International Trade Questions and Answers PDF

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Based on the prescribed book "International Economics : Trade and Finance" by Dominick Salvatore, 11th Edition ...

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ECS3702REVI SI ON

Whatwere t he Mercant i l i st s vi ews on t r ade? How di dt hey r el at et o curr enti deol ogyofprot ect i oni sm? Expl ai nwhot hemer cant i l i st swer e.  Mer cant i l i sm was devel oped by wr i t er si n Eur ope bet ween 1500 and 1800. Di scusswhatt hei rbel i ef sori deol ogi eswer e.  Accor di ngt ot hemer cant i l i st s,t r adei sazer osum gamewher et hegai ns oft hewi nner swer eoffsetbyt hel ossesoft hel oser s.  Si nce notal lnat i ons coul d have t r ade sur pl uses att he same t i me,i t meantonenat i ongai nedatt heexpenseoft heot hernat i on.  Tr adewasbasedonsel f i nt er esti . e.t heybel i evedt hati nor dert obecome r i chandpower f ulanat i onmustexpor tmor et hani ti mpor t edbyso doi ngaccumul at i ngpr eci ousmet alorbul l i ons.  Gover nment shad t ot her ef or eensur et hatexpor t swer est i mul at ed and i mpor t sr es t r i ct edusi ngt ar i ffsandot hert r adebar ri er s.  The excess ofexpor t soveri mpor t sl ed t o an i nflow ofpr eci ousmet al s suchasgol dandsi l ver /bul l i on.  Ther ei sar esur genceofneoMer cant i l i smst oday ,wi t h nat i onspl agued by hi gh unempl oyment seeki ng t or est r i ct i mpor t si n an effor tt o st i mul at edomest i cpr oduct i onandempl oyment . Di scussbr i efly ,whatt hecr i t i ci smsoft hei ri deasar e.  Themer cant i l i stappr oach f ai l ed t of ul l y expl ai nt hewel f ar ebenefit sof t r ade,whi l et heyt hemsel vesr emai ned unawar east ot hef ur t hereffect s ofat r adesur pl usont hedomest i ceconomy

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 The cl assi cal t heor i st Davi d Hume showed t hat a f av our abl et r ade bal ancet endst obea t empor aryphenomenon,asi tcan l ead t ohi gher domest i ci nflat i on( mor emoneychasi ngt hesamequant i t yofgoods) .

 The r esul t ant hi gher pr i ces f or domes t i cal l y pr oduced goods t end t o adver sel y affect t he i nt er nat i onal compet i t i veness of t he economy' s expor t s,t her ebyencour agi ngmor ei mport si nt ot hecount ry .

 Adam Smi t h,al so r ef ut ed t he mer cant i l i st s bel i eft hat" t he si ze oft he wor l d' seconomi cpi ei sconst ant " ,and t her ef or eanat i on mayonl ygai n f r om t r ade att he expense ofi t st r adi ng par t ner s. Smi t h ar gued t hat wor l d out putwas nota fixed amount ,butr at hert hatt r ade bet ween count r i es affor ded t he possi bi l i t yf or t he l at t er t o speci al i se i nt he pr oduct i on of par t i cul ar goods, i mpr ovi ng pr oduct i vi t yt hr ough t he di vi si onofl abour ,andul t i mat el yl eadi ngt oani ncr easei nwor l dout put .

 Fur t her mor e,bot h Smi t h and anot hercl assi calt heor i st ,Davi d Ri car do, ar gued t hatcount ri es who ar e par t ner si nt r ade can si mul t aneousl y achi evehi gherout putl evel sofpr oduct i on and consumpt i on asar esul t off r eet r ade.

Cri t i cal l y eval uat e Adam

Smi t h’ s t heory of absol ut e advant age,

out l i ni ng the assumpt i ons necessary f or t he theory t o hol di ni t s pur estf orm.Whatar ethecr i t i ci smsofthi st heory? Thi squest i onhast hr eepar t st oi t . Whatdoesabsol ut eadvant agemean? Davi dRi car dodevel opedt het heor yofabsol ut eadvant age.Ri car dopoi nt ed t hatmut ual l ybenefici alt r adebet ween t wonat i onsi spossi bl eonl yi feac h had an absol ut e advant agei nt he pr oduct i on of1 oft he commodi t i es.A nat i onhasanabsol ut eadvant agei nt hepr oduct i onofcommodi t yX i fi tcan 2|Page

pr oducei tmor eeffici ent l yt han i t st r adi ngpar t ner .Byt r adi ngaccor di ngt o absol ut eadvant age,compl et especi al i zat i onoccur s. Ther ei s al so i ncr eased out put as a r esul t of speci al i zat i on. Mut ual l y benefici alt r adewi l lnotoccuri fonenat i onhasanabsol ut eadvant agei nt he pr oduct i on ofbot h commodi t i es.Fort r adet ooccurt hedomes t i ct er msof t r ademustf al lwi t hi nt hei nt er nat i onalt er msoft r ade. Thet heoryi sf oundedupont hef ol l owi ngASSUMPTI ONS  Pr oducer sandconsumer sdi spl ayr at i onalbehavi our .  I t ’ sa2commodi t y ,2nat i onmodel .  Ther ei sf ul lempl oyment  Labouri st heonl yf act orofpr oduct i on  Eachcount ryhasafixedendowmentofr esour ces  Per f ectcompet i t i onexi st s  Fact or s ofpr oduct i on ar e mobi l e bet ween t he t wo commodi t i es and wi t hi nt hecount ry ,butnotbet weencount r i es  Ther ear enobar r i er st ot r ade  Pr oduct i onshowsconst antr et ur nst oscal e  Ther ear enot r anspor tcost s  Thel ev eloft echnol ogyi sfixedf orbot hcount ri es,butmaydi fferbet ween t hem. Cri t i ci sms  Thet heor yhasbeen cr i t i ci sedf ort hef actt hati tassumesl abouri st he onl yf act orofpr oduct i on.Thi si snott rueast her ear eot herf act or sof pr oduct i onsuchascapi t alandl and.  Theassumpt i onofper f ectcompet i t i oni sunr eal i st i c.  Mar ketst r uct ur esar echar act er i sedbyi mperf ect i ons.  Thel abourt heor yofval uei sover si mpl i fied.  Theory assumes t hat t r ade l eads t o compl et e speci al i sat i on,however speci al i sat i oni sal waysi ncompl et e

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 The t heor y can be cr i t i ci sed f ornotbei ng abl et o expl ai nt r ade i fone count ry has an absol ut e advant age i n t he pr oduct i on of bot h commodi t i es. Quest i on2 Cri t i cal l ydi scusst heHeckscher Ohl i nt heoryofi nt ernat i onalt r ade. TheHeckscher Ohl i nt heor yi sal soknown ast hef act orpr opor t i onst heor y . I ti s cal l ed t he Heckscher Ohl i nt heor y because i twas devel oped by t wo Swedi sheconomi st s,namel yEl iHeckscherandBer t i lOhl i n,i n1933. Assumpt i onsoft het heory  2×2×2Model

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Twocount r i es;

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Twohomogenouscommodi t i es;

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Twohomogenousf act orofpr oduct i on( FOPs) :

 Capi t alandl abour ;  I ni t i all ev el sfixed;  Level soff act or savai l abl ear edi ffer entf oreachcount ry .  Technol ogyi st hesamei nbot hcount ri es;  Const antr et urnst oscal ei npr oduct i on;  Each commodi t y has a di ffer ent f act or i nt ensi t y( i . e. one i sl abour i nt ensi ve,andt heot heri scapi t al i nt ensi ve) ;  Tast es/pr ef er ences ar e t he same i n bot h count r i es ( i . e. demand condi t i onsar et hesame) ;  Ther ei sper f ectcompet i t i oni nbot hcount r i es;  Ther ei s domes t i cf act ormobi l i t y ,butnoti nt er nat i onalf act ormobi l i t y ( i . e.f act or scannotmovebet weencount r i es) ;  Not r ansportcost s;  Ther ear enor est r i ct i onson: 4|Page

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Tr ade;

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Det er mi nat i onofmar ketpr i ceandout put .

EXPLANATI ON OFTHE THEORY  TheHecksc her Ohl i n( f act orpr opor t i onst heory)r est sont wopr emi ses:i ) Commodi t i esdi fferi nt hei rf act orr equi r ement s;andi i )Count r i esdi fferi n t hei rf act orendowment s.  Accor di ng t ot he Hec kscher Ohl i nt heory ,a count ry has a compar at i ve advant age i nt he pr oduct i on ofa commodi t yt hatuses i t s abundant f act or of pr oduct i on i nt ensi vel y . Thus, a count r y shoul d expor tt he commodi t y t hat uses i t s r el at i vel y abundant f act or of pr oduct i on i nt ensi vel y ,and i mpor tt he commodi t yt hatuses i t sr el at i vel y scar ce f act orofpr oduct i on.  The HO t heor em ext ends t he t heor y of compar at i ve advant age by expl ai ni ngt hesour ceofcompar at i veadvant age .  Count r i eshavecompar at i veadvant agei nt hepr oduct i onofacommodi t y asar esul tofdi ffer entf act orendowment si nt hedi ffer entcount r i es.  Accor di ng t ot he HOt heor em,i nt ernat i onalt r ade i s due t o di ffer ent f act orendowment s.  TheHOt heor em i spr esent edi n2t heor ems,t heH0t heor em andt he f act orpr opor t i onst heor em.  TheH0t heor em st at est hatanat i on wi l lexpor tt hecommodi t ywhose pr oduct i on r equi r es t he i nt ensi ve use ofi t sr el at i vel y abundantand cheap f act orand i mpor tt hecommodi t ywhosepr oduct i on r equi r est he i nt ensi veuseofi t sr el at i vel yscar ceandexpensi vef act or .  I nt er nat i onalt r ade,accor di ng t ot he HOt heory can be expl ai ned by f act ori nt ensi t yandf act orabundance.Gi vent wocommodi t i es,X andY, and 2 f act or sofpr oduct i on,l abourand capi t al ,commodi t yY i scapi t al

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i nt ensi vei ft heK/Lr at i ousedi nt hepr oduct i onofYi sgr eat ert hant hat usedi nt hepr oduct i onofX.  Ther ef or e, Labour abundant nat i ons wi l l expor tl abour i nt ensi ve commodi t i es and i mpor t capi t ali nt ensi ve commodi t i es,whi l e capi t al abundantnat i onswi l lexpor tcapi t ali nt ensi vecommodi t i esand i mpor t l abouri nt ensi vecommodi t i es.  Fact orabundance can be expl ai ned i nt er ms ofphysi calabundance, wher ebyi ft het ot alcapi t alt ot ot all abourr at i oi n nat i on onei sl ar ger t hani nnat i on2,t hennat i on1i ssai dt obecapi t ali nt ensi ve.  Looki ng atf act orpr i ces,nat i on 1 wi l lbe capi t alabundanti ft her /w r at i oi nnat i on1i ssmal l ert hant her /w r at i oi nnat i on2.

Cri t i ci sm oft hef act orpr oport i onst heory Leont i efpar adox  Expl ai nst hesi t uat i onwher eLeont i efexami nedt het r adepat t er nsoft he Uni t ed St at esand not i ced t hatt hough t heUS wasa capi t alabundant nat i on,i ti mpor t ed capi t ali nt ensi ve commodi t i es and expor t ed l abour i nt ensi vecommodi t i es.Thesefindi ngscont r adi ct edt heHOt heor em. Demandr ever sal s  I nt her ealwor l d,t hedemandcondi t i onsbet weent r adi ngpar t ner scani n f actbeverydi ffer ent ,r esul t i ngi n ver ydi ffer entdomest i cpr i cesi n each count ryf r om t hosesuggest edbyf act ori nt ensi t yexpect at i ons.  Forexampl e,di spr opor t i onat edemandmayr esul ti nacount ryi mpor t i ng agoodt hati scapi t al i nt ensi ve,des pi t ei t sowncapi t alabundance.

Fact ori nt ensi t yr ever sal s

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 Overa per i od oft i me,a commodi t yt hatwasi ni t i al l yl abour i nt ensi ve maybecomei ncr easi ngl ycapi t al i nt ensi ve,r esul t i ngi n bot h count r i es wi shi ngt ospeci al i sei nt hepr oduct i onofsuch

I t does not expl ai n i ntr ai ndust ry t r ade/tr ade bet ween devel oped count ri es.  Consi der Ger many and Fr ance. Bot h count r i es ar e atver y si mi l ar l evel sofi ndust ri al i sat i on,andt hei rf act orendowment sar er oughl yt he same. Ther ef or e,accor di ngt of act orpr opor t i onst heor y ,t her eshoul d bel i t t l eornot r adebet weent hecount r i es.However ,t hi si snot ,i nf act , t hecase. Forexampl e,Ger manyexpor t scar st oFr ance,whi l eFr ance expor t scar st oGer many .  Fact orpr opor t i onst heor ypr ovi desagoodexpl anat i onofi nt er i ndust r y t r ade,buti spr obl emat i cwi t hr egar dt oi nt r ai ndust r yt r ade. I ti sbasedonsi mpl i fiedassumpt i onsthatmaynothol di npr act i ce.  Theassumpt i onsofper f ectcompet i t i on,const antr et ur nst o scal e,and t he same l ev eloft echnol ogy exi st i ng i n bot ht r adi ng par t ner si s not r eal i st i c.

Quest i on3 Usi ngawel ll abel l eddi agr am,expl ai n thepart i alequi l i bri um,effect sof at ari ff onasmal lCount ry.

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Consi deramar keti n asmal li mport i ngcount ryt hatf acesan i nt er nat i onal orwor l d pri ceofPFT i nf r eet r ade.Thef r eet r adeequi l i br i um i sdepi ct ed i n t headj oi ni ngdi agr am wher ePFT i st hef r eet r adeequi l i br i um pr i ce.Att hat pr i ce,domes t i cdemandi sgi ven byDFT,domest i csuppl ybySFT andi mpor t s byt hedi ffer enceFD t hebl uel i nei nt hefigur e) . T -SFT ( When a speci fict ar i ff i si mpl ement ed by a smal lcount ry i twi l lr ai set he domest i c pr i ce by t he f ul lval ue oft he t ar i ff.Suppose t he pr i ce i nt he i mpor t i ngcount ryr i sest o r at ewoul dbe

becauseoft het ar i ff.I nt hi scaset het ar i ff ,equalt ot hel engt h oft hegr een l i nesegment

i nt hedi agr am. Thef ol l owi ngTabl epr ovi desasummaryoft hedi r ect i on andmagni t udeof t he wel f ar e effect st o pr oducer s,consumer s and t he gover nmenti nt he i mpor t i ng count ry .The aggr egat e nat i onalwel f ar e effect s ar e al so shown. ed. Posi t i vewel f ar eeffect sar eshowni nbl ack,negat i veeffec t sar eshowni nr

Wel f ar eEffect sofanI mportTar i ff I mpor ti ngCount ry Consumer -( A+B +C +D) Sur pl us Pr oducer +A 8|Page

Sur pl us Govt .

+C

Revenue Nat i onal -B –D We l f ar e

Tari ff Effect son: I mport i ng Count ry Consumer s- Consumer s of t he pr oduct i n t he i mpor t i ngcount ryar ewor seoffasar esul toft het ar i ff.Thei ncr easei nt he domest i cpr i ceofbot hi mpor t edgoodsandt hedomest i csubst i t ut esr educes consumersur pl usi nt hemar ket .Ref ert ot heTabl eand Fi gur et oseehow t hemagni t udeoft hechangei nconsumersur pl usi sr epr esent ed. I mport i ng Count ry Pr oducers-Pr oducer si nt he i mpor t i ng count ry ar e bet t er offasar esul toft het ar i ff.Thei ncr easei nt hepr i ceoft hei rpr oduct i ncr easespr oducersur pl usi nt hei ndust ry .Thepr i cei ncr easesal soi nduces an i ncr ease i n out putofexi st i ng fir ms ( and per haps t he addi t i on ofnew fir ms) , an i ncr ease i n empl oyment , and an i ncr ease i n pr ofit and/or payment st o fixed cost s.Ref er t ot he Tabl e and Fi gur et o see how t he magni t udeoft hechangei npr oducersur pl usi sr epr esent ed. I mport i ng Count ry Government-Thegover nmentr ecei vest ari ff r evenue asar esul toft het ar i ff.Whowi l lbenefitf r om t her evenuedependson how t he gov er nmentspends i t .These f unds hel p suppor tdi ver se gover nment spendi ngpr ogr ams,t her ef or e,someonewi t hi nt hecount rywi l lbet hel i kel y r eci pi entoft hese benefit s.Ref ert ot he Tabl e and Fi gur et o see how t he magni t udeoft het ar i ffr ev enuei sr epr esent ed. I mport i ng Count ry-Theaggr egat ewel f ar eeffectf ort hecount ryi sf ound by summi ng t he gai ns and l osses t o consumer s, pr oducer s and t he gover nment . The net effect consi st s of t wo component s: a negat i ve pr oduct i oneffici encyl oss( B) ,andanegat i veconsumpt i oneffici encyl oss( D) . Thet wol ossest oget herar et ypi cal l yr ef er r edt oas" deadwei ghtl osses. "Ref er t ot heTabl eandFi gur et oseehow t hemagni t udeoft hechangei nnat i onal wel f ar ei sr epr esent ed. 9|Page

Becauset her ear eonl ynegat i veel ement si nt henat i onalwel f ar echange,t he netnat i onalwel f ar e effectofa t ar i ff mustbenegat i ve.Thi s meanst hata t ari ff i mpl ement ed by a " smal l " i mport i ng count ry mustr educe nat i onalwel f ar e.

Thegener aleffect sofat ari ff  Thegener aleffect sofat ar i ffi ncl ude,amongot her s,an i ncr easei nt he domest i cpri ceoft hei mport abl ecommodi t y ,ani ncr easei nt hedomest i c pr oduct i on oft het ar i ffdi st ort ed commodi t y ,adecr easei nt hedomest i c consumpt i onandadecr easei nt heamountoft hecommodi t yi mport ed.  Al so,when a t ar i ff i si mposed,t he gover nmentcol l ect st ar i ff r evenue, whi ch i sdet er mi nedbyt het ar i ffr at eandt heamountoft hecommodi t y i mpor t ed. Ther edi st r i buti oneffect s  Di st r i but i on effect sr el at et ot her edi st r i but i on ofi ncomei nduced by a t ari ff.When a t ar i ff i si mposed some economi c agent s wi l ll ose whi l e ot her s wi l lgai n.Speci fical l y ,t he domest i c consumer si nt he i mpor t i ng count rywi l ll osepar toft hei rconsumer s’sur pl usduet oan i ncr easei n pr i ce.  Par toft he consumer s’surpl us t hathas been l ostby consumer s wi l l benefit t he pr oducer s,whose pr oducer s’sur pl us wi l li ncr ease,whi l e anot her par t wi l lbenefit t he gover nment i nt he f or m ofgover nment r evenue.Howev er ,t her ei sasmal lpor t i onoft heconsumer s’sur pl ust hat has been l ostt o consumer s butwi l lnotbenefitei t her pr oducer s or gover nment .Thepar toft heconsumer s’sur pl ust hatdoesnotbenefitany oft heeconomi cagent si scal l edt he‘ deadwei ghtl oss’ .

ECS3702MAYJUNE 2013PAPER Quest i on1 10 | P a g e

a.Expl ai n the gener alchar act eri st i csofmer canti l i sm.To whatext ent donati onst odaypr act i cemer canti l i sm?( 10) MERCANTI LI SM

I nt er nat i onalt r adecanbevi ewedasei t herast he:

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zer o sum game:a si t uat i on ori nt er act i on i n whi ch one par t i ci pant ' s gai nsr esul tonl yf r om anot her ' sequi val entl osses;orasa

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posi ti ve sum game:asi t uat i on wher et heout comesar esuch t hatt he sum ofwi nni ngsandl ossesi sgr eat ert han zer o.Thi sbecomespossi bl e when t he si ze oft he pi ei s somehow enl ar ged so t hatt her ei s mor e weal t ht o di st r i but e bet ween t he par t i es t han t her e was or i gi nal l y ,or someot herwayi sdevi sedsoev er yonege t swhatt heywantorneed.

 The mer cant i l i st s,a gr oup ofwr i t er s dur i ng t heper i od 1500 t o 1800, bel i evedt hatt r adewasazer osum game.  They hel dt hatt hemot i vat i on f ort r ade was sel f i nt er est ,and t hatt he gai nsoft he" wi nner s"f r om t r adewer eonl yobt ai ned asa r esul toft he " l osses"oft hel oser s.  Themer cant i l i st smeasur edt heeconomi cwel f ar eofacount ryi npar tby t hesi zeofi t sf or ei gn t r adesur pl us. I facount r yexpor t edmor et han i t i mpor t ed,t heni twoul dhaveaf avour abl ebal anceoft r ade,whi ch woul d r esul ti nani nflow ofgol dandsi l verf r om i t st r adi ngpart ner s.Thel at t er woul d encour age demand wi t hi n t he domest i c economy ,i ncr easi ng economi cact i vi t y( out put ,empl oymentet c) .  To achi eve such, t he mer cant i l i st s ar gued i n f avour of government i mposi t i on of t ari ffs, et c.on i mpor t s, accompani ed by si mul t aneous i mpl ement at i on of pol i ci es t o encour age expor t s.

Such st r at egi es

obvi ousl yr eflec tt he sel f i nt er es tt hatt ended t o mot i vat et r ade att he t i me. Towhatext entdonat i onst odaypr act i cemer canti l i sm

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 t he mer cant i l i stappr oach f ai l ed t of ul l y expl ai nt he wel f ar e benefit s of t r ade,whi l et heyt hemsel vesr emai ned unawar east ot hef ur t hereffec t s ofat r adesur pl usont hedomest i ceconomy  Wi t hr egar dt ot hel at t er ,t hecl assi calt heor i stDavi dHumeshowedt hata f avour abl et r adebal ancet endst obeat empor ar yphenomenon,asi tcan l eadt ohi gherdomest i ci nflat i on( mor emoneychasi ngt hesamequant i t y ofgoods) .  The r esul t anthi gher pr i ces f ordomest i cal l y pr oduced goods t ends t o adver sel y affect t he i nt er nat i onal compet i t i veness of t he economy' s expor t s,t her ebyencour agi ngmor ei mport si nt ot hecount ry .  wor l d out putwas nota fixed amount ,butr at her t hatt r ade bet ween count r i es affor ded t he possi bi l i t yf or t he l at t er t o speci al i se i nt he pr oduct i ono  count r i eswho ar epar t ner si nt r adecan si mul t aneousl yachi evehi gher out putl evel sofpr oduct i onandconsumpt i onasar esul toff r eet r ade.

ai n the theory of Compar at i ve advant age . assumpti ons and b.Expl cr i t i ci smsshoul dbecl ear l ystat ed. ( 10)

 I ti spossi bl et hatt r ademayst i l lbebenefici al ,eveni fonecount ryhasan absol ut eadvant ageovert heot heri nt hepr oduct i onofbot hgoods.

Ri car do' sl aw of compar at i ve ( or rel at i ve)advant age st at es t hatbot h count r i eswi l lbenefitf r om t r adei ft heopport uni t ycost sofproduct i on ( or rel at i vepri ces)di fferbet weent het wocount r i es.

I nt er nat i onalt r adewi l loccuri f :

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Compar at i veadvant agesexi st ;and

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Amut ual l ybenefici alt r adi ngr at i ocanbeest abl i shed.

Possi bl eSour cesofCompar at i veAdvant age 12 | P a g e

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Technol ogy;

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Resour ceendowment s;

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Di ffer encesi nt ast es/demandsbet weencount r i es. <...