, it is thus importing goods that would be classified as relatively capital-intensive in the United States and exporting goods that would be classified as being produced relatively labor-intensively in the United States. Because Leontief's test utilized the U.S. input-output table and U.S. techniques, this yields the paradox. In the presence of demand reversal, the relative price of the good intensive in the abundant factor is higher (the relative price of the good intensive in the scarce factor is lower) compared to the relative international price. Consequently, the country will export the good that is intensive in the scarce factor and import the good that is intensive in the abundant factor. A capital- abundant country (in this case the United States) will thus be importing the capital-intensive good and exporting the labor-intensive good (using the price definition of relative factor abundance), contrary to the H-O prediction. This appeared to be the case for the United States in the initial Leontief study (hence the Leontief paradox).

Ch. 6 Assume a country produces and consumes 2 goods, cloth and machines, and is in equilibrium in autarky. It now finds that it can trade at international prices where (Pcloth/Pmachines) on the world mkt is greater than in the domestic mkt. Should it trade? If so, what commodity should it trade? why? Will it gain from trade?

Yes, the country should trade. It should export cloth because that is the good of comparative advantage, and producers will have a profit incentive to sell cloth at its relatively higher price on the world market. The country will gain from trade because its trading line (CPF with trade) will permit larger consumption bundles than are possible in autarky, since the exported cloth allows for the purchase of relatively cheaper machines than in autarky. As long as world prices differ from autarky prices, the country can move to a higher indifference curve by participating in trade.

Ch.4 During the debate on NAFTA, the economist noted that avg wages and fringe benefits in MX manufacturing industries were about 1/5 those in US manufacturing and that US output per worker was about 5 times that of MX manu. Based on the classical model, is there any causal relationship between these two facts?

Yes. Since productivity in U.S. manufacturing is considerably higher than in Mexican manufacturing, one would expect the level of wages to be considerably higher in the United States than in Mexico. For traded goods, if U.S. productivity is five times as high but U.S. wages are less than five times as high, U.S. manufactured goods prices would tend to be lower priced than Mexican goods. The relatively great demand for U.S. goods (relatively small demand for Mexican goods) would therefore drive up U.S. wages (and drive down Mexican wages) until the wage difference roughly matches the productivity difference. Similarly, if U.S. wages are more than five times Mexican wages, Mexican goods would be in relatively great demand (and U.S. goods in relatively small demand). Mexican wages would then rise (and U.S. wages would fall) until the wage difference again is roughly equal to the productivity difference. In practice, the matter is made more complicated by such factors as nontraded goods and a different composition of goods in the two countries. However, the general principle of the link between relative wages and relative productivity differences still holds.