chapter 5.2.1 Flashcards
t or f
The first case for free trade is the argument
that producers and consumers allocate
resources most efficiently when
governments do not distort market prices
through trade policy.
t
National welfare of a small country is highest
with WHAT
free trade.
With WHAT, consumers pay higher
prices and consume too little while firms
produce too much.
restricted trade
T OR F
because tariff rates are already
low for most countries, the estimated
benefits of moving to free trade are only a
small fraction of national income for most
countries.
T
Free trade allows firms or industry to take
advantage of
economies of scale.
Protected markets limit gains from external
economies of scale by inhibiting the
concentration of industries:
Too many firms to enter the protected
industry.
The scale of production of each firm
becomes inefficient.
Free trade provides _ AND _
competition and
opportunities for innovation (dynamic
benefits).
Free trade avoids the loss of resources
through
RENT SEEKING
says that free trade is the best feasible
political policy, even though there may be
better policies in principle.
political argument for free trade
T OR F
Any policy that deviates from free trade would
be quickly manipulated by political groups,
leading to decreased national welfare.
T
For a “large” country, a tariff lowers the
price of imports in world markets and
generates a WHAT
terms of trade gain.
t or f
A large tariff will lead to an increase in
national welfare for a large country.
f - small tariff
A tariff rate that completely prohibits
imports leaves a country worse off, but
tariff rate to may exist that maximizes
national welfare: an _
optimum tariff.
An __ (a negative export subsidy)
that completely prohibits exports leaves a
country worse off, but an export tax rate
may exist that maximizes national welfare
through the terms of trade.
export tax
t or f
export subsidy lowers the terms of trade for
a large country; an export tax raises the terms
of trade for a large country.
t
t or f
export tax may raise the price of exports in
the world market, increasing the terms of trade.
t
A second argument against free trade is
that ___ may exist
that cause free trade to be a suboptimal
policy.
domestic market failures
The economic efficiency loss calculations using
consumer and producer surplus assume that
markets __
function well.
Types of market failures include
Persistently high underemployment of workers
Persistently high underutilization of structures,
equipment, and other forms of capital
Property rights not well defined or well enforced
technological benefits for society discovered
through private production, but from which
private firms cannot fully profit
environmental costs for society caused by
private production, but for which private firms
do not fully pay
sellers that are not well informed about the
(opportunity) cost of production or buyers that
are not well informed about value from
consumption
Economists calculate the __
to represent the additional benefit to society from
private production.
marginal social benefit
With a market failure, __ is not
accurately measured by the producer surplus of private
firms, so that economic efficiency loss calculations are
misleading.
marginal social benefit
t or f
It’s possible that when a tariff increases domestic
production, the benefit to domestic society will
decrease due to a market failure.
f - increase
It’s possible that when a tariff increases domestic
production, the benefit to domestic society will
increase due to a market failure.
The domestic market failure argument
against free trade is an example of a more
general argument called the
theory of the
second best.
t or f
Government intervention that distorts
market incentives in one market may
increase national welfare by offsetting the
consequences of market failures elsewhere.
t
t or f
If the best policy, fixing the market failures, is not
feasible, then government intervention in another market
may be the “third-best” way of fixing the problem.
f; second-best
a domestic policy aimed
directly at the source of the problem.
“first-best” policy:
Government policies to address market
failures are likely to be manipulated by WHAT
politically powerful groups.
Due to distorting the incentives of
producers and consumers, trade policy may
have ___ that make a
situation worse, not better.
unintended consequences
Models of governments maximizing
political success rather than national
welfare:
- Median voter theorem
- Collective action
- A model that combines aspects of collective
action and the median voter theorem
predicts that
democratic political parties pick their
policies to court the voter in the middle of
the ideological spectrum (i.e., the median
voter).
median voter theorem
Assumptions of the Median Voter model:
- There are two competing political parties.
- The objective of each party is to get elected by
majority vote.
What policies will the parties promise to
follow?
Both parties will offer the same tariff policy to
court the median voter (the voter in the middle
of the spectrum) in order to capture the most
votes.
implies
that a two-party democracy should enact
trade policy based on how many voters it
pleases.
median voter theorem
A policy that inflicts large losses on a few people
(import-competing producers) but benefits a
large number of people (consumers) should be
chosen.
median voter theorem
Political activity is often described as a
collective action problem:
T OR F
While consumers as a group have an incentive
to advocate free trade, each individual
consumer has incentive because his benefit
is not large compared to the cost and time
required to advocate free trade.
F - While consumers as a group have an incentive
to advocate free trade, each individual
consumer has “no incentive” because his benefit
is not large compared to the cost and time
required to advocate free trade.
T OR F
for groups who suffer large
losses from free trade (for example,
unemployment), each individual in that
group has a strong incentive to advocate
the policy he desires.
T
was
begun in 1947 as a provisional international agreement
and was replaced by a more formal international
institution called the World Trade Organization in
1995.
General Agreement of Tariffs and Trade
T OR F
Multilateral negotiations mobilize exporters
to support free trade if they believe export
markets will expand.
T
THIS also help avoid a
trade war between countries, where each
country enacts trade restrictions.
Multilateral negotiations
