International Economics Is Different

Four Controversies
We begin with four controversies that show the importance of current issues addressed by international economics.

Four controversial developments that frame the scope of what you will learn:


International Economics Is Different

Economics and the Nation-State
International Economics Is Different

The fact that nations have their sovereignty, their separate interests, and their separate policies means that

nobody is in charge of the whole world economy.

Among the most important policies that each country can manipulate separately are policies toward international movement of resources, government taxation and spending, and money and exchange rates.


International Economics Is Different

What Is a Nation?
The third controversy is about Britain’s relationship with the rest of the European Union. A slim majority of U.K. voters in 2016 voted to leave the EU. While proponents of “remain” stressed the economic benefits of being part of the EU, proponents of “leave” stressed the need to reassert national sovereignty in such areas as control of immigration.

Nations are not like regions or families, they are sovereign.

No central court can enforce its will on them with a global police force.

A nation often ignores the interests of foreigners.


International Economics Is Different

The Trade War of 2018
The first controversy examines the views of U.S. President Donald Trump and his trade policy actions during his first two years in office, which led to the largest trade war since the Great Depression. Soon after his inauguration in 2017, Trump withdrew the United States from the Trans-Pacific Partnership, and later that year he commenced the process of renegotiating the North American Trade Agreement with Canada and Mexico.


International Economics Is Different

Immigration
The second controversy arises from international migration, especially the increasingly vehement complaints about immigrants in many of the major receiving countries. In these countries a rather large (10 percent or more) and rising percentage of the population is foreign-born, including many who are unauthorized. Opponents accuse immigrants of causing general economic harm, imposing fiscal costs as immigrants use government services, and increasing crime.


International Economics Is Different

Brexit
The third controversy is about Britain’s relationship with the rest of the European Union. A slim majority of U.K. voters in 2016 voted to leave the EU. While proponents of “remain” stressed the economic benefits of being part of the EU, proponents of “leave” stressed the need to reassert national sovereignty in such areas as control of immigration.


International Economics Is Different

China’s Exchange Rate
The fourth controversy is the exchange rate value of the Chinese yuan. From the mid-1990s to 2005, the Chinese government maintained a fixed exchange rate of the yuan to the U.S. dollar. As China’s trade surplus increased and the Chinese government continually had to enter the foreign exchange market to buy dollars and sell yuan to keep the exchange rate steady, the United States and the EU increasingly complained about the fixed rate.


International Economics Is Different

The first controversy examines the views of U.S. President Donald Trump and his trade policy actions during his first two years in office, which led to the largest trade war since the Great Depression. Soon after his inauguration in 2017, Trump withdrew the United States from the Trans-Pacific Partnership, and later that year he commenced the process of renegotiating the North American Trade Agreement with Canada and Mexico. In early 2018 he imposed temporary safeguard tariffs on imports of washing machines and solar panels. Then, following investigations which found that imports of steel and aluminum were threats to national security, in March 2018 Trump imposed tariffs, with temporary exemptions for a number of countries. His administration induced South Korea and Argentina to accept “voluntary” steel export restraints and imposed quotas (instead of tariffs) on steel imports from Brazi


International Economics Is Different

Trump’s trade policies and the trade war involve topics that are central to Chapters 2-16 of the book, including:
National gains from international trade (both imports and exports, not at the expense of other countries).
National and global effects of tariffs, quotas, and voluntary export restraints.
The potential for a large country to shift international trade to gain additional national benefits.
The risk of retaliation by other countries, and the likelihood that all countries in a resulting trade war lose.
The role of the WTO and the use of U.S. Section 301.
The shortcomings of the national defense argument for protection.
Dumping, antidumping duties, safeguard actions, export subsidies, and countervailing duties.
The economics of free trade areas.
Foreign direct investment and the global activities of multinational enterprises.
The national trade balance as driven by the difference


International Economics Is Different

The fourth controversy is the exchange rate value of the Chinese yuan. From the mid-1990s to 2005, the Chinese government maintained a fixed exchange rate of the yuan to the U.S. dollar. As China’s trade surplus increased and the Chinese government continually had to enter the foreign exchange market to buy dollars and sell yuan to keep the exchange rate steady, the United States and the EU increasingly complained about the fixed rate. In 2005 the Chinese government began to allow gradual increases in the exchange-rate value of the yuan. In mid-2008, in response to the worsening global financial and economic crisis, the Chinese government reverted to a fixed exchange rate. Then, as the Chinese economy resumed its rapid growth and China’s government continued to amass international reserves through its intervention to defend the fixed exchange rate, foreign pressures reemerged. In mid-201


International Economics Is Different

In mid-2015 the U.S. government imposed much higher tariff duties on U.S. imports of tires from China (by using U.S. antidumping and antisubsidy laws). This action comes several years after temporary high U.S. tariffs that were in effect during 2009-2012. Using economic analysis, how do tire markets adjust to the higher tariff duties? What is the economic analysis of winners and losers from this U.S policy action? What are the politics of imposition of the duties, both within the United States and internationally? Overall, do the tariff duties provide net benefits to the United States? If political pressure impels the U.S. government to do something, and with a view to maximizing net national economic benefit or minimizing net national economic cost, what is the best policy alternative that could be used instead of antidumping and antisubsidy tariff duties?


International Economics Is Different

In 2018, why did the United States impose temporary safeguard tariffs beginning at 30 percent on imports of solar panels and up to 50 percent on imports of washing machines?

The United States wanted to ensure that it remained a net exporter of washing machines and solar panels.

The U.S. International Trade Commission found that rising imports had harmed U.S. firms in these industries.

Because of growing U.S. demand for washing machines and solar panels, the United States government saw the opportunity to increase government revenue and imposed tariffs on these products.

The United States government imposed tariffs on washing machines and solar panels in retaliation for other countries' tariffs on U.S. exports of durable goods.


International Economics Is Different

What was the rationale the United States used to justify imposing tariffs of 25 percent on imports of steel and 10 percent on imports of aluminum in 2018?

The tariffs on steel and aluminum were in retaliation for China and Mexico imposing tariffs on U.S. exports of pork and other products to those countries.

The United States government wanted to protect the steel and aluminum industries until firms in those industries achieved lower production costs associated with scale economies.

The U.S. Department of Commerce found that imports of steel and aluminum threatened United States national security.

The United States government determined that China, a major exporter of steel and aluminum to the United States, was able to charge a lower price in the U.S. market because of government subsidies provided to Chinese steel and aluminum producers.


International Economics Is Different

In July 2018 President Trump acted on recommendations from the Commerce Department and imposed 25 percent tariffs on 818 Chinese products exported to the United States in retaliation for the Chinese government's

support of North Korea's nuclear weapons program.

nationalization of U.S. firms located in China.

direct foreign investment in the United States.

unfair policies and practices toward U.S. intellectual property such as patents, copyrights, and trade secrets.


International Economics Is Different

What is an effect of a tariff on steel imports to the United States?

Foreign consumers benefit from the effective world-wide increase in the price of steel.

U.S. consumers benefit from the increased production of better-quality steel in the United States.

U.S. steel producers benefit as the product's price rises and domestic production increases.

U.S. steel workers lose because the increase in the price of steel results in decreased production and unemployment in the steel industry.


International Economics Is Different

If a country is concerned about protecting a particular industry for national security reasons, which of the following policies is most effective from an economic standpoint?

Voluntary export restraints on countries exporting goods to the United States


International Economics Is Different

Which of the following is NOT a key economic feature of the European Union (EU)?

A customs union, which imposes common tariffs on imports from non-EU

A common currency, the euro, used by all member countries

A single market that promotes free movements of goods, services, financial capital, and people among EU member countries

London's dominance as Europe's financial center


International Economics Is Different

Given the following policy options, how could China's government be most likely to encourage higher growth of China's exports to other countries?

Buy its own currency, the yuan, and sell foreign currency in the foreign exchange markets

Sell its own currency, the yuan, and buy foreign currency in the foreign exchange markets

Allow its own currency, the yuan, to appreciate against foreign currencies by not intervening in foreign exchange markets

Use its policy toward the exchange rate to prevent any devaluation of the yuan


International Economics Is Different

Which of the following was NOT an argument in favor of the United Kingdom (UK) leaving the European Union (EU)?

Proponents of leaving stressed that the UK needed to reestablish British sovereignty.

Proponents of leaving wanted greater control over immigration.

Proponents of leaving wanted greater access to markets in the other EU member countries.

Proponents of leaving believed the UK paid a disproportionate share of membership fees.


International Economics Is Different

What is the effect of a country's saving rate on trade deficits?

A low savings rate means that consumers are buying more, and more buying leads to an increase in a country's trade deficit.

A low savings rate means people are spending more than they earn, and that results in increased financial difficulties for consumers, higher interest rates, and fewer international sales, resulting in a decrease in a country's trade deficit.

A high savings rate means there is more money available for investment, resulting in greater production and increased international sales which, in turn, leads to lower trade deficits.

A country's savings rate has no effect on the country's trade deficit.


International Economics Is Different

"Job-seeking immigration brings net economic benefits not only to the immigrants, but also to the receiving country overall." But there are winners and losers within the receiving country. Who among the following can be considered as a winner within the receiving country?

The workers who compete with the immigrants for jobs

The households who want to rent the same kinds of apartments the immigrants want to rent.

The consumers who buy the products that the immigrants help to produce


International Economics Is Different

Which of the following is an impact of increased illegal immigration on an economy?

The rate of inflation in the receiving country increases.

The demand for labor in the receiving country declines.

The demand for government services like education and health care increases.

The real wage rate of workers increases.


International Economics Is Different

The unskilled wage rate in a country will probably decline if

corporate taxes are lowered by the government.

there's increased immigration of low-skilled workers.

the aggregate demand for goods and services increases in the country.

the demand for unskilled workers increases.


Demand and Supply
The Basic Theory Using Demand and Supply


Two National Markets and the Opening of Trade
The remainder of the chapter examines the use of supply and demand curves to analyze international trade. If there are two national markets for a product and no trade between them, it is likely that the product’s price will differ between the two markets. Someone should notice the difference and try to profit by arbitrage between the two markets.

is buying something in one market and reselling the same thing in another market to profit from a price difference.


Four Questions about Trade
It is useful to organize the analysis of international trade by contrasting a world of no trade with a world of free trade, leaving analysis of intermediate cases (e.g., non-prohibitive tariffs) for Chapter 8-14. The analysis seeks to answer four key questions about international trade: Why do countries trade? What determines the pattern of trade?

Why do countries trade?  What is the basis for trade, especially the product (commodity) composition?

For each country, what are the overall gains (or losses) from trade?

What are the effects of trade on each country’s economic structure?  Production? Consumption?


Demand Curve
This chapter indicates why we study theories of international trade and presents the basic theory using supply and demand curves. Trade is important to individual consumers, to workers and other factor owners, to firms, and therefore to the whole economy. The box “Trade Is Important” provides useful data about the types of products traded and the increasing role of trade in national economies.

Shows the quantity consumers will buy at each possible market price, other things equal.

Shows the value consumers place on units of the product, because it indicates the highest price that some consumer is willing to pay for each unit.

A change in one of the other drivers of quantity demanded for a product (tastes, the prices of other products, or income) causes a shift in the demand curve.


Demand Responsiveness
Basic demand and supply analysis can be used to provide early answers to these four questions, as well as to introduce concepts that can be used in more elaborate theories. Using motorbikes as an example, the chapter first reviews the basic analysis of both demand (the demand curve and the role of the product’s price, other influences on quantity demanded, movements along the demand curve and shifts in the demand curve, and the price elasticity of demand as a measure of responsiveness) and supply (the supply curve, the role of marginal cost, other influences on quantity supplied, movements along the supply curve and shifts in the supply curve, and the price elasticity of supply).

How responsive is quantity demanded to a change in price?

A measure of responsiveness that is “unit-free” is


Consumer Surplus
Basic demand and supply analysis can be used to provide early answers to these four questions, as well as to introduce concepts that can be used in more elaborate theories. Using motorbikes as an example, the chapter first reviews the basic analysis of both demand (the demand curve and the role of the product’s price, other influences on quantity demanded, movements along the demand curve and shifts in the demand curve, and the price elasticity of demand as a measure of responsiveness) and supply (the supply curve, the role of marginal cost, other influences on quantity supplied, movements along the supply curve and shifts in the supply curve, and the price elasticity of supply).

the increase in the economic well-being of consumers who are able to buy the product at a market price lower than the highest price that they are willing and able to pay for the product.


Two national market graphs with no trade, one with a high no-trade price (the United States), and one with a low no-trade price (the rest of the world, or ROW). Question to the class: “If you were the first person to notice this situation, could you make a profit?” This is a good way to motivate international trade driven by arbitrage.
The U.S. national market graph and the international market graph. Question to the class: “Let’s say that the United States is willing to open up to free trade and integrate into the world market. If it does this, the world price will also be the price within the United States. How much will the United States want to import?” It depends on what the world price is. The instructor can pick one or two hypothetical world price(s) (below the no-trade U.S. price), and measure the gap between domestic quantity demanded and domestic quantity supplied. This is the


The remainder of the chapter examines the use of supply and demand curves to analyze international trade. If there are two national markets for a product and no trade between them, it is likely that the product’s price will differ between the two markets. Someone should notice the difference and try to profit by arbitrage between the two markets. If governments permit free trade, then the export supply from the initially low-priced market (the rest of the world in the textbook example) can satisfy the import demand in the initially high-priced market (the United States in the textbook example), and the world shifts to a free-trade equilibrium. We can show this free trade equilibrium by deriving the supply-of-exports curve for the rest of the world and the demand-for-imports curve for the United States. The international market for the product clears at the intersection of the export-supp


Chapter 2 has the first of five boxes about the global financial and economic crisis that began in 2007 and became dramatically worse in 2008. The box “The Trade Mini-Collapse of 2009” documents and discusses the sharp decline in global trade that began in late 2008 (and the bounce back that occurred in 2010). With the series of boxes and the discussion of the global crisis in the final section of Chapter 21, an instructor can weave discussions of the global crisis and its aftermath throughout a course.
Suggested answer to case study discussion question


The same set of three graphs (the two national markets and the international-trade market) is used to show the effects of the shift from no-trade to free-trade on different groups in each country and to show the net gains from trade for each nation. In the importing country consumers of the product gain consumer surplus and producers of the product lose producer surplus. Using the one-dollar, one-vote metric, the country as a whole gains, because the gain in consumer surplus is larger than the loss of producer surplus. In the exporting country producers of the product gain producer surplus and consumers of the product lose consumer surplus. The analysis shows that the country as a whole gains because the gain in producer surplus is larger than the loss of consumer surplus. Furthermore, the country that gains more from the shift to free trade is the country whose price changes more—the co


The Basic Theory Using Demand and Supply

If an individual consumes more of Good X when his/her income doubles, we can infer that

the individual is highly sensitive to changes in the price of Good X.

the demand for Good X is perfectly inelastic.


The Basic Theory Using Demand and Supply

Which of the following factors can lead to an increase in demand for coffee at Starbucks?

An increase in the price of coffee beans

A 10 percent decline in local population


The Basic Theory Using Demand and Supply

If the price of a normal good is measured along the vertical axis and its quantity along the horizontal axis, an increase in the price of the good will lead to

a downward movement along the demand curve.

an upward movement along the demand curve.


The Basic Theory Using Demand and Supply

Everything else remaining unchanged, when the price of a normal good increases, consumers probably


The Basic Theory Using Demand and Supply

Suppose Good X is a substitute for Good Y. Everything else remaining unchanged, an increase in the price of Good Y will lead to


The Basic Theory Using Demand and Supply

Which of the following events would lead to a decrease in demand for air travel?

A decrease in the number of people who are afraid to fly


The Basic Theory Using Demand and Supply

Harry used to work in a launderette and earned $30 a day. After work, he normally had a chicken burger worth $5 at McDonalds. After his pay was lowered to $20 he would purchase a vegetable burger worth $3 instead of the $5 chicken burger. In this scenario, the vegetable burger is an example of a(n)


The Basic Theory Using Demand and Supply

The value of price elasticity of demand is negative because it indicates

the inverse relationship between the price offered and the quantity demanded for the good.

that the value of the consumer surplus is negative for this good.

that the changes in quantity demanded are much less compared to the changes in price for this good.

the direct relationship between the price and consumer surplus from the good.


The Basic Theory Using Demand and Supply

Which of the following will cause a rightward shift of the market supply curve?


The Basic Theory Using Demand and Supply

Which of the following is a "unit-free" measure?

Consumer surplus when the demand curve is horizontal

Producer surplus when the supply curve is vertical


The Basic Theory Using Demand and Supply

If a 1 percent increase in the price of DVD players leads to a 3 percent reduction in the number of DVD players sold, we can conclude that

the supply of DVD players is perfectly inelastic.

the demand for DVD players is relatively elastic.

the demand for DVD players is relatively inelastic.


The Basic Theory Using Demand and Supply

Which of the following is true of consumer surplus?

It is graphically represented as the area under the equilibrium price and above the supply curve of a good.

It is the net gain in economic well-being associated with producing and selling the equilibrium quantity of a good.

It is used to measure the impact of a change in price on the economic well-being of the producers.

It is the difference between the value that one places on a good and the price paid for the good.


Why Everybody Trades: Comparative Advantage

Adam Smith's Theory of Absolute Advantage
The story begins with Adam Smith and absolute advantage. (A box on mercantilism summarizes the view that Smith opposed and shows how mercantilist thinking continues today.) The analysis focuses on the productivity of labor (output per hour) in producing each of two products (wheat and cloth) in two countries (the United States and the rest of the world).

Absolute Advantage
In his
Wealth of Nations,


Ricardo's Theory of Comparative Advantage
Why Everybody Trades: Comparative Advantage

Mutually beneficial trade can occur even when one nation (say, the Rest of the World or ROW) is absolutely better at producing all goods.

Although ROW is absolutely better, the key is


Ricardos Constant Costs and the Production-Possibilities Curve
The chapter uses the Ricardian example to introduce a key analytical device—the production possibility curve, which shows all combinations of outputs of different goods that an economy can produce with full employment of resources and maximum productivity. The resource costs of producing each product in the country and the total amount of labor hours available in the country are used to graph the country's production possibility curve, a straight line whose slope equals the (negative of the) extra (or marginal) cost of additional cloth.

(ppc) shows all combinations of amounts of different products that an economy can produce with full employment of its resources and maximum feasible productivity of these resources.


Principle of Absolute Advantage
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.

A country is expected to export those goods in which it has an


Ricardo’s Theory of Trade
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.


The Ricardian Model
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.

Hence, the U.S. has a
comparative advantage
in production of wheat, and a


10.If the number of labor hours to make a bushel of wheat is reduced by half to 1 hour, this reinforces the U.S. comparative advantage in wheat. (In fact, the United States then has an absolute advantage in wheat.) The United States is still predicted to export wheat and import cloth. If, instead, the number of hours to make a yard of cloth is reduced by half to 2 hours, this reduces the U.S. absolute disadvantage in cloth, but it does not change the pattern of comparative advantage. The relative price of cloth is now 1 (=2/2) bushel per yard in the United States with no trade, but this is still higher than the price of 0.67 bushel per yard in the rest of the world. The United States still has a comparative advantage in wheat, so the United States is still predicted to export wheat and import cloth.


The story begins with Adam Smith and absolute advantage. (A box on mercantilism summarizes the view that Smith opposed and shows how mercantilist thinking continues today.) The analysis focuses on the productivity of labor (output per hour) in producing each of two products (wheat and cloth) in two countries (the United States and the rest of the world). Smith examined the case of absolute advantage, in which labor productivity in producing one product is higher in one country and labor productivity in producing the other product is higher in the other country. With no trade each country must produce both products to meet national demands. The discussion of the Smith case focuses on the increase in global production efficiency achieved by shifting production in each country toward the product in which it has the higher labor productivity. National demands can be met by international trad


Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost. The Ricardian example is developed in more detail. The ratio of resource costs (labor hour input-output coefficients, the inverse of labor productivities) indicates the opportunity costs or relative prices of the products in each country with no trade. The difference in prices with no trade sets up the opportunity for arbitrage, with each good being exported from the initially low-price country and imported by the initially high-price country. The shift to a free trade equilibrium results in an equilibrium international price. Without informatio


2.Agree. Imports permit the country to consume more (or do more capital investment using imported capital goods). Anything that is exported is not available for domestic consumption (or capital investment). Although this loss is bad, exports are like a necessary evil because exports are how the country pays for the imports that it wants.


Why Everybody Trades: Comparative Advantage

According to the Mercantilists, governments should

allow for free trade unencumbered by government regulations and restrictions.

Adam Smith's Theory of Absolute Advantage


Why Everybody Trades: Comparative Advantage

________ wrote the Wealth of Nations.


Why Everybody Trades: Comparative Advantage

When Adam Smith presented his theory of absolute advantage, he assumed that all "value" in an economy was determined by and measured in terms of the ________ used in the production of the various goods.


Why Everybody Trades: Comparative Advantage

Labor productivity refers to:

the number of units of output a worker can produce in one hour.

the money value of a good that all workers in a firm produce in one day.

the number of hours it takes a worker to produce one unit of output.

the total numbers of hours it takes all the workers in a firm to produce a given money value of a good in one day.


Why Everybody Trades: Comparative Advantage

Which of the following is true of mercantilism?

Mercantilists believed that free trade is always beneficial for the trading nations.

Mercantilists believed that under free trade each of the trading countries benefit equally.

Mercantilists believed that a nation does not benefit directly from its exports.

Mercantilism believed that national well-being was based on national holdings of gold and silver.


Why Everybody Trades: Comparative Advantage

If Country X has higher labor productivity in the production of umbrellas than the rest of the world, we would say that Country X has a(n) ________ in the production of umbrellas.


Why Everybody Trades: Comparative Advantage

Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. The number of labor hours required to produce one unit of Good X in Country A is Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70

Ricardo's Theory of Comparative Advantage


Why Everybody Trades: Comparative Advantage

Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. The number of labor hours required to produce one unit of Good Y in Country B is Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70


Why Everybody Trades: Comparative Advantage

Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. Which of the following statements is true? Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70

Country B has an absolute advantage in the production of both Good X and Good Y.

Country A has an absolute advantage in the production of Good X.

Country A has an absolute advantage in the production of both Good X and Good Y.

Country B has an absolute advantage in the production of Good X.


Why Everybody Trades: Comparative Advantage

Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. Country B has an absolute advantage in the production of Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70


Why Everybody Trades: Comparative Advantage

Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. If Country A transfers one labor hour from the production of Good Y to the production of Good X, total world production of Good X will ________ by ________ unit(s). Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70


Why Everybody Trades: Comparative Advantage

Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. If Country B transfers one labor hour from the production of Good X to the production of Good Y, total world production of Good Y will ________ by ________ unit(s). Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70


Trade: Factor Availability and Factor Proportions Are Key

Production with Increasing Marginal Costs
This chapter continues the analysis of international trade in a two-product economy. It picks up from the end of Chapter 3, where it was noted that the assumption of constant marginal cost and the implication that countries will completely specialize in producing only one (or a few) product(s) are unrealistic. In the modern theory of international trade, we use the assumption of increasing marginal costs—as one industry expands at the expense of others, increasing amounts of other goods must be given up to obtain each extra unit of the expanding output.

: As one industry expands at the expense of others, increasing amounts of the other products must be given up to get each extra unit of the expanding industry’s product.


Production and Consumption Together
Putting the production possibility curve together with the community indifference curves results in a picture of an entire (two-product) economy. The chapter shows the equilibrium with no trade (a tangency of a community indifference curve with the production possibility curve). It then shows two countries whose no-trade price ratios differ.

the U.S. must be self-sufficient and find the combination of domestically produced wheat and cloth that will maximize community well-being.


Trade Affects Production and Consumption
Putting the production possibility curve together with the community indifference curves results in a picture of an entire (two-product) economy. The chapter shows the equilibrium with no trade (a tangency of a community indifference curve with the production possibility curve). It then shows two countries whose no-trade price ratios differ.

Trade allows both countries to reach a higher level of economic well-being than before trade.

A country’s gain depends on the price ratios before trade (autarky price) and after trade.

Trade affects both production and consumption patterns in both countries.


The Heckscher-Ohlin Theory
The skewness of production possibility curves can arise because resource availability differs between countries and the use of these factors in producing differs between products. These differences in factor endowments and factor proportions lead to the Heckscher-Ohlin theory of trade patterns—countries export the products that use their abundant factors intensively (and import the products that use their scarce factors intensively).

The Heckscher-Ohlin theory of trade predicts that a country exports product (or products) that uses its relatively abundant factor(s) intensively and imports the product (or products) that uses its relatively scarce factor(s) intensively.


Four Fundamental Questions About Trade
The chapter ends by returning to the first of the four key questions about trade—what determines the pattern of trade. While demand differences might explain some trade, most analysis focuses on production-side differences. If demand is neutral, then the trade pattern is determined by production-side differences that cause no-trade price ratios to differ.

3. What are the effects of trade on production and consumption in each country?


Production Possibilities under Increasing Costs
This chapter continues the analysis of international trade in a two-product economy. It picks up from the end of Chapter 3, where it was noted that the assumption of constant marginal cost and the implication that countries will completely specialize in producing only one (or a few) product(s) are unrealistic. In the modern theory of international trade, we use the assumption of increasing marginal costs—as one industry expands at the expense of others, increasing amounts of other goods must be given up to obtain each extra unit of the expanding output.


What’s Behind the Bowed-Out Production- Possibility Curve?
The chapter ends by returning to the first of the four key questions about trade—what determines the pattern of trade. While demand differences might explain some trade, most analysis focuses on production-side differences. If demand is neutral, then the trade pattern is determined by production-side differences that cause no-trade price ratios to differ.

Why are increasing-cost curves (bowed-out in shape) more realistic than constant-cost (straight-line) production-possibility curves?

A country’s ppc is derived from information on both total factor (resource) supplies and the production functions that indicate how factor inputs can be used to produce outputs in various industries.


What’s Behind the Bowed-Out Production- Possibilities Curve?
The chapter ends by returning to the first of the four key questions about trade—what determines the pattern of trade. While demand differences might explain some trade, most analysis focuses on production-side differences. If demand is neutral, then the trade pattern is determined by production-side differences that cause no-trade price ratios to differ.

The explanation for the realism of increasing costs (and the bowed-out shape):

There are several kinds of factor inputs (land, skilled labor, unskilled labor, capital, etc.).

Different products use factor inputs in different proportions.


9.In Figure 4.4A, the shape of the U.S. production-possibility curve skews toward producing wheat, and the rest of the world production-possibility curve skews toward producing cloth. The Heckscher–Ohlin theory has a specific explanation for the skew. The United States has relatively a lot of the factor inputs (e.g., land) that are most important for producing wheat, so the United States is relatively strong at producing wheat. The rest of the world has relatively a lot of the factor inputs (e.g., labor) that are most important for producing cloth, so the rest of the world is relatively strong at producing cloth.


Putting the production possibility curve together with the community indifference curves results in a picture of an entire (two-product) economy. The chapter shows the equilibrium with no trade (a tangency of a community indifference curve with the production possibility curve). It then shows two countries whose no-trade price ratios differ. When trade is opened between the two countries, an equilibrium international price ratio is established that clears the international markets for the two goods. Production in each country shifts to the tangency with the new price line (whose slope shows the equilibrium international price), and each country trades along the price line to a consumption point determined by a tangency between the price line and a community indifference curve. The right-angle triangle between the production point and the consumption point is a trade triangle showing expo


The graph can be used to show that each country gains from trade. Trade allows each country to consume beyond its ability to produce (shown by the production possibility curve). Trade allows each country to reach a higher community indifference curve. How much the country gains from trade depends on the country's terms of trade—the price of its exports relative to the price of its imports. The graph also shows the effects on the production and consumption quantities for each good in each country.


The skewness of production possibility curves can arise because resource availability differs between countries and the use of these factors in producing differs between products. These differences in factor endowments and factor proportions lead to the Heckscher-Ohlin theory of trade patterns—countries export the products that use their abundant factors intensively (and import the products that use their scarce factors intensively). With no trade the relatively abundant production factors will be relatively cheap, so that the product that uses these factors relatively intensively will have a low no-trade price. As trade is opened, this product is exported.
Tips


Trade: Factor Availability and Factor Proportions Are Key

In international trade jargon, constant-cost production-possibility curves are associated with ________ specialization, while increasing-cost production-possibility curves are associated with ________ specialization.

Production with Increasing Marginal Costs


Trade: Factor Availability and Factor Proportions Are Key

Which of the following statements is true about production-possibility curves?

Constant-cost production-possibility curves are straight lines and usually lead to complete specialization under free trade.

Under free trade, bowed-out production-possibility curves are associated with partial specialization, because the opportunity cost of producing each good is constant along the curve.

Increasing-cost production-possibility curves provide us with information about consumer preferences.

Constant-cost production-possibility curves are convex to the origin.


Trade: Factor Availability and Factor Proportions Are Key

Which of the following best explains why increasing marginal costs of production arise?

The factor endowments vary across countries.

All the factor inputs are not fully utilized in the production of different commodities.

Different consumers have different tastes and preference sets.

Different commodities use inputs in different proportions.


Trade: Factor Availability and Factor Proportions Are Key

Assume that Country X produces two goods—sugar and shoes—and that the country's production possibility curve is "bowed-out." As the country produces more sugar the opportunity cost of sugar in terms of shoes foregone will


Trade: Factor Availability and Factor Proportions Are Key

Consider a two-country, two-commodity model. Each country has an increasing-cost production-possibility curve. In this model the amounts of the goods that are produced in a country in the no-trade situation are determined by:

technology differences between the industries.


Trade: Factor Availability and Factor Proportions Are Key

In the figure below, AB is the production-possibility curve of Canada. I1 and I2 are two of the community indifference curves of Canada. In the absence of trade Canada will:

produce at point S1 and consume at point C0.

produce at point S1 and consume at point C1.


Trade: Factor Availability and Factor Proportions Are Key

In the figure below, AB is the production-possibility curve of Canada. The line PQ shows the price ratio of one bushel of wheat/bale of cotton. The international price ratio is 0.25 bushels of wheat/bale of cotton as shown by the line RS. I1 and I2 are two of the community indifference curves of Canada. After Canada engages in free trade, it will:

produce at point S1 and consume at point C0.

produce at point S1 and consume at point C1.

produce and consume points not labeled in the graph.


Trade: Factor Availability and Factor Proportions Are Key

In the following figure, AB is the production-possibility curve of Canada. The line PQ shows the price ratio of one bushel of wheat/bale of cotton. The international price ratio is 0.25 bushels of wheat/bale of cotton as shown by the line RS. I1 and I2 are two of the community indifference curves of Canada. Which of the following can be inferred from this figure?

Canada has a comparative advantage in the production of wheat.

Canada has a comparative advantage in the production of cotton.

Canada has an absolute disadvantage in the production of both goods.

Canada has an absolute advantage in the production of both goods.


Trade: Factor Availability and Factor Proportions Are Key

In the figure below, AB is the production-possibility curve of Canada. I1 and I2 are two of the community indifference curves of Canada. With free trade, the international price ratio is 0.25 bushel of wheat/bale of cotton, and Canada will export:


Trade: Factor Availability and Factor Proportions Are Key

In the figure below, AB is the production-possibility curve of Canada. I1 and I2 are two of the community indifference curves of Canada. With free trade, the international price ratio is 0.25 bushel of wheat/bale of cotton, and Canada will import:


Trade: Factor Availability and Factor Proportions Are Key

In the figure below, AB is the production-possibility curve of Canada. The line PQ shows the price ratio of one bushel of wheat/bale of cotton. I1 and I2 are two of the community indifference curves of Canada. With free trade, Canada can achieve a level of well-being corresponding to I2. In the absence of international trade, one bushel of wheat will exchange for ________ bale(s) of cotton in Canada. After Canada engages in international trade, one bushel of wheat will exchange for ________ bale(s) of cotton.


Trade: Factor Availability and Factor Proportions Are Key

The figure below shows the production-possibility curves of Canada (AB) and the rest of the world (CD). I1 and I2 are community indifference curves for Canada and the rest of the world. In the absence of trade, Canada consumes ________ bales of cotton and ________ bushels of wheat.


Who Gains and Who Loses from Trade?

Who Gains and Who Loses within a Country
Who Gains and Who Loses from Trade?


Who Gains and Who Loses from Trade?

Three Implications of the H-O Theory
This chapter has two major purposes. First, it examines the implications for factor incomes of trade that follows the Heckscher-Ohlin (H-O) theory. Second, it examines the empirical evidence on the Heckscher-Ohlin theory and some of its implications.

Heckscher-Ohlin Model
The Stolper-Samuelson theorem
The specialized-factor pattern


Who Gains and Who Loses from Trade?

Does Heckscher-Ohlin Explain Actual Trade Patterns?
The chapter then shifts to examine empirical evidence on the Heckscher-Ohlin theory. The box “The Leontief Paradox” summarizes the early tests. The text emphasizes the kinds of information that we need to examine real-world trade patterns—factor endowments and trade patterns, along with knowledge of the factor proportions used in producing different products.

The Heckscher-Ohlin approach to trade provides important insights, in theory, about the gains from trade, the effects of trade on production and consumption, and the effects of trade on the incomes of production factors. These insights are based on the hunch by Heckscher and Ohlin about the basis for trade—why countries export some products and import others.


Who Gains and Who Loses from Trade?

Short-Run Effects of Opening Trade
Generally, the H-O approach has three major implications for factor incomes. First, the conclusion about the effect of opening to free trade is an example of the more general Stolper-Samuelson theorem—the real return to the factor used intensively in the rising-price industry increases, and the real return to the factor used intensively in the falling-price industry declines.

In the short run, with factors of production tied to their current lines of production, gains and losses are divided by output sector. All factors tied to the rising sector gain, and all factors tied to the declining sector lose.

In the U.S., owners of land and labor in the wheat sector are expected to gain, and owners of land and labor in the cloth sector are expected to lose.


Who Gains and Who Loses from Trade?

The Long-Run Factor-Price Response
In the long run, the period of time that is emphasized by the Heckscher-Ohlin approach, factors can easily move between sectors. The implications for factor incomes then depend on the factors demanded by the expanding sector relative to the factors released by the contracting industry. According to the H-O theory, the expanding sector is intensive in the country's abundant factor, while the shrinking sector is intensive in the country's scarce factor.

In the long run, factors can move between sectors in response to differences in returns.

In the long run, wage rates end up lower for all U.S. workers and higher for all foreign workers (each relative to its level with no trade). All land rents end up higher in the U.S. and lower in the Rest of the World (each relative to its level with no trade). Why?


Who Gains and Who Loses from Trade?

How Free Trade Affects Income Distribution in the Long Run
In the long run, the period of time that is emphasized by the Heckscher-Ohlin approach, factors can easily move between sectors. The implications for factor incomes then depend on the factors demanded by the expanding sector relative to the factors released by the contracting industry. According to the H-O theory, the expanding sector is intensive in the country's abundant factor, while the shrinking sector is intensive in the country's scarce factor.


Who Gains and Who Loses from Trade?

The Stolper-Samuelson Theorem
Generally, the H-O approach has three major implications for factor incomes. First, the conclusion about the effect of opening to free trade is an example of the more general Stolper-Samuelson theorem—the real return to the factor used intensively in the rising-price industry increases, and the real return to the factor used intensively in the falling-price industry declines.


Who Gains and Who Loses from Trade?

The chapter then shifts to examine empirical evidence on the Heckscher-Ohlin theory. The box “The Leontief Paradox” summarizes the early tests. The text emphasizes the kinds of information that we need to examine real-world trade patterns—factor endowments and trade patterns, along with knowledge of the factor proportions used in producing different products. It provides evidence on endowments for seven factors—physical capital, highly skilled labor, medium-skilled labor, unskilled labor, crop land, pasture land, and forest land, and it discusses endowments of other natural resources. The examination of the U.S. pattern of international trade suggests that some of its trade seems consistent with the H-O predictions, but some also does not seem consistent. In general, trade patterns for the United States and other countries match the H-O theory reasonably well but not perfectly. (The box


Who Gains and Who Loses from Trade?

1. Mexico is abundant in unskilled labor and scarce in skilled labor relative to the United States or Canada. With freer trade Mexico exports a greater volume of unskilled-labor-intensive products and imports a greater volume of skilled-labor-intensive products. According to the Stolper–Samuelson theorem, a shift toward freer trade then increases the real wage of unskilled labor in Mexico, reduces the real wage of unskilled labor in the United States or Canada, decreases the real wage of skilled labor in Mexico, and increases the real wage of skilled labor in the United States or Canada.


Who Gains and Who Loses from Trade?

According to the H-O approach and the Stolper-Samuelson theorem, the factors that gain from free trade are those that are used intensively in export-oriented production, while the factors that lose are those used intensively in import-competing production. The chapter presents evidence on the factor content of export and import-competing production in the United States and Canada, along with brief comments about other countries.


Who Gains and Who Loses from Trade?

5. Leontief conducted his research shortly after World War II, when it seemed clear that the United States was abundant in capital and scarce in labor, relative to the rest of the world. According to the Heckscher–Ohlin theory, the United States then should export capital-intensive products and import labor-intensive products. But in his empirical work using data on production in the United States and U.S. trade flows, Leontief found that the United States exported relatively labor-intensive products and imported relatively capital-intensive products.


Who Gains and Who Loses from Trade?

Which of the following statements is true?

Free trade causes contraction of the export-oriented sector.

Free trade causes contraction in the import-competing sector.

Free trade restricts consumption choices of domestic consumers.

All domestic producers benefit when a country engages in free trade.

Who Gains and Who Loses within a Country


Who Gains and Who Loses from Trade?

In the short-run, following the opening of trade

workers in the country can change jobs but will receive the same wage.

workers will suffer from lower wages, but landowners will benefit from higher rents.

groups tied to declining sectors of the economy will suffer from lower returns.


Who Gains and Who Loses from Trade?

In the short-run, following the opening of trade

inputs move across sectors, but input returns remain constant.

factor payments in the import-competing sectors will decline.

the supply of resources to the export-oriented sectors will decline.

workers in all sectors will receive lower wages due to cheap imports.


Who Gains and Who Loses from Trade?

The theory which predicts that trade occurs because of differences in the availability of factor inputs across countries and the differences in the proportions in which the inputs are used in producing different products is called

the theory of factor price equalization.


Who Gains and Who Loses from Trade?

If trade corresponds to the Heckscher-Ohlin theory, which of the following is most likely to happen in the long run after a labor-abundant country engages in free trade?

The rate of unemployment in the country is most likely to increase.

The total output in the economy will decline.

The capital to labor ratio used in production in the export sector will increase.

The rental rates of capital will increase but the wage rates will decline.


Who Gains and Who Loses from Trade?

The Heckscher-Ohlin theory predicts that the opening of trade between a land-abundant country and a labor-abundant country should result in

higher rents and wages in both countries.

lower rents and wages in both countries.

higher rents in the labor-abundant country and higher wages in the land-abundant country.

higher wages in the labor-abundant country and higher rents in the land-abundant country.


Who Gains and Who Loses from Trade?

Country A is relatively land-abundant, and wheat is relatively land-intensive. Given the assumptions of the Heckscher-Ohlin model, the opening of trade by this country will cause the domestic price of wheat to

rise at first, but then fall back to its original level.


Who Gains and Who Loses from Trade?

The Stolper-Samuelson theorem indicates that, after a country shifts to free trade

the real return to the factor used intensively in the import-competing industry will rise in the long run.

the real return to the factor used intensively in the export industry will fluctuate around a long-run trend.

the real return to all the resources in an economy will increase.

the real return to the factor used intensively in the export industry will rise in the long run.


Who Gains and Who Loses from Trade?

Let's assume that cloth-making (labor-intensive) and farming (land-intensive) are the only two sectors of production in a country. If this country is labor-abundant, and if trade corresponds to the Heckscher-Ohlin theory, which of the following groups will gain in the short run, but lose in the long run, from the opening of trade?

Domestic landowners in the domestic farming sector

Domestic landowners in the domestic cloth-making sector

Foreign landowners in the foreign farming sector

Foreign workers in the foreign cloth-making sector


Who Gains and Who Loses from Trade?

The Stolper-Samuelson theorem predicts that free trade between the United States, a capital-abundant country, and Mexico, a labor-abundant country, would ultimately result in

higher wages in Mexico and lower wages in the United States.

lower wages in Mexico and higher wages in the United States.


Who Gains and Who Loses from Trade?

According to the factor-price equalization theorem, free trade between any two countries equalizes

product prices as well as the prices of individual factors of production between the countries.

product prices between the countries but not the prices of individual factors of production.

product prices between the countries and factor prices within each country but not between the countries.

average national income per person in the countries.


Who Gains and Who Loses from Trade?

The factor-price equalization theorem tells us that free trade between two countries should result in

all workers in the two countries earning the same wage rate.

all workers in the two countries having the same skill level.

all workers of the same skill level earning the same wage rate in the two countries.

all input prices being equal within each country.


Scale Economies
Scale Economies, Imperfect Competition, and Trade

, input use and total cost rise in the same proportion as output increases.


Monopolistic Competition and Trade
The remainder of the chapter presents the three additional trade theories. The first is based on monopolistic competition. While there may be a number of explanations of intra-industry trade, product differentiation seems to be the major one. The market structure of monopolistic competition is useful for analyzing the role of product differentiation.

If scale economies are modest or moderate, there is room in the industry for a large number of firms.

For products that are differentiated, a mild form of imperfect competition called


Intra-Industry Trade
The next section of the chapter defines intra-industry trade (IIT), in which a country both exports and imports the same product or very similar product varieties. It explains how IIT is measured for an individual product, with examples shown in Figure 6.2. The importance of IIT in a country’s overall trade is the weighted average of the IIT shares for each of the individual products.

for an industry is the difference between exports and imports of the industry’s product(s).


Economies of Scale
Scale Economies, Imperfect Competition, and Trade


Oligopoly and Trade
The second theory is global oligopoly. In some industries, a few large firms account for most global sales, perhaps because internal scale economies are large. Although we do not have a single dominant full theory of oligopoly, we can make several observations about oligopoly and trade. First, scale economies tend to concentrate production in a few production sites.


b.With respect to short-run pressures on economic well-being, owners of factors employed in industries that could expand exports are likely to support the policy shift, because the demand for these factors increases as firms attempt to expand production. Owners of factors employed in industries that will receive increased competition from imports are likely to oppose the policy shift (unless they feel that other benefits from such changes as greater product variety more than offset their direct income losses). With respect to long-run pressures on economic well-being, the Stolper-Samuelson theorem is relevant. Owners of India's abundant factors of production are likely to support the policy shift, because they will gain real income. Owners of India's scarce factors are likely to oppose the shift, because they will lose real income (again, unless other benefits more than offset the direct


b.From the perspective of the well-being of the United States or Europe, a high-price equilibrium could be desirable because it involves setting high prices on export sales to other countries. This equilibrium also results in sales to domestic buyers at high prices, so there is some loss of pricing efficiency domestically. But the benefits to the country from charging high prices on exports and improving its terms of trade can easily be larger, so that overall the high-price equilibrium can be desirable.


Our third theory is based on scale economies that are external to the individual firm but arise from advantages of having a high level of production in a geographic area. With external scale economies (also called agglomeration economies), an expansion of demand (such as that caused by increased exports) can result in a lower unit cost for all producers in the area and a lower product price. With free trade production tends to be concentrated in one or a few locations. In the shift from no trade to free trade, production in some locations would increase so that their unit costs and prices fall, while production in other locations would decrease or cease. It is not easy to predict which locations become dominant—luck, a large domestic market, or government policy may be important. The importing countries gain from trade, even if local production ceases, because consumers benefit from the


Standard trade theory presented in Chapters 3-5 is based on perfect competition, with constant returns to scale at the level of the individual firm and constant or increasing cost of expanding production at the level of the industry. Comparative advantage predicts that countries will trade with other countries that are different (the source of the comparative cost differences) and that each country will export some products and import other, quite different products. While much international trade conforms to these patterns, a substantial amount does not. Most obviously, industrialized countries trade a lot with each other, and in much of their trade each is exporting and importing similar products.


Scale Economies, Imperfect Competition, and Trade

The Heckscher-Ohlin theory predicts that trade between similar industrialized countries should

be much greater than trade between developed and developing countries.

consist mainly of highly sophisticated manufactured goods.

consists mainly of manufactured products intensive in low- and medium-skill labor.


Scale Economies, Imperfect Competition, and Trade

Scale economies are said to be present when

an increase in output leads to an increase in average cost.

an increase in output has no impact on average cost.

an increase in output leads to a decrease in average cost.


Scale Economies, Imperfect Competition, and Trade

Internal scale economies occur when

expansion of output by a firm leads to greater specialization of labor.

expansion in an industry drives down input prices.

industry growth leads to a greater diffusion of knowledge among firms.

a firm pays higher input prices to expand production.


Scale Economies, Imperfect Competition, and Trade

________ is a market structure in which a large number of firms compete vigorously with each other in producing and selling different varieties of a basic product.


Scale Economies, Imperfect Competition, and Trade

When Firm X doubled its output, it was found that its cost per unit declined by 10 percent. It can be concluded that

the firm was facing external scale diseconomies.

the firm was enjoying internal scale economies.

the firm was operating on the inelastic portion of the demand curve.

the marginal cost of production at the initial output level was constant.


Scale Economies, Imperfect Competition, and Trade

Which of the following can best explain the clustering of some industries, such as banking and finance in New York City and high-technology computer production in Silicon Valley?


Scale Economies, Imperfect Competition, and Trade

Which of the following refers to a two-way trade in which a country both exports and imports the same or very similar products?


Scale Economies, Imperfect Competition, and Trade

Which of the following is the formula for the intra-industry trade (IIT) share in a product's total trade?


Scale Economies, Imperfect Competition, and Trade

Suppose the amount of exports of textile machinery from Italy to the rest of the world equals 60 billion tons. The amount of imports of textile machinery into Italy from the rest of the world is 40 billion tons. Therefore, the intra-industry trade share for machinery is


Scale Economies, Imperfect Competition, and Trade

Which of the following is true of intra-industry trade?

Intra-industry trade is mostly based on the differences stressed in the Heckscher-Ohlin trade theory.

Intra-industry trade is usually discouraged by the government.

Intra-industry trade is said to occur when the United States exports Ford automobiles and imports Honda automobiles.

Intra-industry trade is said to occur when the United States exports Ford automobiles and imports petroleum.


Scale Economies, Imperfect Competition, and Trade

Which of the following can help explain the rise of intra-industry trade?

Recent recessions and increases in the price of oil have led to lower national income levels.

The demand for product variety has increased substantially over time.

Countries widely vary in terms of their resource endowments.

The developed nations have recently implemented more conservative fiscal policies.


Scale Economies, Imperfect Competition, and Trade

Which of the following indicates the difference between the volume of exports and imports of a product?


Growth and Trade

Balanced Versus Biased Growth
Growth in a country's production capabilities shifts the country's production-possibility curve out. Growth is balanced if the ppc shifts out proportionately. Balanced growth could occur because all factors are growing at similar rates, or because production technology is improving at the same rate in both sectors. Growth is biased if the outward shift in the ppc is skewed, so that the growth favors producing more of one product than the other.

Growth in a country’s production capabilities shifts the country’s production-possibility curve (ppc) outward.

As the ppc shifts out, we are interested in knowing the effects on:

The general shape of the production-possibility curve.


Growth and Trade

Growth in Only One Factor
Growth in a country's production capabilities shifts the country's production-possibility curve out. Growth is balanced if the ppc shifts out proportionately. Balanced growth could occur because all factors are growing at similar rates, or because production technology is improving at the same rate in both sectors. Growth is biased if the outward shift in the ppc is skewed, so that the growth favors producing more of one product than the other.

: In a two-good world, and assuming that product prices are constant, growth in the country’s endowment of one factor of production, with the other factor unchanged, has two results:


Growth and Trade

Changes in the Country's Willingness to Trade
If instead this is a large country, then changes in its willingness to trade change the equilibrium international price ratio. If the growth reduces the country's willingness to trade, then the reduced supply of exports and the reduced demand for imports results in an increase in the equilibrium relative price of the country's exportable product.

As production and consumption change with growth, a country’s willingness to or interest in engaging in international trade can also change. It could:

Increase its willingness to trade (export and import more).

Decrease its willingness to trade (export and import less).


Growth and Trade

Effects on the Country's Terms of Trade
If instead this is a large country, then changes in its willingness to trade change the equilibrium international price ratio. If the growth reduces the country's willingness to trade, then the reduced supply of exports and the reduced demand for imports results in an increase in the equilibrium relative price of the country's exportable product.

: If the country is small (i.e. a price-taker in world trade), then its trade has no impact on the international price ratio ( the country’s terms of trade, TOT).


Growth and Trade

Technology and Trade
Growth in a country's production capabilities shifts the country's production-possibility curve out. Growth is balanced if the ppc shifts out proportionately. Balanced growth could occur because all factors are growing at similar rates, or because production technology is improving at the same rate in both sectors. Growth is biased if the outward shift in the ppc is skewed, so that the growth favors producing more of one product than the other.

Another basis for comparative advantage can arise over time as technological changes occur at different rates in different sectors and countries.

In some ways, a technology-based explanation is an alternative that competes with the H-O model.

In other ways, technology differences can be consistent with an H-O view of the world.


Growth and Trade

Balanced and Biased Growth
Growth in a country's production capabilities shifts the country's production-possibility curve out. Growth is balanced if the ppc shifts out proportionately. Balanced growth could occur because all factors are growing at similar rates, or because production technology is improving at the same rate in both sectors. Growth is biased if the outward shift in the ppc is skewed, so that the growth favors producing more of one product than the other.


Growth and Trade

Single-Factor Growth: The Rybczynski Theorem
One example of very biased growth is growth in only one factor, the other factor unchanged. While the entire ppc shifts out, the growth is strongly biased in favor of the product that uses the growing factor intensively. The Rybczynski theorem indicates that, if product prices are constant, then the output quantity of the product that uses the growing factor intensively will increase, while the output quantity of the other product must contract.


Growth and Trade

c.The U.S. willingness to trade increases. With growth of production and income, the United States wants to consume more of both goods. Demand for imports of clothing increases because domestic consumption increases while domestic production decreases. (Supply of exports also increases because the increase in domestic production of machinery is larger than the increase in domestic consumption.)


Growth and Trade

Finally, the box “Trade, Technology, and U.S. Wages” (another Focus on Labor) confronts an important issue—why has the difference in wages between skilled and less skilled workers widened since the 1970s, in the United States and other countries. This could be the Stolper-Samuelson theorem at work, if expanding trade with developing countries placed downward pressure on the prices of products intensive in less skilled labor. But several studies conclude that this effect is smaller than another—biases in technological change. Technological change seems to have created rising demand for skilled labor for two reasons. First, technological progress has been faster in industries that are intensive in skilled labor, resulting in their faster growth. Second, technological progress is biased in favor of using more skilled labor.
Tips


Growth and Trade

b.The U.S. willingness to trade probably decreases because the United States is now capable of producing its import good at a lower cost. Although the extra production and income lead to an increase in U.S. demand for clothing, the expansion of the supply of clothing that results from the improved technology is likely to be larger, so U.S. demand for clothing imports probably decreases.


Growth and Trade

The growth of the country's production capabilities is likely to change the country's willingness to trade—the quantities that it wants to export and import—even if product prices do not change. The change in the country's willingness can be documented by examining the change in the country's trade triangle for the price ratio that held in the free-trade equilibrium before the growth occurs. The change in the production point depends on whether growth is balanced or biased. The change in the consumption point depends on tastes in the country. At the same price ratio the quantities consumed of both products will increase if both goods are normal. Growth that is balanced or biased toward producing the exportable product is likely to increase the country's willingness to trade. Growth that is sufficiently biased toward producing more of the importable product will reduce the country's willi


Growth and Trade

Which of the following is one of the fundamental sources of long-run economic growth?

An expansion of foreign gross domestic product (GDP)

An increase in demand for the country's importable product

An improvement in production technologies

An reduction in local purchasing of the country's exportable products


Growth and Trade

In the figure below, we see an expansion of the production-possibility curve (from PPC1 to PPC2). The two goods produced are wheat and cloth, which are land-intensive and labor-intensive, respectively. The outward shift of the production-possibility curve shows

a move from a no-trade situation to free trade.

an increase in the production costs of both goods.


Growth and Trade

In the figure below, we see an expansion of the production-possibility curve (from PPC1 to PPC2). The two goods produced are wheat and cloth, which are land-intensive and labor-intensive, respectively. The outward shift of the production-possibility curve is likely the result of

a fall in the average cost of producing cloth.

an increase in the size of the labor force, the area under cultivation remaining unchanged.

an increase in the national amount of usable land, the size of the labor force remaining unchanged.


Growth and Trade

Which of the following statements is true?

Increases in a country's endowments of land, labor, and capital will lead to long-run economic growth.

Improvements in the technology used in production can lead to increases in current output levels but are not a source of long-run economic growth.

Improvements in production technology do not affect the shape or position of the production-possibility curve.

Biased growth leads to a proportionate shift in the production-possibility curve.


Growth and Trade

In a country that produces only wine and guns, which of the following is least likely to lead to biased growth?

The amount of usable land has increased substantially.

The relaxation of migration laws has led to a huge influx of unskilled workers.

The technology used to produce guns improves while the technology used to produce wine does not change.

The relative price of guns in the international market changes.


Growth and Trade

The Rybczynski theorem asserts that in a two-good model, assuming that product prices stay constant, growth in the endowment of one factor of production with the other factor remaining unchanged, will result in

an equal increase in the output of both goods.

an increase in the output of the good that uses the growing factor intensively and a decrease in the output of the other good.

an increase in the output of both goods, but a relatively greater increase in the output of the good that uses the growing factor intensively.

an increase in the output of the good that uses the growing factor intensively, but the output level of the other good will remain unchanged.


Growth and Trade

Assume that a capital-abundant country trades only two goods with the rest of the world, medical equipment and corn. Medical equipment is relatively capital-intensive. According to the Rybczynski theorem, with the relative price of the goods remaining unchanged, an increase in the country's endowment of capital will cause the output of medical equipment to ________ and the output of corn to


Growth and Trade

Assume that a large capital-abundant country trades only two goods with the rest of the world, medical equipment and corn. Medical equipment is relatively capital-intensive. An increase in the country's endowment of capital will cause the price of medical equipment relative to the price of corn to


Growth and Trade

If trade is consistent with the Heckscher-Ohlin (H-O) theory, then growth in a country's scarce factor of production will lead to

a deterioration in the country's terms of trade.


Growth and Trade

Assume a country produces only wine and cups. Both wine and cup production use land and labor as their only inputs. Wine production is relatively land-intensive while cup production is relatively labor-intensive. According to the Rybczynski theorem, a significant rise in immigration is most likely to lead to

an increase in the production of both wine and cups.

an increase in wine production by a greater proportion than the increase in the size of the labor force due to immigration.

an increase in the production of cups by a greater proportion than the increase in the size of the labor force due to immigration.

an increase in wine production by a greater proportion than the increase in the production of cups.


Growth and Trade

The Rybczynski theorem suggests that development of a new natural resources in a country

may cause the country to export only manufactured products.

will increase output in all sectors of the economy.

may cause the manufacturing sector of the country to shrink.


Growth and Trade

The rapid accumulation of capital and worker skills in the United States in the 1800s

resulted in an increase in the export of natural resources by the country.

made the United States more dependent on imported minerals.

made the United States more self-sufficient and led to a reduction in its trade volume.

resulted in rapid deindustrialization in the country.

Changes in the Country's Willingness to Trade


Analysis of a Tariff

A Preview of Conclusions
This chapter starts the analysis of government policies that limit imports, by examining the tariff—a government tax on imports.


Analysis of a Tariff

The Effect of a Tariff on Domestic Consumers
Domestic consumers of the product are also affected by the imposition of the tariff. They must pay a higher price (for both imported and domestically produced products), they reduce the quantity that they buy and consume (a movement along the domestic demand curve), and they suffer a loss of consumer surplus.


Analysis of a Tariff

The Effects of a Tariff on Domestic Producers
We begin by examining the effects of an import tariff imposed by a small country (contrasted with free trade), using supply and demand within the importing country. Since foreign exporters do not change the price that they charge for the product, the domestic price of the imported product rises by the amount of the tariff.

The U.S. Market for Bicycles with Free Trade:


Analysis of a Tariff

The Net National Loss from a Tariff
We thus have two domestic winners (domestic producers and the national government) and one domestic loser (domestic consumers) because of the imposition of a tariff. We can evaluate the net effect on the whole country, if we have some way of comparing winners and losers. As we did beginning in Chapter 2, we can, for instance, use the one-dollar, one-vote metric.

: Every dollar of gain or loss is just as important as every other dollar of gain or loss, regardless of who the gainers or losers are.


Analysis of a Tariff

The Tariff as Government Revenue
The government also collects tariff revenue, equal to the tariff rate per unit imported times the quantity that is imported with the tariff in place (less than the free-trade import quantity).

As long as the tariff is not so high as to prohibit all imports, it also brings revenue to the country’s government

Revenue equals the unit amount of the tariff times the volume of imports with the tariff (Area c in the diagram)

This revenue could be used to pay for extra government spending, matched by an equal cut in some other tax, or serve as extra income.


Analysis of a Tariff

The Terms-of-Trade Effect and a Nationally Optimal Tariff
The net effect on the importing country depends on which of these two is larger. For a suitably small tariff, the rectangle is larger, so the importing country has a net gain from imposing a tariff. A prohibitive tariff would cause a net national loss, because the rectangle would disappear. It is possible to determine the country’s nationally optimal tariff—the tariff rate that makes the net gain to the importing country as large as possible.

A tariff almost always lowers world well-being.

A tariff usually lowers the well-being of each nation,  including the nation imposing the tariff.


Analysis of a Tariff

The Effect of a Tariff on Domestic Producers
We begin by examining the effects of an import tariff imposed by a small country (contrasted with free trade), using supply and demand within the importing country. Since foreign exporters do not change the price that they charge for the product, the domestic price of the imported product rises by the amount of the tariff.


Analysis of a Tariff

Early in the chapter, the first in a series of boxes on Global Governance introduces the World Trade Organization (WTO), created in 1995, which subsumed the General Agreement on Tariffs and Trade (GATT), formed in 1947. The major principles of the WTO include trade liberalization, nondiscrimination, and no unfair encouragement of exports. Eight completed rounds of multilateral trade negotiations have been successful in lowering tariffs imposed on most nonagricultural imports into industrialized countries. The box also notes the different path that developing countries have taken to their tariff reductions.


Analysis of a Tariff

In addition to beginning the examination of the role and activities of the WTO, the chapter has two major purposes. First, the analysis shows the effects of a tariff when the importing country is small, so that its import policies have no effect on world prices. Second, the analysis of a large importing country—one whose policies can affect world prices—shows that a large country can use a tariff to lower the price that it pays foreigners for its imports. Furthermore, the box “They Tax Exports, Too” shows that analysis of an export duty parallels that of an import tariff.


Analysis of a Tariff

We present the analysis of a tariff in this chapter for both the small country and the large country, and we present the analysis of an import quota and a voluntary export restraint (VER) in the next chapter. In your class presentation you might consider a different way of organizing this material, in which you present the small country analysis of the tariff, the quota, and the VER as a package, and then turn to looking at the large country analysis of the tariff and the quota. This alternative approach is designed to emphasize the fundamental similarities of the analyses of these different government policies, as well as the specific ways in which they are different. Students generally find it easier to grasp the small country analyses, so it can be useful to do all three policies for this easier case before turning to the large country analyses.


Analysis of a Tariff

They Tax Exports, Too: There are a number of possible reasons that a country would limit the export of a product like cotton. First, if the government uses a tax, it would gain revenue. Second, the limit on exports would tend to force additional sales of the product in the local market, so the domestic price would fall below the world price, and domestic consumers would benefit. Third, if the country is a large exporter of the product, then the world price will rise when the country exports less, and the country can gain from an increase in its terms of trade. An export ban is an extreme limitation, and two of the three possibilities do not apply. There is no government revenue. Even if the world price of the export product increases, there are no exports on which to receive the gain from the higher price paid by foreigners. The most likely reason for the Indian prohibition of cotton exp


Analysis of a Tariff

A(n) ________ is a tax on imports that is stipulated as a money amount per unit.


Analysis of a Tariff

Which of the following is an impact of tariffs on the country imposing them?

The domestic producers of import-competing products are forced to charge a lower price for their products to retain market share.

The supply of the domestic import-competing products declines.

The domestic consumers pay a higher price for the imported products.

The demand for the imported goods by the domestic consumers increases.

The Effect of a Tariff on Domestic Consumers


Analysis of a Tariff

Which of the following correctly identifies the impact of tariffs on the producers of import-competing products in the imposing country?

They can price their products higher than the imported goods.

They can expand their production and sales.

They are forced to go out of business in the long run.

They are forced to charge a price equal to the average cost of production.

The Effects of a Tariff on Domestic Producers


Analysis of a Tariff

If a small country imposes a tariff on imported motorcycles, the world price of motorcycles will ________ and the domestic price of motorcycles will


Analysis of a Tariff

If a small country imposes a tariff on imported motorcycles

the surplus of the domestic producers of motorcycles will decline, but the surplus of the domestic consumers will increase.

the surplus of both the domestic producers and consumers of motorcycles will decline.

the surplus of both the domestic producers and consumers of motorcycles will increase.

the surplus of the domestic producers of motorcycles will increase, but the surplus of the domestic consumers will decline.


Analysis of a Tariff

Which of the following is the basis for the consumption effect of a tariff imposed on imported automobiles?

The decline in the purchase of the product due to the increase in its price

The net increase in the availability of the domestic automobiles for the consumers owing to higher prices

The net increase in the government revenue by taxing the domestic consumers who buy the imported automobiles

The net increase in the consumption of imported automobiles by the domestic consumers


Analysis of a Tariff

Which of the following refers to the extra cost of shifting to more expensive home production following the imposition of a tariff?


Analysis of a Tariff

The figure below shows the market for shoes in a small importing country. Dd and Sd are the domestic demand and supply curves of shoes, respectively. Following the imposition of a tariff, the domestic producer surplus ________ by the area


Analysis of a Tariff

The figure below shows the market for shoes in a small importing country. Dd and Sd are the domestic demand and supply curves of shoes, respectively. Following the imposition of a tariff, the domestic consumer surplus ________ by the area


Analysis of a Tariff

The figure below shows the market for shoes in a small importing country. Dd and Sd are the domestic demand and supply curves of shoes, respectively. The tariff revenue of the country's government is shown by area


Analysis of a Tariff

The figure below shows the market for shoes in a small importing country. Dd and Sd are the domestic demand and supply curves of shoes, respectively. The imposition of a tariff on shoes caused economic well-being in the country to ________ by an amount measured by the area


Analysis of a Tariff

The figure below shows the market for shoes in a small importing country. Dd and Sd are the domestic demand and supply curves of shoes, respectively. The production effect of the tariff on shoes is measured by the area


Nontariff Barriers to Imports

The Import Quota
This chapter has four major purposes: Present analysis of an import quota and a voluntary export restraint (VER), for both a small importing country and a large one. Provide an overview of other nontariff barriers (NTBs) to imports. Explore the relative sizes of the economic costs of tariffs and nontariff barriers. Continue the discussion of the World Trade Organization (WTO), including its role in liberalizing NTBs and its role in the settlement of international trade disputes.

An import quota is a limit on the total quantity of imports of a product allowed into the country during a period of time.

Reasons why protectionists and government officials may favor quotas:

A quota ensures the quantity of imports is strictly limited.


Nontariff Barriers to Imports

Types of Nontariff Barriers to Imports
After describing the types of nontariff barriers to imports, the text of the chapter develops the analysis of an import quota. If both the domestic industry and the foreign export industry are perfectly competitive, then the effects of a quota are almost all the same as the effects of a tariff that permits the same quantity of imports.


Nontariff Barriers to Imports

Voluntary Export Restraints
The VER is usually not voluntary, but it is an export restraint. Because the government of the exporting country must organize its exporters into a kind of cartel, they should realize that they should raise the export price. If the exporters do raise the export price, then the exporters get the amount that otherwise would be government revenue with a tariff, or the price markup with an import quota.

A voluntary export restraint is an odd-looking trade barrier in which the importing country government compels the foreign exporting country to agree to “voluntarily” limit its exports to the importing country.

The export restraint usually requires that the foreign exporting firm act as a cartel by restricting sales and raising price.


Nontariff Barriers to Imports

How Big Are the Costs of Protection?
How relatively large are the economic costs of tariffs, quotas, VERs, and other nontariff barriers to imports? The chapter shows that the net national loss is probably a small fraction of the value of domestic production (GDP), for a country like the United States that has moderate import barriers and is not highly dependent on imports, if the only national losses are the deadweight-loss triangles.

The net national loss as a percentage of GDP:


Nontariff Barriers to Imports

International Trade Disputes
This chapter has four major purposes: Present analysis of an import quota and a voluntary export restraint (VER), for both a small importing country and a large one. Provide an overview of other nontariff barriers (NTBs) to imports. Explore the relative sizes of the economic costs of tariffs and nontariff barriers. Continue the discussion of the World Trade Organization (WTO), including its role in liberalizing NTBs and its role in the settlement of international trade disputes.

Forum for multilateral trade negotiations.  Current Doha Round, now suspended


Nontariff Barriers to Imports

Protecting Domestic Producers against Import Competition
The chapter then examines three other NTBs based on product standards, domestic content requirements, and government procurement. Product standards can be worthy efforts to protect health, safety, and the environment. But they can also be written to limit imports and protect domestic producers. Domestic content requirements mandate that a minimum percentage of the value of a product produced or sold in a country be local value added (including domestically produced components and materials).

• Clearly helps those domestic producers.

• Harms domestic consumers of the products.

• Probably hurts the importing nation as a


Nontariff Barriers to Imports

The Effects of a Quota
This chapter has four major purposes: Present analysis of an import quota and a voluntary export restraint (VER), for both a small importing country and a large one. Provide an overview of other nontariff barriers (NTBs) to imports. Explore the relative sizes of the economic costs of tariffs and nontariff barriers. Continue the discussion of the World Trade Organization (WTO), including its role in liberalizing NTBs and its role in the settlement of international trade disputes.


Nontariff Barriers to Imports

Area
Early in the chapter the second in the series of boxes on Global Governance examines the role of the WTO in limiting and reducing NTBs. Recent rounds of multilateral trade negotiations have included NTBs, but with less success in lowering them than the WTO has had with tariffs. The box also discusses how the WTO has extended into nontraditional areas.

A quota results in a higher price and larger production quantity, so domestic producers gain surplus equal to Area

With a higher price and smaller consumption quantity, domestic consumers lose surplus equal to Area


Nontariff Barriers to Imports

The final section of the chapter examines international trade disputes and how they can be resolved. The GATT had a dispute settlement procedure, but it was weak and became increasingly ineffective. The United States moved outside of the GATT by enacting Section 301 of the U.S. Trade Act of 1974, which aims to lower foreign barriers to U.S. exports by threatening to raise U.S. barriers to the foreign country’s exports if the foreign country does not change its policies. Other countries have resented such a heavy-handed unilateral approach, and well-being for both countries would probably decline if the U.S. government carries out the threat. Fortunately, the United States decreased its use of Section 301; the U.S. government is more likely to send its complaints about unfair foreign trade practices to the WTO for resolution. But, in a Section 301 case that began in 2017, the U.S. governm


Nontariff Barriers to Imports

VERs: Two Examples: In 1981 the U.S. government forced the Japanese government to impose a “voluntary” export restraint, so that total Japanese automobile exports in 1981 had to be 8 percent less than the total exports in 1980. The Japanese government told Honda (and each of the other Japanese auto companies) the maximum number of cars that the company could export to the United States. With quantity strictly limited, Honda raised the prices of the cars that they did export. For the Civic, the increase was about $1,000. When your grandfather went to the Honda dealer to buy a new Civic, he saw and paid the higher price. Essentially, a slice of area c in a graph like Figure 9.2 was the extra $1,000 that your grandfather had to pay for the Civic in 1981 (above what he would have paid for a new Civic in 1980).


Nontariff Barriers to Imports

The VER is usually not voluntary, but it is an export restraint. Because the government of the exporting country must organize its exporters into a kind of cartel, they should realize that they should raise the export price. If the exporters do raise the export price, then the exporters get the amount that otherwise would be government revenue with a tariff, or the price markup with an import quota. The net national loss is larger for the importing country with a VER because of this additional rectangle loss. The box “VERs: Two Examples” discusses (1) the costs to the United States of the VER on imports of Japanese automobiles and (2) the web of export restraints that developed to limit international trade in textile and clothing products.


Nontariff Barriers to Imports

This chapter has four major purposes: Present analysis of an import quota and a voluntary export restraint (VER), for both a small importing country and a large one. Provide an overview of other nontariff barriers (NTBs) to imports. Explore the relative sizes of the economic costs of tariffs and nontariff barriers. Continue the discussion of the World Trade Organization (WTO), including its role in liberalizing NTBs and its role in the settlement of international trade disputes.


Nontariff Barriers to Imports

Restricting imports into a small country by the government

protects domestic producers from foreign competition.

increases consumer welfare in the country.

increases the general welfare of the importing nation.


Nontariff Barriers to Imports

Which of the following is NOT true of nontariff barriers to imports?

Nontariff barriers can limit imports with greater certainty than tariffs.

Unlike tariffs, nontariff barriers do not increase the price of imported goods in the domestic markets.

Some nontariff barriers create uncertainty about the conditions under which imports will be permitted.

Like tariffs, nontariff barriers result in a net welfare loss in a small country.


Nontariff Barriers to Imports

One of the reasons protectionists and government officials may favor using a quota instead of a tariff is

quotas generate more revenue for the government than tariffs.

quotas ensure that the quantities of imports are strictly limited.

quotas create less market distortions than tariffs.

quotas give less power to politicians than tariffs.


Nontariff Barriers to Imports

Which of the following is true of a quota?

Imposition of a quota causes domestic prices to fall below world prices.

Imposition of a quota by a country causes the world price of the good imported by this country to rise.

A quota is a quantitative restriction on imports.

A quota is usually less inefficient than a tariff.


Nontariff Barriers to Imports

Under which of the following situations will a tariff imposed by a country fail to reduce imports by as much as expected?

The current tariff rate is less than the prohibitive tariff rate.

The foreign export quantity supplied of the good imported by this country is more responsive to changes in the world price than was expected.

The domestic supply of the import-competing products is more price-elastic than was expected.

The domestic quantity demanded of the imported product is less responsive to price changes than was expected.


Nontariff Barriers to Imports

In the case of a small country, the effects of a quota and a tariff are (almost) identical if

the government allocates licenses for free to importers using a rule or process that involves (almost) no resource cost.

the government auctions off import licenses to the highest bidder.

the government allocates licenses to importers through application and selection procedures that require the use of substantial resources.

the government allocates import licenses directly to the public using a free lottery system.


Nontariff Barriers to Imports

Which of the following is a means of allocating import licenses by assigning the licenses without competition, applications, or negotiation?