EC4371 Chapter 1

Question 1

What are the components of globalisation? How has trade contributed to globalisation?

Answer 1

1. Inclusion of developing countries (economic liberalisation!)
2. Increased trade in manufactured and intermediate goods
3. Trade in services
4. Establishment of GATT / WTO and other trade agreements (eliminates / reduces tariffs and other trade barriers)
5. Physical and human capital accumulation
6. Technology transfer (increases capacity for trade and changes composition of trade)

Question 2

What are the four sources of gains from trade?

Answer 2

1. Comparative advantage
2. Intra-industry trade
3. Intra-firm trade
4. Vertical specialisation trade

Question 3

Define comparative advantage.

Answer 3

Comparative advantage is determined by pre-trade relative prices among trading partners.

The country with a lowest pre-trade relative price (compared to its trading partners) is said to have a comparative advantage in producing that particular good.

Question 4

What are the determinants of relative prices?

Answer 4

1. Market structure
   
   • Type of competition
   • Product homogeneity
2. Aggregate demand
3. Supply
   
   • Factor prices (determined by S&D)
   • Technology (factor productivity and economies of scale)

Question 5

What are the implications of comparative advantage?

Answer 5

1. Trade patterns directly result from country characteristics.
2. Countries experiencing similar trade patterns should also have similar characteristics.

Question 6

What is the difficulty of determining comparative advantage? How can this be remedied?

Answer 6

Problem: pre-trade relative prices cannot be observed!

Solution: measure empirically using revealed comparative advantage index

RCA > 1 comparative advantage

RCA < 1 comparative disadvantage

Question 7

Discuss the mechanism and weaknesses of revealed comparative advantage.

Answer 7

Weaknesses:

1. RCA indicates net export in good j, no comparison across trading partners
2. Observed trade patterns can be a result of OTHER FACTORS (besides comparative advantage)
   
   • factor price differences
   • technological differences
   • economics of scale
   • market power

Question 8

What is the standard assumption underlying trade models? Is this assumption reasonable?

Answer 8

Assumption: factors of production are internationally immobile

Labour: YES, assumption is reasonable.

Labour mobility has declined since 1900.

Capital: NO, not reasonable.

Increased private investment across countries, especially between major industrialised countries

FDI to and from Asia and Latin America has also been increasing

Question 9

What is tariff escalation?

Answer 9

Tariff escalation refers to the fact that tariffs tend to increase with the stage of fabrication of goods. I.e. the more processed a good, the higher the tariff attached to it.