Download Answers to Questions in Chapter 22

Answers to Questions in Chapter 22
Note: No. before  indicates a page number
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512  Why does the USA not specialise as much as General Motors or Texaco? Why does
Australia not specialise as much as BHP? Is the answer to these questions similar to
the answer to the questions, `Why does the USA not specialise as much as Singapore?',
and `Why does BHP or Ford not specialise as much as the local butcher?'
There are two elements to the answer. One concerns costs, one concerns demand and
revenue.
In terms of costs, as a firm or country specialises and increases production, so the
opportunity costs of production are likely to fall at first, due to economies of scale, and
then rise as resources become increasingly scarce. The butcher's shop may not have
reached the point of rising long-run opportunity costs. Also it is too small to push up
the price of inputs as it increases its production. It is a price taker. BHP and Texaco,
however, probably will have reached the point of rising opportunity costs. Countries
certainly would have if they specialised in only one product. Thus the larger the
organisation or country, the more diversified they are likely to be.
Turning to the demand side: the butcher's shop supplies a relatively small market and
faces a relatively elastic demand. It is therefore likely to find that complete
specialisation in just one type of product is unlikely to lead to market saturation and a
highly depressed price. Large companies, however, may find that complete
specialisation in one product restricts their ability to expand. The market simply is not
big enough. Countries would certainly find this. The USA could hardly just produce
one product! The world market would be no where near big enough for it. The general
point is that overspecialisation would push the price of the product down and reduce
profits.
513  Draw up a similar table to Table 22.1, only this time assume that the figures are: LDC
6 wheat or 2 cloth; DC 8 wheat or 20 cloth. What are the opportunity cost ratios now?
The opportunity cost of wheat in terms of cloth is 2/6 in the LDC and 20/8 in the DC
(i.e. 7.5 times higher in the DC).
The opportunity cost of cloth in terms of wheat is 6/2 in the LDC and 8/20 in the DC
(i.e. 7.5 times higher in the LDC).
514  1. Show how each country could gain from trade if the LDC could produce (before
trade) 3 wheat for 1 cloth and the developed country could produce (before trade) 2
wheat for 5 cloth, and if the exchange ratio (with trade) was 1 wheat for 2 cloth. Would
they both still gain if the exchange ratio was (a) 1 wheat for 1 cloth; (b) 1 wheat for 3
cloth?
The LDC still gains by exporting wheat and importing cloth. At an exchange ratio of
1:2, it now only has to give up 1 kilo of wheat to obtain 2 metres of cloth, whereas
without trade it would have to give up 3 kilos of wheat to obtain just 1 metre of cloth.
The developed country still gains by importing wheat and exporting cloth. At an
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Answers to questions in Economics by Sloman and Norris
exchange ratio of 1:2, it can now import 1 kilo of wheat for only 2 metres of cloth,
whereas without trade it would have to give up 5 metres of cloth for 2 of wheat (i.e. 2_
of cloth for 1 of wheat).
(a) Yes. (This ratio is between their two pre-trade ratios.)
(b) No. The LDC would gain, but the DC would lose. It would now have to give 3
metres of cloth for 1 kilo of wheat, whereas before trade it only had to give 2_
metres of cloth for 1 kilo of wheat. Thus the developed country would choose not
to trade at this ratio.
514  2. In question 1, which country gained the most from a trade exchange ratio of 1 wheat
for 2 cloth?
The LDC. The opportunity cost of its import (cloth) has fallen much more than that of
the developed country.
516  (Box 22.1) In Ricardo's example, what is the opportunity cost of wine in terms of cloth
in (a) Portugal; (b) England? (Assume that the only costs are labour costs.)
(a) 90/90 = 1; (b) 120/100 = 1.2
517  (Box 22.3) Under what circumstances would a gain in revenues by exporting firms not
lead to an increase in wage rates?
When there is such surplus labour (e.g. through high unemployment or the firms being
legally required to pay minimum wages) that an increase in demand for labour will not
bid up the wage rate. At least, however, unemployment will probably fall, unless new
workers flood in from the countryside to take advantage of new jobs created in the
towns.
517  1. If the opportunity cost ratio of wheat for cloth is 1/2 in the LDC, why is the slope of
the production possibility curve 2/1? Is the slope of the production possibility curve
always the reciprocal of the opportunity cost ratio.
Because if the cost of a unit of wheat is only _ unit of cloth, then 2 units of wheat can
be produced for every one unit of cloth. The slope of the production possibility curve is
thus always the reciprocal of the opportunity cost ratio of the good measured on the
vertical axis.
517  2. Show (graphically) that, if the (pre-trade) opportunity cost ratios of the two
countries were the same, there would be no gain from trade - assuming that the
production possibility curves were straight lines and did not shift as a result of trade.
The two blue lines in Figure 19.1 (a) and (b) respectively, would have the same slope.
Given that the slope of the lines after trade will shift until they are the same in both
countries, the lines will not shift, since they already have the same slope. Thus
consumption cannot take place beyond the production possibility curve.
518  1. If 4x exchange for 3m what are the terms of trade?
3/4
518  2. If the terms of trade are 3, how many units of the imported good could I buy for the
money earned by the sale of 1 unit of the exported good? What is the exchange ratio?
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Chapter 22
If Px/Pm = 3/1, then 3 units of imports can be purchased with the money earned by the
sale of 1 unit of the exports. The exchange ratio is 1x:3m.
519  Would it be possible for a country with a comparative disadvantage in a given product
at pre-trade levels of output to obtain a comparative advantage in it by specialising in
its production and exporting it?
Yes, if the country has potential economies of scale in producing that good (which it
had not yet exploited). Specialisation could then reduce the opportunity costs of that
good below that of the same good in other countries. (This assumes that the other
country does not have potential economies of scale in that good or does not exploit
them if it does.)
521  (Box 22.3) Go through each of these four arguments and provide a reply to the
criticisms of them.

Imports are not always matched by exports. If imports exceed exports, then the
resulting trade deficit has to be matched by a surplus elsewhere on the balance of
payments account, which might bring problems (e.g. short-term financial inflows
leading to exchange rate volatility). A rise in imports, being a withdrawal from the
circular flow of income, will tend to reduce income unless matched by a
corresponding rise in exports. Sometimes imports may influence consumer tastes,
and this may be seen as undesirable. For example, imports of soft drinks into
poorer developing countries has been criticised for distorting tastes.

The greater competition from free trade will provide a permanently less certain
market for domestic producers and possibly a permanently higher rate of structural
unemployment, given the greater rate of entry and exist of firms from markets.

The gain to consumers may be short-lived, and if more efficient domestic firms
have been driven from the market, there will be a long-term net welfare loss to the
country.
522  How would you set about judging whether an industry had a genuine case for
infant/senile industry protection?
Whether it can be demonstrated that, with appropriate investment, costs can be reduced
sufficiently to make the industry internationally competitive.
522  Does the consumer in the importing country gain or lose from dumping?
In the short run the consumer will gain from cheaper products. In the long run the
consumer could lose if domestic producers were driven out of business, which then
gave the foreign producer a monopoly. At that point, it is likely that prices would go up
above the pre-dumping levels.
523  In what ways may free trade have harmful cultural effects on developing countries?
The products and the lifestyles which they foster could be seen as alien to the values of
society. For example, many developing countries have complained about the
`cocacolonisation' of their economies, whereby traditional values are being overcome
by Western materialist values.
524  If economics is the study of choices of how to use scarce resources, can these other
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Answers to questions in Economics by Sloman and Norris
objectives be legitimately described as `non-economic'?
In this sense they clearly are economic objectives. That is why I used inverted commas
for the words `non-economic' in the title.
524  In this model, where the country is a price taker and faces a horizontal supply curve
(the small country assumption), is any of the cost of the tariff borne by the overseas
suppliers?
The whole of the tariff is passed on in higher prices to the consumer. The overseas
suppliers still receive a price of Pw after the tariff has been paid. Thus none of the per
unit cost of the tariff is borne by the overseas suppliers. There will, nevertheless, be a
loss in sales for them from Q2 - Q1 to Q4 - Q3.
526  (Box 22.4) Should the world community welcome the use of tariffs and other forms of
protection by the rich countries against imports of goods from developing countries
that have little regard for the environment?
There is no simple answer to this question. In terms of social efficiency, trade should
take place as long as the marginal social benefit was greater than the marginal social
cost (where environmental benefits and costs are included in marginal social benefits
and costs). The problem with this approach is in identifying and measuring such
benefits and costs. Then there is the problem of whether a social efficiency approach
towards sustainability is the appropriate one (see page 329 [in 4th edition]). Then there
is the issue of the response by the developing countries to the protection. Will they
respond by introducing cleaner technology? This may prove difficult to predict.
529  (Box 22.5) Airbus, a consortium based in four European countries, has received
massive support from the four governments, in order to enable it to compete with
Boeing, which until the rise of Airbus had dominated the world market for aircraft. To
what extent are (i) air travellers; (ii) citizens of the four countries likely to gain or lose
from this protection?
(i) To the extent that the resulting competition reduces the costs of aircraft and hence
air fares, the traveller will gain.
(ii) Whether citizens of the EU as a whole gain depends on whether the costs of the
support (including external costs), as are recouped in the benefits of lower fares to
travellers, profits to Airbus Industries and external benefits (such as spillover
research benefits to other industries). Of course, the costs and benefits will not be
equally distributed to EU citizens and thus there will be redistributive effects of the
policy, effects which may be considered to be desirable or undesirable.
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