Micro_ch_17_answers.doc

McConnell Microeconomics 12CE CH 17 - International Trade McConnell Microeconomics 12CE CH 17 - International Trade McConnell Microeconomics 12CE CH 17 - International Trade McConnell Microeconomics 12CE CH 17 - International Trade McConnell Microeconomics 12CE CH 17 - International Trade McConnell Microeconomics 12CE CH 17 - International Trade CHAPTER 17 INTERNATIONAL TRADE ANSWERS TO END-OF-CHAPTER QUESTIONS 17-1 Distinguish among land-, labour-, and capital-intensive commodities, citing an example of each. What role do these distinctions play in explaining international trade? Land-intensive commodities include agricultural products such as corn and steel. Labour-intensive commodities, such as transistor radios and clothing, require much skilled labour in production. Capital-intensive products are produced with a large amount of capital equipment and include manufactured items such as aircraft and automobiles. These distinctions are important because they indicate the types of resources used in the production of certain products. If a nation has an abundant supply of particular resources, it can produce items that are intensive in these resources with a comparative cost advantage. On the other hand, if it has a relative scarcity of certain resources, such as land, then it will be relatively expensive to produce land-intensive products such as corn and steel. The difference in resource abundance among nations leads to differences in comparative costs of production, which are the basis for international trade and specialization. 17-2 Suppose nation A can produce 80 units of X by using all its resources to produce X and 60 units of Y by devoting all its resources to Y. Comparative figures for nation B are 60 of X and 60 of Y. Assuming constant costs, in which product should each nation specialize? Why? Indicate the limits of the terms of trade. The cost ratio for the two goods in nation A is 1-1/3 units of X for each unit of Y; in nation B it is 1 unit of X for 1 unit of Y. The opportunity cost of producing X is lower in A (3/4 unit of Y) than it is in B (1 unit of Y). Conversely, the opportunity cost of producing Y is lower in B (1 unit of X) than it is in A (1-1/3 units of X). Nation A should produce X since it has a comparative cost advantage in the production of this good, and B should produce Y, in which it has a comparative advantage. The limits of the terms of trade for the two goods are the cost ratios in the two countries; this will be between 1X and 1-1/3X for each unit of Y. 17-3 (Key Question) The following are hypothetical production possibilities tables for New Zealand and Spain. New Zealand’s production possibilities table (millions of bushels) Product Production alternatives A B C D Apples 0 20 40 60 Plums 15 10 5 0 Spain’s production possibilities table (millions of bushels) Product Production alternatives R S T U Apples 0 20 40 60 Plums 60 40 20 0 Using a graph, plot the production possibilities data for each of the two countries. Referring to your graphs, determine: (a) Each country’s domestic opportunity cost of producing plums and apples. (b) Which nation should specialize in which product. (c) The trading possibilities lines for each nation if the actual terms of trade are 1 plum for 2 apples. (a) New Zealand’s cost ratio is 1 plum = 4 apples (or 1 apple = 1/4 plum). Spain’s cost ratio is 1 plum = 1 apple (or 1 apple = 1 plum). See the graphs. (b) New Zealand should specialize in applies, Spain in plums. (c) See the graphs. (d) Total production before specialization and trade: 40 apples (20 + 20) and 50 plums (10 + 40). After specialization and trade: 60 apples and 60 plums. Gain = 20 apples and 10 plums. 17-4 “Canada can produce product X more efficiently that can Great Britain. Yet we import X from Great Britain.” Explain. Trade is based on comparative rather than absolute cost advantages. Canada may have an absolute advantage in the production of good X yet still import it from another country because its cost advantage in the production of another good Y is even greater. By producing Y and importing X from Great Britain, Canadians are devoting resources to their most productive use, even though an isolated analysis of the international production of X might suggest otherwise. 17-5 (Key Question) Refer to Figure 3-6 on page 61. Assume the graph depicts Canada’s domestic market for corn. How many bushels of corn, if any, will Canada export or import at a world price of $1, $2, $3, $4, and $5? Use this information to construct Canada’s export supply curve and import demand curve for corn. Suppose the only other corn-producing nation is France, where the domestic price is $4. Why will the equilibrium world price be between $3 and $4? Who will export corn at this world price? Who will import it? At $1: import 15,000. At $2: import 7,000. At $3: no imports or exports. At $4: export 6,000. At $5: export 10,000. Canada will export corn, France will import it. 17-6 (Key Question) Draw a domestic supply and demand diagram for a product in which Canada does not have a comparative advantage. What impact do foreign imports have on domestic price and quantity? On your diagram show a protective tariff that eliminates approximately one-fourth the assumed imports. What are the price–quantity effects of this tariff to (a) domestic consumers, (b) domestic producers, and (c) foreign exporters? How would the effects of a quota that creates the same amount of imports differ? See the graph. Canada does not have a comparative advantage in this product because the world price Pw is below the Canadian domestic price of Pd. Imports will reduce the price of Pw, increasing consumption from non-trade Qc to Qe and decreasing domestic production from Qc to Qa. See the graph. A tariff of PwPt (a) harms domestic consumers by increasing price from Pw to Pt and decreasing consumption from Qe to Qd; (b) aids domestic producers through the increase in price from Pw to Pt and the expansion of domestic production from Qa to Qb; (c) harms foreign exporters by decreasing exports from QaQe to QbQd. An import quota of QbQd would have the same effects as the tariff, but there would be no tariff revenues to government from these imports; this revenue would in effect be transferred to foreign producers. 17-8 “The potentially valid arguments for tariff protection are also the most easily abused.” What are these arguments? Why are they susceptible to abuse? Evaluate the use of artificial trade barriers, such as tariffs and import quotas, as a means of achieving and maintaining full employment. Trade barriers can be legitimately defended as being necessary to protect domestic firms from foreign dumping, to protect so-called infant industries, and to ensure adequate production levels in sectors deemed to be essential in the event of international hostilities. (The arguments relating to supposed increases in domestic employment, protection from foreign low-wage labour, and economic diversification are either invalid or are irrelevant to the Canadian economy.) Each of the former arguments, though logically valid, is often misapplied. Proven cases of dumping by foreign firms in Canada are relatively infrequent, and all too often domestic producers will claim their foreign competitors are dumping when their lower prices simply reflect a comparative advantage in production. If this is so, the use of antidumping duties lessens the benefits of free trade. The protection of new domestic industries in order to allow them to gradually establish efficient production techniques is of questionable legitimacy in the case of an advanced economy such as Canada’s. There is a tendency for trade barriers to remain in place even after the industry has become established. Moreover, it can be argued that protection provides incentives for “Peter Pan” behaviour as firms refuse to mature. The argument relating to military self-sufficiency is of questionable relevance to sectors other than those directly related to defence. Almost all industries can claim to play a marginal role in a wartime economy. As a rule, direct government subsidies are a more equitable means of financing military security than trade protection, since taxpayers as a whole, rather than just consumers of protected industries, will shoulder the burden. Direct subsidies also make the costs of these programs explicit rather than allowing them to be hidden in the form of higher prices. Trade barriers on imports, by themselves, will cause consumers to partially substitute domestically produced items for imported items, leading to a short-run increase in domestic output and employment in an economy experiencing a recession. These barriers will have several indirect effects, however, that tend to counteract this short-term rise in employment. First, a decrease in imports will lower employment in sectors that use these goods as inputs or are involved in the distribution and sale of these goods. Second, employment and income in other countries will decrease. Not only will the demand for Canadian exports and hence domestic employment automatically decrease as a result, but foreign governments will likely retaliate by imposing trade restrictions of their own, leading to a further decline in exports and employment. These indirect effects severely limit the employment benefits of trade restrictions, and can completely cancel them in the long run. The primary result of trade restrictions will be a reallocation of Canadian and foreign resources to relatively inefficient industries, decreasing national and world output. 17-7 The next three questions refer to the information in the following table. Quantity demanded domestically Price Quantity supplied domestically 700 $6 1100 800 5 1000 900 4 900 1000 3 800 1100 2 700 1200 1 600 (a) What would price and quantity be if the market were closed to international trade? What would the domestic and foreign quantity supplied be if it were open to international trade and the world price was $2? (b) If the world price was $2 and a tariff of $1 were placed on the product, what would be the total revenues going to domestic producers, foreign producers (after-tax), and the government? Explain. (c) Given a world price of $2, what would be the difference in the total revenue received by foreign producers with a $1 per unit tariff compared with a quota of 200 units? (a) The price would be $4 and 900 units would be produced in a closed economy. In an open economy with a $2 world price, the market price would be $2 and 1100 units would be demanded. There would be 1100 units supplied. (700 domestic and 400 foreign.) (b) Domestic producers would receive $2400 ($3 800). Foreign producers would receive $400 [($3 200) – ($1 200)]. The government would receive $200 ($1 200). (c) Foreign producers would receive $200 more in revenue with a quota than a tariff because there would be no payment to government. 17-8 “The potentially valid arguments for tariff protection are also the most easily abused.” What are these arguments? Why are they susceptible to abuse? Evaluate the use of artificial trade barriers, such as tariffs and import quotas, as a means of achieving and maintaining full employment. Trade barriers can be legitimately defended as being necessary to protect domestic firms from foreign dumping, to protect so-called infant industries, and to ensure adequate production levels in sectors deemed to be essential in the event of international hostilities. (The arguments relating to supposed increases in domestic employment, protection from foreign low-wage labour, and economic diversification are either invalid or are irrelevant to the Canadian economy.) Each of the former arguments, though logically valid, is often misapplied. Proven cases of dumping by foreign firms in Canada are relatively infrequent, and all too often domestic producers will claim their foreign competitors are dumping when their lower prices simply reflect a comparative advantage in production. If this is so, the use of antidumping duties lessens the benefits of free trade. The protection of new domestic industries in order to allow them to gradually establish efficient production techniques is of questionable legitimacy in the case of an advanced economy such as Canada’s. There is a tendency for trade barriers to remain in place even after the industry has become established. Moreover, it can be argued that protection provides incentives for “Peter Pan” behaviour as firms refuse to mature. The argument relating to military self-sufficiency is of questionable relevance to sectors other than those directly related to defence. Almost all industries can claim to play a marginal role in a wartime economy. As a rule, direct government subsidies are a more equitable means of financing military security than trade protection, since taxpayers as a whole, rather than just consumers of protected industries, will shoulder the burden. Direct subsidies also make the costs of these programs explicit rather than allowing them to be hidden in the form of higher prices. Trade barriers on imports, by themselves, will cause consumers to partially substitute domestically produced items for imported items, leading to a short-run increase in domestic output and employment in an economy experiencing a recession. These barriers will have several indirect effects, however, that tend to counteract this short-term rise in employment. First, a decrease in imports will lower employment in sectors that use these goods as inputs or are involved in the distribution and sale of these goods. Second, employment and income in other countries will decrease. Not only will the demand for Canadian exports and hence domestic employment automatically decrease as a result, but foreign governments will likely retaliate by imposing trade restrictions of their own, leading to a further decline in exports and employment. These indirect effects severely limit the employment benefits of trade restrictions, and can completely cancel them in the long run. The primary result of trade restrictions will be a reallocation of Canadian and foreign resources to relatively inefficient industries, decreasing national and world output. 17-9 Evaluate the following statements: a. “Protective tariffs limit both the imports and the exports of the nation levying tariffs.” b. “The extensive application of protective tariffs destroys the ability of the international market system to allocate resources efficiently. c. “Unemployment can often be reduced through tariff protection, but by the same token inefficiency typically increases.” d. “Foreign firms that ‘dump’ their products onto the Canadian market are in effect presenting the Canadian people with gifts.” d. “In view of the rapidity with which technological advance is dispersed around the world, free trade will inevitably yield structural maladjustments, unemployment, and balance of payments problems for industrially advanced nations.” f. “Free trade can improve the composition and efficiency of domestic output. Only the Volkswagen forced Detroit to make a compact car, and only foreign success with the oxygen process forced Canadian steel firms to modernize.” g. “In the long run, foreign trade is neutral with respect to total employment.” (a) This statement is true. Protective tariffs increase domestic prices of imported goods, decreasing demand for these products, limiting import volumes, and causing real incomes in producing countries to fall. This decline in incomes will cause foreigners to demand fewer goods and services, including exports from the nation that originally imposed the tariff. Other countries may also retaliate, decreasing export volumes of the tariff-levying nation even further. (b) This statement is true. Extensive protective tariffs dampen every trading country’s ability to export, and since exports ultimately pay for imports, each country’s ability to import is hampered as well. As trade flows decrease, countries will be forced to devote scarce resources to the production of goods in which they do not have a comparative advantage, decreasing both world output and real incomes in each nation. (c) This statement is true. While tariffs directly increase domestic employment in sectors that compete with foreign exporters, there will be indirect employment losses in other sectors. Not only will jobs be lost in the tariff-levying country’s own export industries, as incomes and import levels in foreign countries decrease, but also in industries that distribute or use imported goods because of rises in price and unit cost. (d) This statement is true, at least in the short run. Dumping by foreign firms causes prices in Canadian markets to decline, increasing quantities purchased by domestic consumers and enhancing economic welfare. But lower production in domestic industries will cause a drop in Canadian incomes, decreasing economic welfare, and in the long run, the price wars caused by dumping may force some firms out of the market, restricting competition in domestic markets and allowing foreign firms to raise prices. If this occurs, the welfare of Canadian consumers will decline, and remaining domestic producers will benefit. (e) This statement is true in the short run. Industrially advanced nations have erected a multitude of trade barriers for manufactured exports from less developed countries, given the cost advantage these countries possess because of their adoption of modern production techniques and the availability of low-wage labour. If these trade barriers were removed, not only would manufactured exports from these countries immediately increase, but entrepreneurs in both industrially advanced and less developed countries would find it profitable to set up additional production facilities in these countries, raising exports even more in the long run. There is no doubt that these low-priced exports would cause short-term harm to manufacturing industries in industrially advanced countries that use predominantly unskilled labour. Output and employment levels in these sectors would fall, and import levels in industrially advanced countries would rise, leading to the possibility of short-run balance of payments deficits in countries maintaining fixed exchange rates. In the long run, however, industrially advanced economies will benefit from free trade, as resources move to sectors in which these countries have a comparative advantage. Moreover, exports to previously less developed countries will increase as output levels and real incomes in these countries rise. (f) This statement is true. Not only does free trade increase efficiency in the short run by allowing countries to specialize in those products in which they possess a comparative advantage, but by increasing levels of competition and the size of potential markets it acts as a spur to technological innovation and enhanced product quality in the long run. (g) This statement is true. While changes in levels of foreign trade can cause temporary effects on employment through fluctuations in the net export component of aggregate expenditures, in the long run total employment levels in trading nations are determined by domestic macroeconomic policies and labour market conditions. Foreign trade, however, has a significant effect on the allocation of labour among various industries in an economy, shifting employment into sectors in which a particular economy has a comparative cost advantage. 17-10 Suppose Japan agreed to a voluntary export restraint that reduced Canadian imports of Japanese automobiles by about 10 percent. What would you expect the short-run effects to have been on Canadian and Japanese automobile industries? If this restriction were permanent, what would be its long-run effects in the two nations on (a) the allocation of resources, (b) the volume of employment, (c) the price level, and (d) the standard of living? In the short run, the limitation on imported Japanese automobiles would cause a domestic shortage of these items. Japanese companies can respond to this shortage in two ways. They can maintain prices at current levels and ration sales through delivery delays, or they can increase prices for their products in the Canadian market. The latter response will cause a long-term decrease in the firms’ Canadian market shares, but the longer the import limitations are in effect the more probable it becomes, since the increase in unit profits that results from higher prices will partly counteract the effects of sales losses. No matter which policy is followed, some prospective purchasers will shift their demand to other goods, including domestically produced automobiles. Profits for Canadian producers will rise either through increases in sales or in price. (a) Resource allocation will be made less efficient in both Canada and Japan. Canadian automobile firms will be devoting scarce resources to the production of units in which they do not have a comparative advantage. As for Japan, decreased exports will lead to a fall in imports in the long run, and resources will be moved to sectors in which Japan’s comparative advantage is less. (b) Employment in each country will not change appreciably in the long run, although there could be a temporary increase in Canadian employment as automobile production rises and a corresponding decrease in Japan as production declines. (c) Automobile prices in Canada will rise in the long run, boosting the general price level. Other prices will rise as costs for car-using firms increase and Canadian consumers purchase fewer automobiles and more of other goods and services. The decrease in Japanese exports to Canada, meanwhile, will cause a drop in the supply of Canadian dollars being exchanged for yen, leading to an appreciation of the yen price of the dollar. Prices of Canadian imports in Japan therefore rise. Other Japanese prices increase as costs for import-using firms rise and consumers shift spending to other products. (d) Because voluntary quotas decrease trade flows between Canada and Japan, some of the benefits arising from specialization will be lost, decreasing total output and real incomes in both countries. 17-11 In 2005, manufacturing workers in Canada earned an average wage of $21.55 per hour. That same year, manufacturing workers in Mexico earned an average wage of $2.63 per hour. How can Canadian manufacturers possibly compete? Why isn't all manufacturing done in Mexico and other low-wage countries? Canada can compete if the workers are more productive. That is, if the productivity level for Canadian workers is higher. If this is the case, then some manufacturing will take place in Canada. (with productivity adjusted wages equalized). The other reason that all manufacturing doesn’t take place in the low wage countries may be due to trade barriers. (Answer to The Last Word) How does a fair-trade product differ from an otherwise imported good? What is the purported benefit of fair-trade certification on purchases of goods such as chocolate, coffee, bananas, and tea? Do fair trade goods improve average wage and level of income in low-income nations? Why or why not? Fair Trade Standards guarantee the producers higher-than-market prices if they agree to pay their workers higher-than-market wages. The purported benefit is that there is more redistribution to low-income producers, although, most economists believe that fair-trade has not caused the average wage to increase. Copyright © 2010 McGraw-Hill Ryerson Ltd. Page 12 of 13 Copyright © 2010 McGraw-Hill Ryerson Ltd. Page 1 of 8 Copyright © 2010 McGraw-Hill Ryerson Ltd. Page 12 of 13 Copyright © 2010 McGraw-Hill Ryerson Ltd. Page 1 of 8 Copyright © 2010 McGraw-Hill Ryerson Ltd. Page 12 of 13 Copyright © 2010 McGraw-Hill Ryerson Ltd. Page 1 of 8