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Question

ECON 475V6 Assignment 1H & 2H

 

     Answer all 10 questions in one file. Each question is worth 20 marks. Keep your answer concise. Use figures to illustrate your point wherever possible. Show all your work and attach your graphs when submitting your assignment for grading and feedback.

 

  1. Define and explain the difference between absolute advantage and comparative advantage. What is the significance of each in international trade processes?

 

  1. Suppose that, from an initial consumer equilibrium position, the price of good X falls while the price of good Y remains the same. Using indifference curve analysis, explain how and why the consumer’s relative consumption of the two goods will change.

 

  1. Suppose that the price of labour rises. Explain how producers would respond, using the isocost/isoquant framework. What would happen to the capital/labour ratio?

 

  1. What do you regard as the main weaknesses of the Ricardian/Classical model as an explanation of trade patterns? Why do you regard them as weaknesses?

 

  1. In light of the Ricardian model, how might you evaluate the claim by developing countries that they are at a disadvantage in trade with powerful industrialized nations?

 

  1. Define the Leontief paradox, and discuss how Raymond Vernon’s product cycle theory might help explain this paradox.

 

  1. Write a brief explanation of each of the following terms:

 

  1. terms-of-trade argument for protection
    b. intra-industry trade
  2. factor price equalization theorem

 

  1. Explain the difference between the price and the physical definitions of factor abundance. When could they give conflicting answers about which factor is the abundant factor?

 

  1. Briefly describe the Linder theory. What would this theory suggest about the prospects developing countries have for exporting goods to developed countries? Do you think this is a realistic suggestion? Why or why not?

 

  1. Using a general equilibrium approach, point out the real income loss from a tariff to a country. What is the consumer welfare loss? Why might consumers prefer a production subsidy rather than a tariff?

 

 

Subject Economics Pages 10 Style APA

Answer

ECON 475V6 Assignment 1H & 2H

 

      Answer all 10 questions in one file. Each question is worth 20 marks. Keep your answer concise. Use figures to illustrate your point wherever possible. Show all your work and attach your graphs when submitting your assignment for grading and feedback.

 

  1. Define and explain the difference between absolute advantage and comparative advantage. What is the significance of each in international trade processes?

Comparative advantage explains the ability of one country to produce a give product at a lower opportunity cost relative to another one. On the other hand, absolute advantage, explains the ability of a country to produce more of a given commodity using little resources compared to another country which producers the same commodity given the same amount of resources.

At the international level, absolute advantage helps countries specialize in the production of a given commodity for which it can use fewer units of the same resources in order to maximize output. As a result, such counties are able to specialize and accrue benefits such as increased utilization of the resources, cheap production and other benefits which comes along with specialization. On the other hand, comparative advantage allows countries at the international level to trade with each other owing to the parity in their production capacity.

 

  1. Suppose that, from an initial consumer equilibrium position, the price of good X falls while the price of good Y remains the same. Using indifference curve analysis, explain how and why the consumer’s relative consumption of the two goods will change.

Basically this happens in the case of normal goods and how consumer responds to the changes in their prices with other things such as tastes, income and prices held constant (Ceteris paribus). Fall in the price of good X would consequently result to the consumption of more of the quantities as the price of good Y remain unchanged. In such a case, the entire change is as illustrated below;

 

 

 

 

 

Good Y

 

 

 

 

 

 

 

 

       Pe                   e0

 

                                                 U0                           Price consumption curve

       P*e                                            e1

     U1

 

 

 

                             Q0                Q1                                                      

                                                                          Good X

 

 

Fall in the price of good x while holding the price of good Y constant would lead to consumption of more of good X. Initially the equilibrium position was e0 while the consumption level for good X was Q0. As a result of price decrease for good X from Pe to P*e, the budget line tilted at Y axis leading to outward movement along the X axis leading to a new consumption level Q1

  1. Suppose that the price of labour rises. Explain how producers would respond, using the isocost/isoquant framework. What would happen to the capital/labour ratio?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital  A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                                                C                            B

                                                                 Labor

Given the same production budget, the producers will react to the situation by purchasing less of labor units and employ more of units of capital. As a result, the isocost curve would still meet the Y-axis at point A since the price of the capital remain invariable. Eventually, the budget line/Isocost curve would shift from point B to point This implies that less of labor units will be used unlike capital units.

  1. What do you regard as the main weaknesses of the Ricardian/Classical model as an explanation of trade patterns? Why do you regard them as weaknesses?
  2. Assumption of full employment of factor inputs

The model assumes that resources are full employed by producing countries which is never the case. For instance, the case of developing countries where labor is not fully employed due to lack of adequate employment opportunities.

  1. Assumption of free trade

The model assumes that countries can freely trade with each other which is never the case since at the international level, tariff and non-tariff barriers are imposed.

  1. It is a restrictive model

It only considers the case of two commodities and two countries yet there exist many commodities and many trading countries at the international level.

  1. Assumes mobility of the factors of production

The model assumes that all factors of production are mobile which is never the case. This is because factors like capital and labor lack mobility owing to certain reasons. For instance, government ban policy on the mobility of certain category of labor skills.

  1. Demand is overlooked

The model defines the international trade in terms of supply as opposed to demand.

 

 

  1. In light of the Ricardian model, how might you evaluate the claim by developing countries that they are at a disadvantage in trade with powerful industrialized nations?

The Ricardian model assumes a free trade among different countries and full employment of resources. However, the full employment of resources among the developing countries is never the case since such countries lag behind owing to lack of technological advancement. In addition, developing countries mainly rely on tax as the main source of revenue unlike the developed countries. This move leads to increased production costs among the developing countries. On the contrary, developed countries focus on subsidies in their production. Eventually, the developing countries end up being disadvantaged at the international level since their products are unable to compete effectively with those from the developed nations since products from the developed countries are sold cheaply and are of high quality as well.

  1. Define the Leontief paradox, and discuss how Raymond Vernon’s product cycle theory might help explain this paradox.

The Leontief paradox arises from the test conducted by Wassily on the Heckscher-Ohnlin theorem. Leontief held that the US is endowed abundantly with capital relative to other countries and so was in a position to export capital intensive goods and importer of labor intensive commodities. However, study conducted by Leontief revealed that exports made by US were less capital intensive and this gave birth to the Leontief paradox. Raymond Vernons product life cycle theory explains how products initially produced in the US and exported in other countries helped in attracting innovation which further led to production of similar products. In this case, other countries were in a position to produce such products for themselves and so the US could not dominate the world market with time.

 

  1. Write a brief explanation of each of the following terms:

 

  1. terms-of-trade argument for protection

The terms-of-trade argument for protection appeals for tariff in import competing industries and an export tax in export countries. It also holds that small countries have a little bargaining power.

  1. intra-industry trade

Refers to trading of similar commodities belonging to the same industry. This occurs where similar types of goods are exported and imported.

 

  1. factor price equalization theorem

It is an economic theorem which holds that prices of similar factors of production like wage rates or rent for capital can be equalized among different countries as a result of international trade commodities (Samuelson, 1975).

 

  1. Explain the difference between the price and the physical definitions of factor abundance. When could they give conflicting answers about which factor is the abundant factor?

     The physical definition of factor abundance is pegged on the relative physical quantities of factors which are present in a country. For instance, labor to capital ratios. A country with greater capital to labor ratio is regarded as the largest in terms of capital endowment and vice versa. On the other hand, the price definition is pegged on relative prices of the factor endowments other than measurements in the host countries. The hypothesis that relatively abundant factor in a country would result to the production of cheap products as opposed to that which is less endowed is thus justified. Therefore, based on these definitions, if the ration of labor to capital is greater in one country relative to another, then the former country would be regarded as labor intensive and the reverse is true.

      However, under the assumptions of Heckscher-Olins, both definitions would yield the same results. In the case where the tastes for two countries happen to differ, the factor price would not only manifest in the supply side but also the demand side. In this case, the physical and the price definition would result to conflicting conclusions about relative factor abundance. For instance, if consumers of a physically labor-abundant country greatly rather the labor intensive products then the price of the labor would consequently hike.

 

  1. Briefly describe the Linder theory. What would this theory suggest about the prospects developing countries have for exporting goods to developed countries? Do you think this is a realistic suggestion? Why or why not?

     This theory was postulated by Linder in the year 1961 as one of the likely solutions to the Leontief paradox and it sought to objectively establish the practical validity of the Heckshcer –Ohlin theory which influence the features and the patterns of the international trade as determined by relative factor endowments. This theory holds that the greater the similarity in demand structures between countries the more they are likely to trade with each other. Moreover, international trade would still take place between counties with analogous preferences and resource endowments owing to leniency on specialization aimed at enhancing comparative advantage in the production of commodities which are differentiated between the trading countries. The theory also holds that countries endowed with labor relative to capital would result to producing labor intensive products and vice versa. Linder also suggested an alternative trade theory which is consistent with Leontief Paradox and subsequently tabled a trade theorem based on demand juxtaposing the ordinary theories based involving resources endowments. She further proposed that countries with analogous demand structures would consequently develop. Eventually, these countries would trade with each other either by exporting or importing similar but differentiated commodities.

 

  1. Using a general equilibrium approach, point out the real income loss from a tariff to a country. What is the consumer welfare loss? Why might consumers prefer a production subsidy rather than a tariff?

             The illustration below provides an explanation of the effects of imposing a tariff by                           the government of a particular country. Prior imposition of tariff the price of the good in the domestic market is denoted as Pw. Imposition f the tariff increases the          domestic/world price to Pt consequently increasing domestic production from Qs1         to Qs2 but domestic consumption will reduce from Qc2 to Qc1.This shows that there        will be a well fare loss by the society as a result of reduced consumption (Tullock,        1967). In this case only the government is made better of through tax revenue.     Comparatively, the loss accrued to the consumers is larger compared to that         experienced by the government and the producers thus implementation of the tariff             would be costly to the society. In this case, implementation of subsidy would neither             harm the producers neither the producers but would be borne by the government             which can be compensated through different mechanisms

 

 

 

        Price        Demand                                                                              Supply

 

 

                         Consumer surplus

 

              Pt     Producer surplus

                                          Social benefit Tax revenue Social cost            Tariff size

   Pw

 

 

                                      Qs1                  Qs2                     QC1               QC2       Quantity

                                                                Imports with tax

 

                                                Imports without tax

 

 

 

 

 

 

 

 

 

 

 

References

References

Golub, S. S., & Hsieh, C. T. (2000). Classical Ricardian theory of comparative advantage revisited. Review of international economics8(2), 221-234.

Hunt, S. D., & Morgan, R. M. (1995). The comparative advantage theory of competition. The Journal of Marketing, 1-15.

Maskus, K. E. (1985). A test of the Heckscher-Ohlin-Vanek theorem: the Leontief commonplace. Journal of international Economics19(3-4), 201-212.

McPherson, M. A., Redfearn, M. R., & Tieslau, M. A. (2001). International trade and developing countries: an empirical investigation of the Linder hypothesis. Applied Economics33(5), 649-657.

Samuelson, P. A. (1974). Insight and detour in the theory of exploitation: a reply to Baumol. Journal of Economic Literature12(1), 62-70.

Stolper, W. F., & Samuelson, P. A. (1941). Protection and real wages. The Review of Economic Studies9(1), 58-73.

Smith, A. (1975). The Theory of International Trade. Essays on Adam Smith. Clarendon Press: Oxford, 472.

Tullock, G. (1967). The welfare costs of tariffs, monopolies, and theft. Economic Inquiry5(3), 224-232.

 

 

 

 

 

 

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