Download Chapter 19: International Trade Policy, Comparative Advantage, and

Chapter 19: International Trade Policy, Comparative Advantage, and Outsourcing
Questions and Exercises
1.
A country does better exporting a good for which it has a comparative advantage
and importing goods for which other countries have comparative advantages.
2.
If Widgetland produces only widgets, it can make 240 of them and the
opportunity cost is 1/1. If Wadgetland makes only wadgets, it 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. Here is one
possibility: 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.
3. a. Since their opportunity costs differ, they can gain from specializing: Nebraska
will produce only wheat, and Iowa will produce only corn. If Iowa produces only
corn, it can increase its production of corn by 60 million to 180 million. Similarly
Nebraska can increase its production of wheat to 180 million. There are now 180
million bushels of both to be divided in whatever way the states decide, making it
possible to meet the distribution given in the question.
b. The states together produce 180 million bushels of both corn and wheat and
consume 160 million bushels, so the trader gets 20 million bushels of corn and 20
million bushels of wheat.
4. a. The countries can move to those points through specialization and trade.
Machineland has the comparative advantage in machines and should specialize in
them and trade them for food from Farmland. If Machineland produces 200
machines and Farmland produces 200 units of food, then they can trade on a 1 to
1 basis to reach points B and D.
b. At points A and C the total production of machines is 110 and of food is 170. By
specialization the total production of each would increase to 200, so production of
machines increases by 90 and production of food increases by 30.
c. There is no set amount that a trader should receive, but the trader's share should
compensate him and still allow for the two nations to gain from trade. Eventually,
the above-normal returns will be competed away.
d. Economies of scale would mean that the production possibilities curves would not
be straight lines, and would be a further argument in favor of specialization; the
recommendation doesn’t change, but the economic case behind it becomes
stronger.
5. a. The production possibility curves are shown in the
accompanying graph.
b. Busytown has a comparative advantage in producing
cars and Lazyasiwannabe has a comparative
advantage in gourmet meals.
c. 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 26,400 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.
6.
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 passed to the citizens.
7.
Smaller countries tend to get more of the gains from trade because more
opportunities are opened up for them. This is true only under the condition that
competition among traders prevails.
8.
International traders in small countries often have little competition and so keep
large shares of the gains from trade for themselves; hence, the people of the small
country may not get the gains from trade.
9.
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.
No. Both countries’ opportunity cost of producing pickles is 2 (they must give up
2 olives to get 1 pickle). Neither has a comparative advantage, so there is no basis
for trade.
b. 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 in which
good is an open question since neither has a comparative advantage.
10.a.
11.
Three reasons are: (1) Economists can identify both the costs and benefits of
trade. Laypeople often do not recognize that the decline in product prices is the
result of trade, while they can readily identify that lost jobs are the costs. (2)
Economists know that comparative advantage implies that each country is better
at producing at least one good. Laypeople worry that since wages are lower in
China, it has a comparative advantage in all goods and the U.S. will lose all its
jobs. Economists admit that because the U.S. has a trade deficit, the U.S. will face
difficult economic forces to restore a more nearly equal division of comparative
advantage. (3) Economists recognize that trade occurs in more sectors than
manufacturing. They see the comparative advantage that the U.S. has in trading
services. Laypeople tend to see trade as trade in manufactured goods only.
12.
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.
13.
Inherent comparative advantages are those that are based on factors that are
relatively unchangeable, while transferable comparative advantages are those
based on factors that can change relatively easily.
14.
A country would prefer to have an inherent comparative advantage because it
would not lose that comparative advantage or face the adjustment costs that
accompany the change of comparative advantages.
15.
The law of one price is that in a competitive market there will be pressure for
equal factors to be priced equally.
16.
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.
17.
The law of one price will likely eliminate a transferable comparative advantage
because the law depends on the factors of production to be mobile to equalize
their payments across countries. Factors that are inherent to a country are not
mobile.
18.
The two methods by which the wage gap between Chinese and U.S. workers will
likely narrow are (1) relatively slow wage growth in the United States and
relatively faster wage growth in China and (2) a fall in the value of the dollar
relative to the Chinese yuan.
19.
Tariffs and quotas have similar effects on limiting
trade. A tax shown in the graph shifts the curve up
while a quota Q* will limit supply to the quantity
resulting from the tax. The equilibrium price is the
same in both cases. 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, shown by the shaeded region.
With a quota, the revenues accrue to the foreign
producers.
20.
Both increase the price of the import, which helps 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.
21. a. The gains to domestic producers are shown in
the accompanying graph. Domestic producers
now produce B at Pt instead of A at Pw.
Domestic producers gain additional revenue
shown by areas FHKG and ABKE.
b. The revenue to the government is the quantity
supplied by foreign producers, BC, multiplied
by the tariff. This is shown in the
accompanying graph as HIJK.
c. The cost to domestic producers to produce
additional units is shown by area ABKHE.
d. The gain to domestic producers is greater than
the cost to domestic producers by area FHEG.
22.
The answer in part will depend on what advice is being given. Most economists
would argue that some trade restrictions might benefit a country, but almost no
country can limit its restrictions to the beneficial ones. Trade restrictions are
addictive; most economists would not recommend them, even in a recession.
23.
Economists support free trade for many reasons. Two are that it forces domestic
producers to operate efficiently and it increases consumer welfare.
24. a. 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).
b. Consumers benefited because they were able to
buy a greater quantity at a lower price. This is
represented by an increase in consumer surplus
shown by the shaded region in the accompanying
graph.
c. 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.
25.
The WTO is the successor to GATT. Both work toward agreements to reduce
trade barriers. The WTO includes enforcement mechanisms that GATT did not
have.
Issues to Ponder
1.
Outsourcing to China and India today differs from outsourcing in the past in two
ways: (1) the potential size of outsourcing is much larger today (those countries
have combined population of about 2.5 billion) and (2) China and India are able
to compete on a larger number of production levels thank in the past (China and
India have adopted more technological advances).
2. a. Three assumptions are that the good is tradable, that transportation costs are
minimal, and that taxes between the two countries do not differ significantly.
b. To the degree that production facilities and labor can move easily, the law of one
price should hold for labor, too. Given the wage differentials that exist among
countries with seemingly equivalent productivities, it seems that these conditions
do not hold for labor. Barriers such as language and family ties likely explain this
observation.
c. Since capital is more mobile than labor, the law of one price should have a greater
tendency to hold for capital. Financial capital is a great example. Interest rates
among countries tend to equate much faster than wages.
3.
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.
a. 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.
b. The political problems with implementation include: (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.
4.
With a price floor, there is a loss of consumer surplus, higher prices and lower
quantities.
5.
There is no “right” answer to this question. To the extent that the chemicals
present a health problem, the government may want to restrict tomatoes imported
from Mexico. Doing so, however, will raise the price of tomatoes for American
consumers. Domestic producers will lobby for such restrictions because they will
be able to charge more for the tomatoes they sell.
6. a. Yes, if the deductions in lost taxes exceed the amount collected. This is indeed the
case. Congressional tax experts have estimated that the deductions exceed the
amount corporations pay in taxes by $6 billion a year.
b. The natural suggestion would be to eliminate the tax, including the accompanying
deductions from corporate taxable income. This would have the added benefit of
eliminating the administrative costs associated with the tax.
c. It is likely that the companies want the tax because they benefit from it—in other
words, because the tax results in lower taxable corporate income, it is an implicit
subsidy, and they will lobby strongly to keep it. The government may keep the tax
because it wants to encourage exports. (Source: “U.S. Overseas Tax Is Blasted,”
The Wall Street Journal, May 5, 2004)
7. a. Economists opposed the tariff because it
creates dead weight loss and hurts the welfare
of the whole society.
b. The tariff shifts the supply curve of imports
up, which increases equilibrium price to P1
and lowers equilibrium quantity to Q1 as
shown in the accompanying graph.
c. 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, further stimulating the domestic economy.
d. The macro economy would be worsened because a retaliatory tariff reduces
the trade between countries, which hurts both of them. The countries do not
benefit from the full extent of their comparative advantages.