CH 1 and 2 Study Guide

Question 1

Theory of comparative advantage

Answer 1

• Adam Smith (1723-1790) stated that countries should specialize in the production of the good for which they have an absolute advantage in terms of productivity
• What if a country has no absolute advantage?
• Ricardo introduces the notion of comparative advantage
• -A country should specialize in the production of a good for which the opportunity cost (what is given up to produce one unit of that good) is the lowest
• -A country always has a comparative advantage
• -By specializing, overall output and quantities traded increase: there are gains from trade
• Adam Smith was before Ricardo
• Stated countries should specialize in production they have absolute advantage in (production costs)
• However, if a country doesn’t have absolute advantage then. This is where Adam Smith’s theory hits the wall

-Ricardo comes in and introduces comparative advantage: country should specialize production of good for which OC is the lowest - specialization = gains from trade will occur

Question 2

Gains and pains from trade (gains amplifiers, pain amplifiers)

Answer 2

Gains from trade

• Gain 1: higher consumption: consumers in each nation get something from abroad for less than they would pay at home -> lower prices, wider variety of goods
• Gain 2: Increased productivity: scarce productive resource are shifted into the comparative advantage good industry

Gains from trade: amplifiers
The static sources are amplified by dynamic sources:
-Greater scale economics (higher production volume tends to lower per-unit production costs) and agglomeration of activities (can boost productivity: software in Silicon Valley, automobiles in Detroit)
Ex: Silicon Valley: FB compete for algorithms, since they are in the same area, firms benefit from ideas off each other
-Upgrading (improving production processes, skills, quality, etc…)
-Trade creates new investment opportunities which drives investment-led growth
Ex: If you know another country is not making wine, then there is an investment opportunity in that country
-Trade may induce innovation which drives productivity and growth
-Diplomatic gains: trade fosters cooperation. “Peace is a natural effect of trade” (Montesquieu). Not obvious which between peace or trade comes first, but empirical evidence of a link is strong and gets stronger over time
Ex: If you buy from a certain seller on ebay, you will buy from them more often.
-But where there is gain there is pain….

Pains from trade
Trade (and specialization) can have adverse effects for some parts of an economy:
-Pain 1: relative prices (price of one good over the price of another) change:
–Within a sector: if prices increase from exporting, domestic consumers lose but domestic producers win
–Within an economy: inputs used intensively for export sectors increase in value (wage, profits…) but inputs used intensively for import sectors decrease in value (as demand for them decreases)
Ex: If wages increase in the wine industry, all other sectors that aren’t as important and will be in low demand. Means that shoe industry wages aren’t in demand.
-Pain 2: restructuring: workers/firms in import-competing sectors tend to suffer, those in sectors that export tend to benefit
Ex: Workers in a shoe factory in France; however Adidas started to go to Asia. Thomas’s Dad had to shut down the factory since there were no contracts, workers had to switch jobs.

Pain amplifiers
The static effects are amplified by dynamic effects:
-Trade can lock nations into slow innovation industries, little to no economies of scale…. (mining, agricultural products)
-Exporting natural resources may foster corruption and poor governance: the “natural resource curse” (although some countries like Canada and Norway export resources but have low corruption and good governance. What about African countries exporting diamonds, OPEC countries?)
Tends to be a lot of corruption in rich natural resource countries. Owners of mines need permission from government to mine, so bribes happen (NATURAL RESOURCE CURSE)

Question 3

Critical views of globalization (Polanyi, Marx, Klein, Stiglitz/Rodrik)

Answer 3

Karl Polanyi

• Market economy arises around machinery-based production
• When machines started showing up, costly to operate machine, large amount of goods need to be produced, you constantly need people to operate machines
• Society went from workers produce to survive to workers need to produce enough to cover costs of machines

-We don’t produce to survive, we produce to make more money

Karl Marx
-Workers don’t get credit for extra value they create
-Marx says there will be a surplus of production, demand won’t follow and capitalism will fall
Marx is not against capitalism, he thinks it will fail

Naomi Klein
-Countries will exploit crisis to advance libertarian free market policies

Stiglitz

• How globalization is being led
• He knows there are losers
• Emphasizes the losers lose way more than the winners gain

Rodrik
-Worried about the pressure some nations put on others or some organizations put on nations that compose it
Ex: European union cannot solve issues in their economy since countries cannot manipulate the euro.

Question 4

Phase 1 (humanizing the globe)

Answer 4

• During this phase, humanity hunted and gathered their way around the world: consumption goes to “production” as human groups move to one spot where they can feed themselves, and go to another spot once depleted
• Climate change provoked two migrations out of Africa:
• -125,000 BC (failed)
• -83,000 BC, following a millennium-long spike in the planet’s averaged temperature
• There is a long-distance trade (obsidian as an example; used as knives/arrowheads/scarpers) but without pack animals, it is very limited

Question 5

Phase 2 (localizing the world economy)

Answer 5

Phase 2 can be decomposed into 3 stages:
1. Rise of Asia (12,00 BCE up to 200 BCE)
-GDP growth comes from population
Bigger population = larger output
So Middle East/China had the largest share of GDP at that time

2. Eurasian integration (200 BCE to 1350 AD)
   -Silk road allowed to integrate China
   Only exotic/luxury items went on these roads
   -However transportation technology limited the amount of trade
3. Rise of Europe (1350 AD to 1850 AD)
   1850 is where the first unbundling starts
   -1.Black death (plague) arrived in Europe in 1347
   -2.The shutdown of the silk road - Black Plague came from Silk Road
   Following damages of black plague, came -3.Proto-globalization (1450-1776)
   –What resulted: Renaissance/Reformation/Enlightenment, Age of Discovery, and Columbian Exchange

Question 6

General patterns and overall trend: The great stagnation

Answer 6

Before 1820 there was the great stagnation: G7 was much below China + India in world shares of GDP.

The proto-globalization period allowed income to rise in Europe:
The industrial revolution began, but was limited to Britain (French revolution and following Napoleonic wars delayed the spread to the continent, and financial intermediation developed in London)
But Asia still dominates due to its massive population, although it stagnates