Globalization Final Exam

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four ideas that show that their is gains from trade

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1. both can be made better off.
2. export goods made with relatively abundant resources and imports goods made with relatively scarce resources
3. larger-scale production
4.Countries may also gain by trading current resources for future resources

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Why some countries export certain products can stem from differences in

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Labor productivity
Relative supplies of capital, labor and land and their use in the production of different goods and services

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Things important in trade

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> size matters, bigger the nation bigger exports and imports
>Distance- transportation cost
>Culture> creates more ties
>Geography, ocean, mountains.

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gravity model

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In its basic form, the gravity model assumes that only size and distance are important for trade in the following way


Tij = A x Yi x Yj /Dij
Trade
A-constant
Y- GDP
D- distance
Nation J and i

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the main things counties trade

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> Manufacturing 54%
> Services 19.77%
> Agriculture 7%
> Fuels and Mining 18%

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why trade occurs can be grouped into three categories:

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>Market size and distance between markets determine how much countries buy and sell. These transactions benefit both buyers and sellers.
>Differences in labor, labor skills, physical capital, natural resources, and technology create productive advantages for countries.
>Economies of scale (a larger scale is more efficient) create productive advantages for countries.

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The Ricardian model

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says differences in the productivity of LABOR between countries cause productive differences

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The Heckscher-Ohlin model

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differences in labor, labor skills, physical capital, land, or other factors of production between countries cause productive differences

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comparative advantage

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in producing a good if the opportunity cost of producing that good is lower in the country than it is in other countries.

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A One Factor Ricardian Model assumptions

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>Labor services are the only resource important for production.
>Labor productivity varies across countries, usually due to differences in technology, but labor productivity in each country is constant across time.
The supply of labor services in each country is constant.
>Only two goods are important for production and consumption: wine and cheese.
>Competition allows workers to be paid a “competitive” wage, a function of their productivity and the price of the good that they can sell, and allows them to work in the industry that pays the highest wage.
>Only two countries are modeled: domestic and foreign.

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unit labor requirement

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>as the constant number of hours of labor required to produce one unit of output.
EX:
if aLW = 2, then it takes 2 hours of labor to produce one liter of wine

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The production possibility frontier

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of an economy shows the maximum amount of a goods that can be produced for a fixed amount of resources.

aLC*QC + aLW*QW = L

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PC /aLC > PW/aLW people will only make_____

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Cheese

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PC /PW < aLC /aLW people will make ?

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workers will only make wine
>The economy will specialize in wine production if the price of wine relative to the price of cheese exceeds the opportunity cost of producing wine

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If PW /PC > aLW /aLC people will make?

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workers will only make wine
>The economy will specialize in wine production if the price of wine relative to the price of cheese exceeds the opportunity cost of producing wine

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relative supply of cheese

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the quantity of cheese supplied by all countries relative to the quantity of wine supplied by all countries at each price of cheese relative to the price of wine, Pc /PW.

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When PC /PW = aLC /aLW

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domestic workers will be indifferent between producing wine or cheese, but foreign workers will still produce only wine

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aLW

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is the unit labor requirement for wine in the domestic country. For example, if aLW = 2, then it takes 2 hours of labor to produce one liter of wine

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Relative wages

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Relative wages are the wages of the domestic country relative to the wages in the foreign country

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Richards model on wages when trade

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predicts that relative prices equalize across countries after trade, it does not predict that relative wages will do the same.
>A country with absolute advantage in producing a good will enjoy a higher wage in that industry after trade.

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Relationship between Wages and Productivity

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The cost of high wages can be offset by high productivity.
The cost of low productivity can be offset by low wages.

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Misconceptions-Free trade is beneficial only if a country is more productive than foreign countries.

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But even an unproductive country benefits from free trade by avoiding the high costs for goods that it would otherwise have to produce domestically.

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Misconceptions-Free trade with countries that pay low wages hurts high wage countries.

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trade benefits consumers and other workers.

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Misconceptions- Free trade exploits less productive countries

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Deeper poverty and exploitation (ex., involuntary prostitution) may result without export production

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Not capture by Richards model and key assumptions

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>income distribution effect
>The only factor is labor
 2. Full mobility of labor within the same country. Zero mobility of labor between countries.

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Specific Factors Model assumptions

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There are only two goods, manufactures (M) (Kapital Labor) and food ( F)(Terrain Labor).
Factors of production: labor (L), capital (K), and land (T for terrain).

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. Effect of Price change on capitalists’ income

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Since PM in turn has risen relative to PF , the income of capitalists has clearly gone up in terms of both goods

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Real income of land owners when the prices of M increase

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The total real income of landlords in terms of F decreases.

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Effect of Price change on labor income

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AMBIGUOUS-Overall real wage of workers may increase or decrease, depending on how much A and M they consume, i.e., depending on their preferences

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three main reasons why economists do not generally stress the income distribution effects of trade.

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1. Income distribution effects are not specific to international trade
2. It is always better to allow trade and compensate those who are hurt by it than to prohibit the trade.
3. Those who favor trade protection are typically better organized than those who gain from free trade.

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Why do economists advocate free trade despite its income distribution effects?

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1. Changes in income distribution occur with every economic change, not only international trade
2. . It would be better to compensate the losers from trade (or any economic change) than prohibit trade
3. There is a political bias in trade politics: potential losers from trade are better politically organized than the winners from trade.

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isovalue

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line as a line representing a constant value of production


The slope of an isovalue line is – (PC /PF)

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An increase in the relative price of cloth, PC /PF, is predicted to:

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raise income of workers relative to that of landowners, w/r.
raise the ratio of land to labor services, T/L, used in both industries and raise the marginal productivity of labor in both industries and lower the marginal productivity of land in both industries.
raise the real income of workers and lower the real income of land owners.

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How do levels of output change when the economy’s resources change?

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Rybczynski theorem- If we hold output prices constant as the amount of a factor input increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases.

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Stolper-Samuelson theorem

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if the relative price of a good increases, then the real return to the factor used intensively in the production of that good increases, while the real return to the other factor decreases

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This proposition is called the Heckscher-Ohlin theorem

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An economy is predicted to export goods that are intensive in its abundant factors of production and import goods that are intensive in its scarce factors of production

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Quantity of imports=(Price of exports relative to imports)(Quantity of exports
)

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(DF – QF) = (PC /PF)(QC – DC)

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Equation for V= value

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V = PCQC + PF QF

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Value = consumption equation

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PC DC + PF DF = PC QC + PF QF = V

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Consumer preferences

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preferences are represented by indifference curves: combinations of goods that make consumers equally satisfied

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income effect

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The change in welfare (income) when the price of one good changes relative to the price of another

>The income effect is represented by moving to another indifference curve.

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substitution effect

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The substitution of one good for another when the price of the good changes relative to the other

>The substitution effect is represented by a moving along a given indifference curve

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terms of trade

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refers to the price of exports relative to the price of imports

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Increase in terms of trade improves or worsens a nations welfare ?

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Improves

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Biased growth in the cloth industry

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will lower the price of cloth relative to the price of food and lower the terms of trade for cloth exporters

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Export-biased growth

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is growth that expands a country’s production possibilities disproportionally in that country’s export sector

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Import-biased growth

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is growth that expands a country’s production possibilities disproportionally in that country’s import sector

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the terms of trade measures relative external or internal prices

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external

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The effects of tariffs and subsidy on home nation welfare

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an import tariff by the domestic country can increase domestic welfare at the expense of the foreign country.
an export subsidy by the domestic country reduces domestic welfare to the benefit of the foreign country.

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specific tariff

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is levied as a fixed charge for each unit of imported goods

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ad valorem tariff

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is levied as a fraction of the value of imported goods

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why dose the increase in the price of at good at home less then the amount of the tariff in a big country

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world price would go down as world demand would lower

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effective rate of protection

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measures how much protection a tariff or other trade policy provides domestic producers.

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Production distortion loss

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the domestic firms produce too much

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Consumption distortion loss

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the domestic consumers consume too little

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Export Subsidy effects on surplus

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An export subsidy raises the price of a good in the exporting country, decreasing its consumer surplus (making its consumers worse off) and increasing its producer surplus (making its producers better off).

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voluntary export restraint

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works like an import quota, except that the quota is imposed by the exporting country rather than the importing country.

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local content requirement

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is a regulation that requires a specified fraction of a final good to be produced domestically

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The Cases for Free Trade

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1.allocate resources most efficiently
> avoid rent seeking waist.
2. economies of scale
3.provides competition and opportunities for innovation
4. political argument for free trade

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optimum tariff

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A tariff rate that completely prohibits imports leaves a country worse off, but tariff rate t0 may exist that maximizes national welfare

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Cast against free trade

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1. optimum tariff
2.domestic market failures

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Types of market failures include

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>Persistently high under-employment of workers
>Persistently high under-utilization of structures, equipment and other forms of capital

>Technological benefits for society discovered through private production, but from which private firms can not fully profit
>Environmental costs
> property rights
>sellers not well inform

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marginal social benefit

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to represent the additional benefit to society from private production

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theory of the second best

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This theory states that government intervention which distorts market incentives in one market may increase national welfare by offsetting the consequences of market failures elsewhere.