Download CHAPTER 21 (17)

CHAPTER 21 (17)
Questions for Thought and Review
2.
If Widgetland produces only widgets, it can make 240 of them and the opportunity cost is 1/1. If
Wadgetland makes only wadgets could produce 720 of them at an opportunity cost of .25/1 (widgets to
wadgets). Since the opportunity costs differ, there is a basis for trade in production. Widgetland should
produce 240 widgets, and trade 60 of the widgets for 120 wadgets. Wadgetland should produce only 720
wadgets and trade 120 wadgets for 60 widgets. Both countries will be better off.
4.
Traders get big gains from trade in newly opened markets. The more competition that exists in international
trade, the more the traders’ gains will be reduced and the more gains are.
Countries producing goods with economies of scale get a larger gain from trade. Trade allows an increase in
production and if there are economies of scale, the increase can lower the average cost of production, and
lower the price of the good in the producing country.
6.
8.
Any three of the following ten would be correct: (1) Skills of the U.S. labor force, (2) U.S. governmental
institutions, (3) U.S. physical and technological infrastructure, (4) English as the international language of
business, (5) wealth from past production, (6) U.S. natural resources, (7) cachet, (8) inertia, (9) U.S.
intellectual property rights, and (10) relatively open immigration policy.
10. The law of one price is that in a competitive market there will be pressure for equal factors to be priced
equally. It is important to any discussion of the future of the U.S. economy because relative wages are
higher in the United States than in most other countries. The U.S. faces forces that will adjust these wages
until the relative prices are equal. This will likely happen by a combination of the following: (1) faster wage
growth in other countries, (2) slower wage growth in the United States, and (3) a decline in the value of the
dollar.
12. An equitable method might be to tax those who gain from the trade liberalization and give the proceeds to
those who are hurt by it. Assuming the original distribution is equitable and the government is not trying to
redistribute income, this method is equitable because the combined policies make everyone better off. The
political problems with implementation includes: (1) Everyone will try to exaggerate the amount they are
hurt and minimize the amount they are helped. Thus actually finding a tax that accomplishes the goal will be
difficult. (2) Once the taxes and subsidies are in place, they may not be removed after the adjustment of
displaced workers is complete. Losers will be overcompensated and gainers will be taxed too much. (3)
Those who have big gains (big business) may have more political power and be able to prevent the
implementation of this policy.
14. Economists support free trade because it forces domestic producers to operate efficiently and it increases
consumer welfare.
15. Tariffs and quotas have similar effects on limiting trade (both shift the supply curve to the left). The big
difference is who gets the revenue from the resulting increase in the price of imports. With a tariff the
government gets the revenue. With a quota, the revenues accrue to the foreign producers. You can see this
graphically in the margin graph on page 493 of the text.
16. Both increase the price of the import, helping the domestic producers. In the case of the voluntary restraint,
increases in price result in increased revenue to foreign firms and increased demand is met entirely by the
domestic market. In the case of the tariff, the revenue raised goes to the domestic government.
18. With a price floor, there is a loss of consumer surplus, higher prices and lower quantities.
20. The WTO is the successor to GATT. Both work toward agreements to reduce trade. WTO includes
enforcement mechanisms that GATT did not have.
Problems and Exercises
2.
No. Both countries’ opportunity cost of producing pickles is 2/1 (they must give up 2 olives to get 1
pickle). Neither has a comparative advantage, so there is no basis for trade.
If there are economies of scale, it definitely pays for both countries to specialize since doing so would
lower total costs. Which one should specialize is an open question since neither has a comparative
advantage.
a.
b.
4.
a.
Firms may produce in Germany, because (1) transportation costs in the other countries may be very
high, so that if these costs are included, it would not be efficient to produce there; (2) there might be
tariffs or quotas for imports into Germany that will prevent producing elsewhere; (3) the productivity of
German labor may be so much higher that unit labor costs in Germany are the lowest; and (4) historical
circumstances may have led to production in Germany and the cost of moving production may exceed
potential gains.
One would expect some short-run movement from Greece and Italy into Germany, but only in the long
run will there be substantial movement. Social restrictions such as language and culture will limit labor
mobility. With such high unemployment in Germany already, one would not expect much short-run
movement.
I would need to know how stable the political system is, what the worker productivity rates are, how
sound the infrastructure (such as roads) is, and what the tax differences are between the two countries.
b.
c.
a.
Cars in thousands
6.
The production possibility curve is shown in the accompanying graph.
60
50
busytown
40
30
20
10
lazyasiwannabe
0
10
20
30
40
50
60
Meals in thousands
b.
c.
8.
a.
Since Busytown can produce more cars when all of its resources are devoted to producing cars,
Busytown has an absolute advantage in producing cars. Neither has an absolute advantage in producing
gourmet meals since if each devotes all of its resources to producing meals, each can produce 50, but
Lazyasiwannabe has a comparative advantage in gourmet meals. It must give up 1 cars for each
gourmet meal while Busytown must give up 1.2 cars for each gourmet meal.
Busytown should produce 60,000 cars and Lazyasiwannabe should produce 50,000 meals.
Lazyasiwannabe then offers Busytown 22,000 meals for 24,000 cars. Since Busytown must give up
only 24,000 cars for 22,000 meals (instead of the 26,4,00 cars it would have to if it made 22,000 meals
itself) it accepts this offer. Lazyasiwannabe ends up with 28,000 meals and 24,000 cars while Busytown
ends up with 22,000 meals and 36,000 cars.
With the quota, the quantity of clothes sold was fixed. Suppliers charged the price (P0) consumers were
willing to pay for that quantity. With the removal of the quota, as the accompanying graph
demonstrates, equilibrium quantity rose (to Q1) and equilibrium price fell (to P1).
Price
P0
P1
Demand
Q1
Quantity
Quota
b.
c.
10. a.
b.
Consumers benefited because they were able to buy a greater quantity at a lower price. Graphically this
is shown by an increase in consumer surplus shown by the shaded region in the accompanying graph.
The short-run effect of the removal of the quota is that profits declined because the equilibrium price
declined. If economies of scale lower average total costs by more than the decline in equilibrium price,
in the long run profits might increase with the removal of the quotas.
Economists opposed the tariff because it creates dead weight loss and hurts the welfare of the whole
society.
The tariff shifts the supply of imports up, increasing equilibrium price to P 1 and lowering equilibrium
quantity to Q1 as shown in the accompanying graph.
Price
S1
tax
S0
P1
P0
Demand
Q1 Q0
c.
d.
Quantity
The tariff would help the economy by increasing the price of imported goods, making domestic goods
relatively more competitive and allowing domestic producers to raise their prices if they chose to do so.
It would also provide revenue for government that it could spend on consumption or investment goods,
further stimulating the domestic economy.
The macro economy would be worsened because a retaliatory tariff reduces the trade between
countries, thereby hurting both of them. They do not benefit from the full extent of their comparative
advantages.
Web Questions
2.
a.
b.
c.
4.
Three trade barriers listed are biotechnology bans, quotas on lumber, and export control licensing.
The biotechnology bans are implemented because of perceived health risks to genetically modified
food. The lumber quotas are to save American jobs in the timber industry. Export control licensing of
satellites has shifted from the Commerce Department for security reasons.
The ban on genetically modified food is hurting the U.S. agriculture market. The import quota on
lumber has led to a 35 percent increase in the price of U.S. lumber. We are losing business from China
due to the change in license control.
The answer to this question depends on the country chosen.
Appendix A
a.
b.
Thousands of pounds of
Roquefort cheese
2.
The opportunity cost for Greece of making 1 million olives is 1,000 pounds of cheese. The opportunity
cost for France of making 1 million olives is 250 pounds of cheese. The opportunity cost for Greece of
making 1,000 pounds of cheese is 1 million olives. The opportunity cost for France of making 1,000
pounds of cheese is 4 million olives.
They are worse off since France has a comparative advantage in producing olives and Greece has a
comparative advantage in producing cheese. Under the new law France produces 50,000 pounds of
cheese and Greece produces 500 million olives—point A. They could have had a greater combination:
100,000 pounds of cheese produced by Greece and 600 million olives (200 million by France and 400
million by Greece)—point B. Their combined possibility curve if they were able to trade is the
outermost production possibility curve shown.
700
600
Greece
500
400
Specialization
& trade
300
200
100
France
A
B
0
0 0 0 0 0 0 0
10 20 30 40 50 60 70
Millions of oliv es
c.
See the accompanying graph. All the points in the shaded area were unattainable without specialization
and trade.