Deck 17: International Trade

Question 1

COMPARATIVE ADVANTAGE Suppose that each U.S. worker can produce 8 units of food or 2 units of clothing daily. In Fredonia, which has the same number of workers, each worker can produce 7 units of food or 1 unit of clothing daily. Why does the United States have an absolute advantage in both goods? Which country enjoys a comparative advantage in food? Why?

Answer 1

Absolute advantage:
Country K labors can produce 8 units of food or 2 units of clothing daily. On the other side, Country F labors can produce 7 units of food or 1 unit of clothing daily.
Absolute advantage of producing a good for a country is producing it with minimum cost compared to other country. Country K can produce maximum of both food and clothing with same resources than country F. Hence, country K gets absolute advantage of producing both food and clothing.
Comparative advantage:
Country K labors can produce 4 units of food by sacrificing 1 unit of clothing; at the same time, country F labors can produce 7 units of food by sacrificing 1 unit of clothing. Hence, country F labors can produce more units of food by sacrificing 1 unit of clothing than country K labors; country F labors get co mparative advantage of producing food.

Question 2

COMPARATIVE ADVANTAGE The consumption possibilities frontiers shown in Exhibit 4 assume terms of trade of 1 unit of clothing for 1 unit of food. What would the consumption possibilities frontiers look like if the terms of trade were 1 unit of clothing for 2 units of food? 11eb5b3a_fa27_b8ac_a9f3_a34271307d02

Answer 2

Terms of trade:
Terms of trade refers to the amount of goods imported by a country in exchange of amount of goods exported.
Change in terms of trade:
In Exhibit-4, Terms of trade of 1 units of clothing is exchanged for 1 unit of food. If the terms of trade between two goods are exchanged to 1 units of clothing for 2 units of food, then the consumption possibility frontier will shift toward food as food becomes cheaper.

Question 3

REASONS FOR INTERNATIONAL SPECIALIZATION What determines which goods a country should produce and export?

Answer 3

Production specialization of a country is determined by the following factors:
Labor skill setup:
A country with relative abundance of skilled labor force will produce and export technology-oriented manufacturing goods.
On the other hand, a country with relative abundance of unskilled or semi-skilled labor force will produce and export less technology-oriented manufacturing goods and agriculture products.
Fertility of land:
Difference in fertility of land and climate condition of a county determines whether a country should be specialized in agricultural or non-agricultural product.
Natural resources:
Availability of natural resources within the domestic territory reduces the cost of producing a good. Hence, owning natural resources also determines the product specialization of a country.
For instance, countries like Iran, Iraq, Kuwait, and Saudi Arabia have natural resources of oil; hence, they are specialized in oil exports.

Question 4

IMPORT QUOTAS How small must a quota be to have an impact? Using a demand-and-supply diagram, illustrate and explain the net welfare loss from imposing such a quota. Under what circumstances would the net welfare loss from an import quota exceed the net welfare loss from an equivalent tariff (one that results in the same price and import level as the quota)?

Question 5

Outline the gains from trade, and explain why countries might still decide to trade even if no country had a comparative advantage
(Trade Restrictions) Suppose that the world price for steel is below the U.S. domestic price, but the government requires that all steel used in the United States be domestically produced.
a. Use a diagram like the one that follows to show the gains and losses from such a policy.
b. How could you estimate the net welfare loss (deadweight loss) from such a diagram?
c. What response to such a policy would you expect from industries (like automobile producers) that use U.S. steel?
d. What government revenues are generated by this policy?
Effect of a Tariff 11eb5b3a_fa28_54f6_a9f3_65819a4558d3
Effect of a Quota 11eb5b3a_fa28_54f7_a9f3_d7f3cf212b2e

Question 6

Outline the gains from trade, and explain why countries might still decide to trade even if no country had a comparative advantage
(Trade Restrictions) The previous three graphs show net losses to the economy of a country that imposes tariffs or quotas on imported sugar. What kinds of gains and losses would occur in the economies of countries that export sugar?

Question 7

THE WORLD TRADE ORGANIZATION What is the World Trade Organization (WTO) and how does it help foster multilateral trade? (Check the WTO Web site at http://www.wto.org/.)

Question 8

ARGUMENTS FOR TRADE RESTRICTIONS Explain the national defense, declining industries, and infant industry arguments for protecting a domestic industry from international competition.

Question 9

ARGUMENTS FOR TRADE RESTRICTIONS Firms hurt by lower-cost imports typically argue that restricting trade will save U.S. jobs. What's wrong with this argument? Are there ever any reasons to support such trade restrictions?

Question 10

Outline the gains from trade, and explain why countries might still decide to trade even if no country had a comparative advantage
(Trade Without Comparative Advantage) Even if neither country had a comparative advantage, why might these countries still experience gains from trade?