Part A-
1. Assume that Norway and Sweden trade with each other, with Norway exporting fish to Sweden, and Sweden exporting Volvos (automobiles) to Norway. Illustrate the gains from trade between the two countries using the standard trade model, assuming first that tastes for the goods are the same in both countries, but that the production possibility frontiers differ: Norway has a long coast that borders on the north Atlantic, making it relatively more productive in fishing. Sweden has a greater endowment of capital, making it relatively more productive in automobiles.
2. In the trade scenario in problem 1, due to overfishing, Norway becomes unable to catch the quantity of fish that it could in previous years. This change causes both a reduction in the potential quantity of fish that can be produced in Norway and an increase in the relative world price of fish PfIPa.
a. Show how the overfishing problem can result in a decline in welfare for Norway.
b. Also show how it is possible that the overfishing problem could result in an increase in welfare for Norway.
3. In some economies relative supply may be unresponsive to changes in prices. For example, if factors of production were completely immobile between sectors, the production possibility frontier would be right-angled, and output of the two goods would not depend on their relative prices. Is it still true in this case that a rise in the terms of trade increases welfare? Analyze graphically.
4. The counterpart to immobile factors on the supply side would be lack of substitution on the demand side. Imagine an economy where consumers always buy goods in rigid proportions-for example, one yard of cloth for every pound of food-regardless of the prices of the two goods. Show that an improvement in terms of trade benefits this economy as well.
5. Japan primarily exports manufactured goods, while importing raw materials such as food and oil. Analyze the impact on Japan's terms of trade of the following events:
a. A war in the Middle East disrupts oil supply.
b. Korea develops the ability to produce automobiles that it can sell in Canada and the United States.
c. U.S. engineers develop a fusion reactor that replaces fossil fuel electricity plants.
d. A harvest failure in Russia.
e. A reduction in Japan's tariffs on imported beef and citrus fruit.
6. The internet has allowed for increased trade in services such as programming and technical support, a development that has lowered the prices of such services relative to those of manufactured goods. India is particular has been recently viewed as an "exporter" of technology-based services, an area in which the United States has been a major exporter. Using manufacturing and services as tradable goods, create a standard trade model for the U.S. and Indian economies that shows how relative price declines in exportable services that lead to the "outsourcing" of services can reduce welfare in the United States and increase welfare in India.
7. Countries A and B have two factors of production, capital and labor, with which they produce two goods, X and Y. Technology is the same in the two countires. X is capital-intensive; A is capital-abundant. Analyze the effects on the terms of trade and on the two countries' welfare of the following:
a. An increase in A's capital stock.
b. An increase in A's labor supply.
c. An increase in B's capital supply
d. An increase in B's labor supply.
8. Economic growth is just as likely to worsen a country's terms of trade as it is to improve them. Why, then, do most economists regard immiserizing growth, where growth actually hurts the growing country, as unlikely in practice?
9. From an economic point of view, India and China are somewhat similar: Both are huge, low wage countries, probably with similar patterns of comparative advantage, which until recently were relatively closed to international trade. China was the first to open up. Now that India is also opening up to the world trade, how would you expect this to affect the welfare of China? Of United States? (Hint: Think of adding a new economy identical to that of China to the world economy.)
10. Suppose that Country X subsidized its exports and Country Y imposes a "countervailing" tariff that offsets the subsidy's effect, so that in the end, relative prices in Country Y are unchanged. What happens to the terms of trade? What about welfare in the two countries? Suppose, on the other had, that Country Y retaliates with an export subsidy of its own. Contrasts the result.
11. Explain the analogy between international borrowing and lending and ordinary international trade.
12. Which of the following countries would you expect to have inter-temporal production possibilities biased toward current consumption goods, and which biased toward future consumption goods?
a. A country like Argentina or Canada in the last century that has only recently been opened for large-scale settlement and is receiving large inflows of immigrants.
b. A country like the United Kingdom in the late 19th century or the United States today that leads to world technologically but is seeing that lead eroded as other countries catch up.
c. A country like Saudi Arabia that has discovered large oil reserves that can be exploited with little new investment.
d. A country that has discovered large oil reserves that can be exploited only with massive investment, such as Norway, whose oil lies under the North Sea.
e. A country like South Korea that has discovered the knack of producing industrial goods and is rapidly gaining on advanced countries.
Part B -
1. For each of the following examples, explain whether it is a case of external or internal economies of scale:
a. Most musical wind instruments in the United States are produced by more than a dozen factories in Elkhart, Indiana.
b. All Hondas sold in the Unites States are either imported or produced in Marysville Ohio.
c. All airframes for Airbus, Europe's only produces of large aircraft, are assembled in Toulouse, France.
d. Hartford, Connecticut, is the insurance capital of the northeastern United States.
2. It is often argued that the existence of increasing returns is a source of conflict between countries, since each country is better off if it can increase its production in those industries characterized by economics of scale. Evaluate this view in terms of the external economy model.
3. Give two examples of products that are traded on international markets for which there are dynamic increasing returns. In each of your examples, show how innovation and learning-by doing are important to the dynamic increasing return in the industry.
4. Evaluate the relative importance of economics of scale and comparative advantage in causing the following:
a. Most of the world's aluminum is smelted in Norway of Canada.
b. Half of the world's large jet aircraft are assembled in Seattle.
c. Most semiconductors are manufactured in either the United States or Japan.
d. Most Scotch whiskey comes from Scotland
e. Much of the world's best wine comes from France.
5. Consider a situation similar to that in Figure 7-3, in which two countries that can produce a good are subject to forward-falling supply curves. In this case, however, suppose that the two countries have the same costs, so that their supply curves are identical.
a. What would you expect to be the pattern of international specialization and trade? What would determine who produces the good?
b. What are the benefits of international trade in this case? Do they accrue only to the country that gets the industry?
6. It is fairly common for an industrial cluster to break up and for production to move to locations with lower wages when the technology of the industry is no longer rapidly improving - when it is no longer essential to have the absolutely most modern machinery, when the need for highly skilled workers has declined, and when being at the cutting g edge of innovation conveys only a small advantage. Explain this tendency of industrial clusters to break up in terms of the theory of external economies.
7. Recently, a growing labor shortage has been causing Chinese wages to rise. If this trend continues, what would you expect to see happen to external economy industries currently dominated by China? Consider, in particular, the situation illustrated in Figure 7-4. How would change take place?
8. In our discussion of labor market pooling, we stressed the advantages of having two firms in the same location: If one firm is expanding while the other is contracting, it's to the advantage of both workers and firmw that they be able to draw on a single labor pool. But it might happen that both firms want to expand or contract at the same time. Does this constitute an argument against geographical concentration? (Think through the numerical example carefully.)
9. Which of the following goods or services would be most likely to be subject to (1) external economies of scale and (2) dynamic increasing returns? Explain your answers.
a. Software tech-support services
b. Production of asphalt or concrete
c. Motion pictures
d. Cancer research
e. Timber harvesting
Part C -
1. In perfect competition, firms set price equal to marginal cost. Why can't firms do this when there are internal economies of scale.
2. Suppose the two countries we considered in the numerical example of pages 166-169 were to integrate their automobile market with a third country, which has an annual market for 3.75 million automobiles. Find the number of firms, the output per firm and the price per automobile in the new integrated market after trade.
3. Suppose the fixed costs for affirm in the automobile industry (start-up costs of factories, capital equipment, and so on) are $5 billion and that variable costs are equal to $17,000 per finished automobile. Because more firms increase competition in the market, the market price falls as more firms enter an automobile market, or specifically, P + 17,000 + (150/n), where n represents the number of firms in a market. Assume that the initial size or the U.S. and the European automobile markets are 300 million and 533 million people, respectively.
a. Calculate the equilibrium number of firms in the U.S. and European automobile markets without trade.
b. What is the equilibrium price of automobiles in the United States and Europe if the automobile industry is closed to foreign trade?
c. Now suppose that the United States decides on free trade in automobiles with Europe. The trade agreement with the Europeans adds 533 million consumers to the automobile market, in addition to the 300 million in the United States. How many automobile firm will there be in the United States and Europe combined? Why will be the new equilibrium price of automobiles?
d. Why are prices in the United States different in © and (b)? Are consumers better off with free trade? In what ways?
4. Go back to the model with firm performance differences in a single integrated market (pages 182-183). Now assume that a new technology becomes available. Any firm can adopt the new technology, but its use requires an additional fixed-cost investment. The benefit of the new technology is that it reduces a firm's marginal cost of production by a given amount.
a. Could it be profit maximizing for some firms to adopt the new technology but not profit maximizing for other firms to adopt that same technology? Which firms would choose to adopt the new technology? How would they be different from the firms that choose not to adopt it?
b. Now assume that there are also trade costs. In the new equilibrium with both trade costs and technology adoption, firms decide whether to export and also whether to adopt the new technology. Would exporting firms be more or less likely to adopt the new technology relative to non exporters? Why?
5. In the chapter, we describe a situation where dumping occurs between two symmetric countries. Briefly describe how things would change if the two countries had different sizes.
a. How would the number of firms competing in a particular market affect the likelihood that an exporter to that market would be accused of dumping? (Assume that between its domestic price and its export price: the higher the price difference, the more likely the dumping accusation).
b. Would a firm from a small country be more or less likely to be accused of dumping when it exports to a large country (relative to a firm from the large country exporting to the small country)?
6. Which of the following are direct foreign investments?
a. A Saudi businessman buys $10 million of IBM stock
b. The same businessman buys a New York apartment building.
c. A French company merges with an American company; stockholders in the U.S. company exchange their stock for shares in the French firm.
d. An Italian firm builds a plant in Russia and manages the plant as a contractor to the Russian government
7. For each of the following, specify whether the foreign direct investment is horizontal or vertical; in addition, describe whether that investment represents and FDI inflow or outflow from the countries that are mentioned.
a. McDonald's (a U.S. multinational) opens up and operates new restaurants in Europe.
b. Total (a French oil multinational) buys ownership and exploration rights to oil fields in Cameroon.
c. Volkswagen (a German multinational auto produces) opens some new dealership in the United States. (Note that, at this time, Volkswagen does not produce any cars in the United States.)
d. Nestle (a Swill multinational producer of foods and drinks) builds a new production factory in Bulgaria to produce Kit Kat chocolate bars. (Kit Kat bars are produced by Nestle in 17 countries around the world.)
8. If there are internal economies of scale, why would it ever make sense for a firm to produce the same good in more than one production facility?
9. Most firms in the apparel and footwear industries choose to outsource production to countries where labor is abundant (primarily, Southeast Asia and the Caribbean) - but those firms do not integrate with their supplier there. On the other hand, firms in many capital-intensive industries choose to integrate with their suppliers. What could be some differences between the labor intensive apparel and footwear industries on the one hand and capital-intensive industries on the other hand that would explain these choices?
10. Consider the example of industries in the previous problem. What would those choices imply for the extent of intra-firm trade across industries? That is, in what industries would a greater proportion of trade occur within firms?
Part D -
1. Home's demand curve for wheat is
D = 100 - 20P
Its supply curve is
S = 20 + 20P
Derive and graph Home import demand schedule. What would the price of wheat be in the absence of trade?
2. Now add Foreign, which has a demand curve
D* = 80 - 20P
And a supply curve
S* = 40 + 20P
a. Derive a graph Foreign's export supply curve and find the price of what that would prevail in Foreign in the absence of trade.
b. Now allow Foreign and Home to trade with each other, at zero transportation cost. Find and graph the equilibrium under free trade. What is the world price? What is the volume of trade?
3. Home imposes a specific tariff of 0.5. on wheat imports.
a. Determine and graph the effect of the tariff on the following: (1) the price of wheat in each country; (2) the quantity of wheat supplied and demanded in each country; (3) the volume of trade.
b. Determine the effect of the tariff on the welfare of each of the following groups: (1) Home import-competing producers; (2) Home consumers; (3) The Home government.
c. Show graphically and calculate the terms of trade gain, the efficiency loss, and the total effect on welfare of the tariff.
4. Suppose that Foreign had been a much larger country, with domestic demand.
D* = 800 - 200P, S* = 400 + 200P
(Notice that this implies that the Foreign price of wheat in the absence of trade would have been the same as in problem 2).
Recalculate the free trade equilibrium and the effects of a 0.5 specific tariff by Home. Relate the difference in results to the discussion of the small country case in the text.
5. What would be the effective rate of protection on bicycles in China if China places a 50 percent tariff on bicycles, which have a world price of $200, and no tariff on bike components, which together have a world price of $100?
6. The United States simultaneously limits imports of ethanol for fuel purposes and provides incentives for the use of ethanol in gasoline, which raise tha price of ethanol by about 15 percent relative to what it would be otherwise. We do, however, have free trade in corn, which is fermented and distilled to make ethanol, and accounts for approximately 55 percent of its cost. What is the effective rate of protection on the process of turning corn into ethanol?
7. Return to the example of problem 2. Starting from free trade, assume that Foreign offers exporters a subsidy of 0.5 per unit. Calculate the effects on the price in each country and on welfare, both of individual groups and of the economy as a whole, in both countries.
8. Use your knowledge about trade policy to evaluate each of the following statements:
a. "An excellent way to reduce unemployment is to enact tariffs on imported goods."
b. "Tariffs have a more negative effect on welfare in large countries than in small countries>"
c. Automobile manufacturing jobs are heading to Mexico because wages are so much lower there than they are in the United States. As a result, we should implement tariffs on automobiles equal to the difference between U.S. and Mexican wage rates."
9. The nation of Acirema is "small" and unable to affect world prices. It imports peanuts at the price of $10 per bag. The demand curve is.
D = 400 - 10P
The supply curve is
S = 50 + 5P
Determine the free trade equilibrium. Then calculate and graph the following effects of an import quota that limits imports to 50 bags.
a. The increase in the domestic price
b. The quota rents.
c. The consumption distortion loss
d. The production distortion loss.
10. If tariffs, quotas, and subsidies each cause net welfare losses, why are they so common, especially in agriculture, among the industrialized countries such as the United States and the members of the European Union?
11. Suppose that workers involved in manufacturing are paid less than all other workers in the economy. What would be the effect on the real income distribution within the economy if there were a substantial tariff levied on manufactured goods?
Part E -
1. "For a small country like the Philippines, a move to free trade would have huge advantages. It would let consumers and produces make their choices based on the real costs of goods, not artificial prices determined by government policy; it would allow escape from the confines of a narrow domestic market; it would open new horizons for entrepreneurship; and, most important, it would help to clean up domestic politics." Separate and identify the arguments for free trade in this statement.
2. Which of the following are potentially valid arguments for tariffs or export subsidies, and which are not? Explain your answers.
a. "The more oil the United States imports, the higher the price of oil will go in the next world shortage."
b. "The growing exports of off-season fruit from Chile, which now accounts for 80 percent of the U.S. supply of such produce as winter grapes, are contributing to sharply falling prices of these former luxury goods."
c. "U.S. farm exports don't just mean higher incomes for farmers, they mean higher income for everyone who sells goods and services to the U.S. farm sector."
d. "Semiconductors are the crude oil of technology; if we don't produce our own chips, the flow of information that is crucial to every industry that uses microelectronics will be impaired."
e. "The real price of timber has fallen 40 percent, and thousands of timber workers have been forced to look for other jobs."
3. A small country can import a good at a world price of 10 per unit. The domestic supply curve of the good is
S = 20 + 10P
The demand curve is
D + 400 - 5P
In addition, each unit of production yields a marginal social benefit of 10.
a. Calculate the total effect on welfare of a tariff of 5 per unit levied on imports.
b. Calculate the total effect of a production subsidy of 5 per unit.
c. Why does the production subsidy produce a greater gain in welfare than the tariff?
d. What would the optimal production subsidy be?
4. Suppose that demand and supply are exactly as described in problem 3 but that there is no marginal social benefit to production. However, for political reasons the government counts a dollar's worth of gain to producers as being worth $3, of either consumer gain or government revenue. Calculate the effects on the government's objective of a tariff of 5 per unit.
5. Suppose that upon Poland's entering the European Union, it is discovered that the cost of automobile production in Poland is E20,000 while it is E30,000 in Germany. Suppose that the EU, which has customs union, has an X percent tariff on automobiles and that the costs of production are equal to Y (valued in euros) in Japan. Comment on whether the addition of Poland to the European Union would result in trade creation or trade diversion under the following scenarios:
a. X = 50% and Y - E18,000
b. X = 100% and Y - E18,000
c. X = 100% and Y - E12,000
6. "There is no point in the United States complaining about trade policies in Japan and Europe. Each country has a right to do whatever is in its own best interest. Instead of complaining about foreign trade policies, the United States should let other countries go their own way, and give up our own prejudices about free trade and follow suit." Discuss both the economics and the political economy of this viewpoint.
7. Give an intuitive explanation for the optimal tariff argument.
8. If governments make trade policies based on national economic welfare, is the problem of trade warfare still represented by a Prisoner's dilemma game as in Table10-3? What is the equilibrium solution to the game if governments formulate policy in this way? Would they ever choose the strategy of protectionism?
9. Recently, the United States has taken action to restrict imports of certain Chinese goods. Such as toys containing lead and seafood that doesn't meet health standards, in order to protect U.S. consumers. Some People have said that this shows a double standard: If we're willing to restrict goods on these grounds, shy shouldn't we restrict imports of goods that are produced with badly paid labor? Why is or isn't this argument valid?
10. International trade agreements
a. What does GATT and WTO stand for? What year were they created?
b. Each round of WTO negotiations address trade restrictions in at least which 3 ways? Explain each in one sentence.
11. List, describe, and provide an example of two different types of preferential trading agreements in which tariff rates are set at or near zero.