Chapter 9: International Trade Policy, Comparative ...



CHAPTER 17: COMPARATIVE ADVANTAGE, EXCHANGE RATES ANDGLOBALIZATIONQuestions and Exercises1.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.There is a basis for trade because Wadgetland can produce wadgets at a lower opportunity cost than Widgetland. Wadgetland gives up 1/4 of a widget for every wadget it makes, while Widgetland gives up 1 widget for every wadget it makes. So Widgetland has a lower opportunity cost of producing widgets. They give up 1 wadget while Wadgetland gives up 4 wadgets to make a widget. Wadgetland has a comparative advantage in producing wadgets and Widgetland has a comparative advantage in producing widgets. If each specializes in their respective comparative advantage, Wadgetland ought to produce 720 wadgets and 0 widgets and Widgetland ought to produce 240 widgets and 0 wadgets. With this production combination, a possible deal in which each can consume more than before is for Widgetland to trade 120 widgets for 240 wadgets. It could then consume 120 widgets and 240 wadgets, doubling the amount of wadgets they are now able to consume. Wadgetland would then consume 480 wadgets and 120 widgets, doubling the amount of widgets they were previously able to consume. Both countries will be better off than before.3.a.Iowa has a comparative advantage in bushels of corn (gives up 1/3 bushels of wheat for every bushel of corn). Nebraska has a comparative advantage in wheat (gives up 1/3 bushels of corn for every bushel of wheat). It would be recommended that Iowa produce 180 bushels of corn [120 + (3 × 20)] and 0 bushels of wheat and Nebraska produce 0 bushels of corn and 180 bushels of wheat [120 + (3 × 20)]. With this combination, Nebraska can trade 120 bushels of wheat for 60 bushels of corn. With this trade, Nebraska will end up with 120 bushels of corn and 60 bushels of wheat and Iowa will end up with 60 bushels of corn and 120 bushels of wheat. Nebraska ends up with 20 more bushels of corn and Iowa ends up with 20 more bushels of wheat than required by the question. Thus, each can achieve at least the consumption combination required by the question. The excess must go somewhere and part b tells us where—the trader.b.The states together produce 180 million bushels of both corn and wheat, but consume 160 million bushels of each leaving the trader 20 million bushels of corn and 20 million bushels of wheat.4.a. The countries must realize that the only way to get to the new consumption combinations is if they specialize and then trade. Machineland has the comparative advantage in machines and should specialize in them and trade them for food from Farmland. Doing so, Machineland produces 200 machines and Farmland produces 200 units of food. They can then end up at points B and D with a one-to-one trade with Machineland trading 50 machines for 50 units of food.b.At points A and C the total production of machines is 110 and the total production 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.If costs fell as production rose, the argument for specialization is even stronger. 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. Lazyasiwannabe ends up with 28,000 meals (50,000 ? 22,000) and 24,000 cars. If it had produced 24,000 cars on its own, it would have had only 24,000 meals. Busytown ends up with 36,000 cars. If it had produced 22,000 meals on its own, it would be left with only 33,600 cars (60,000 ? 26,400). 6.Traders get bigger gains from trade in newly opened markets where strong competition among traders has yet to develop. The more competition that exists in international trade, the more the traders will compete with one another and will offer to arrange the trade for less and less. With more competition, gains to traders will be reduced, leaving more gains for citizens of the countries involved in the trade. 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 larger shares of the gains from trade for themselves; hence, the people of the small country may not get the gains from trade.9.a.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 per-unit cost of producing pickles and olives falls as more of each is produced, it definitely pays for both countries to specialize in either olives or pickles since doing so would lower total costs. Which country should specialize in which good is an open question since neither has a comparative advantage and we do not know how much per-unit costs fall for each’s production. 10.Four 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. (4) Economists' models do not take into account the effect of trade on the distribution of income. A change in a country's comparative advantage will affect the distribution of income. Laypeople do take this into account. 11. False. According to the theory of comparative advantage, if one country has a comparative advantage in one good, the other country must have a comparative advantage in another good.12.While the loss of a comparative advantage in the manufacturing sector might have hurt the United States’ economy in some ways, it has freed resources for the sectors in which the United States does have a comparative advantage. Today that comparative advantage is facilitating international trade. This change creates a demand for U.S. advertising, management, and distribution of goods. This creates jobs and income in those sectors. 13.Outsourcing has reduced the demand for manufactured jobs, reducing employment and income in that industry. Manufacturing supported the middle class for a number of years. Globalization has also created demand for technology, finance, and trade, which all require specialized skills, and ultimately pay higher salaries. Because globalization increases the market for their skills, income in these sectors has increased enormously. The overall result is a greater disparity in income.14.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.15.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. 16.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.17. The depreciation of a currency means that it takes fewer foreign currency units to buy one domestic currency unit. In the case of the United States and China where the dollar depreciates, the price of U.S. exports to China declines and the price of U.S. imports from China increases as more U.S. dollars would be needed to buy a Chinese import. 18.Domestic production is shown by Q0. Domestic consumption is Q1. The difference, Q1 ? Q0, represents imports.a.The United States would like to raise world supply since it would increase domestic production and reduce imports. b.This might happen in a variety of ways. The United States could gain a comparative advantage in the good by increasing productivity, relative U.S. wages could fall, or the U.S. dollar could depreciate. 19.The resource curse would worsen the distribution because it would cause an appreciation in the value of the currency, lowering the world price level, making the trade position for tradable goods worse. That is, a country’s exports would cost more and imports would cost less. The resource sector benefits because by definition, foreign countries demand the resource. Tradable goods sectors tend to employ a large number of workers as compared to natural resource sectors. Resource sectors tend to have fewer employees, concentrating the rise of income among a few, as compared to other tradable goods sectors. Questions from Alternative Perspectives1. AustrianAn Austrian would tend to agree with this statement because they believe that people tend to know what is good for them much better than government does.2. ReligiousThis is a judgment question in which answers will differ. A religiously oriented economist is more likely to give weight to such issues--maintaining cultural identity--than is a mainstream economist. 3. Post-Keynesiana.Outsourcing tends to undermine the bargaining power of U.S. workers and increase the bargaining power of U.S. employers. b.It will likely lead to lower U.S. wages than otherwise would have been the case. c.Since lawyers need to be certified by state boards, they do not face as much competition from outsourcing, so outsourcing will not tend to lower lawyers’ wages.d.Yes, given that lawyers tend to have more influence in government, they would likely institute policies to limit outsourcing law services that have the potential to be outsourced. 4. Radicala.This is a judgment call but an argument could be made that since there are economies to scale in the production of cloth and the production of cloth has linkages to other important industries (for example, chemical and machine making) that are key to an initiating industrial revolution that are missing in the production of wine, Ricardo’s advice was self-serving for England. b.No, I probably would have advised them not to specialize in wine making. 5.Austrian and Post-KeynesianSmith’s is a moral claim that is difficult to support or dispute. It depends on sensibilities of people. Most people’s sensibilities would be similar to Smith’s. Individuals care about others, especially the poor. Not only do they say this, but they also demonstrate it by politically supporting programs that assist the poor and provide basic needs for people. But those programs have not been very successful at reducing income inequality, and the distribution of income is becoming less equal in the United States due in part to the adjustments caused by a decline in the comparative advantage for manufactured goods in the United States. Lower-income workers in the tradable sectors are seeing their income fall, while others at the top of the trading pyramid are gaining enormously. Whether this increase in inequality undermines Smith’s claim that all people care about the poor is unclear. Society today is much richer than it was in Smith’s time, and there are many different judgments about whether low-income individuals in U.S. society should be classified as poor and miserable. Some would argue yes, they should be classified as such, and the fact that we haven’t done anything to stop the increase in inequality shows that people don’t care about society. Others would argue no, low-income individuals in the United States do not meet Smith’s conception of “poor and miserable” and thus the fact that income inequality is increasing should not be of concern, nor does it demonstrate that society doesn’t care about the poor. They believe that the best way to help society is to allow market trade to “lift all boats.” Programs designed specifically to help the poor will likely backfire, and not help the poor, but instead help those who design the programs. Smith also made this argument when he explained why most proposed government programs “ought never to be adopted, till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.” The problem is that the proposals to help the poor “come… from an order of men, whose interest is never exactly the same with that of the public, who generally have an interest to deceive and even oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.”Issues to Ponder1.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 3 billion) and (2) China and India are able to compete on a larger number of production levels than in the past (China and India have adopted more technological advances).2.The law of one price states that the price of equivalent goods will cost the same across countries. Reasons why the law of one price might not hold include different social institutions, laws, and transportation costs. Another reason is that while two products might be equivalent, consumers might not perceive them as equivalent. American goods currently have cache in some countries that will keep their prices higher than "equivalent" goods in other countries.3.The normal textbook presentation might not include the international trader because it complicates the model. How much of the gains go to trader depends on the cost of facilitating the trade, the competition among traders, and the bargaining power of the country relative to the trader. There is no simple model to reflect these complications. Including the trader in the model recognizes that traders are a necessary component of trading. This allows one to acknowledge the comparative advantage the United States currently has in facilitating trade. Including traders provides a more comprehensive view of how the benefits of trade are distributed. 4.a.Since the trade would be balanced, the price of the certificates would be zero.b.In order to import, the price would be very high.c.Since the United States has a trade deficit with China. Chinese companies that wanted to export to the United States would pay a high price to American exports for the license to do so. In China, the price of certificates to export would be highly positive, which means that the price of certificates to import would be highly negative. Exporter would have to pay importers to import. d.Such a law would make exchange rate fluctuations less likely because it would equalize the current account balance5. The subgroup of workers that would have likely been most helped are low-wage manufacturing workers in tradable sectors. They would have had their industries supported in order to encourage exports, and they would have faced fewer imports. The subgroup of workers that would likely have been most hurt are the international traders who would have had to give up some of their gains from importing to create offsetting exports. ................
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