IE2016Q4 Flashcards

1
Q

What is the naïve gravity model?

A
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2
Q

What is the full gravity model? (Theoretically derived)

A

Remoteness:

  • If distance (d) is high, the denominator will be low and GDPL/Dij0 will be high
  • If China grow, (GDPl), Rj will be lower and thus trade between the two countries, ij will decrease.
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3
Q

Has the world gotten smaller and what influenced the two globalization wawes?

A

First wave:

  • Steamships
  • Telegraph
  • Railrods

Second wave:

  • Jets
  • The rise of the Internet
  • Telecommunication

World trade dropped in 1914 (WW1) and didn’t recover to the same level before 1970.

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4
Q

What is a comparative advantage?

A

A country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countries.

Ricardian model

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5
Q

What does a straight-lined PPF tell us?

A

That the opportunity cost of one good in terms of another good is constant.

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6
Q

When does a country have an absolute advantage?

A

When one country can produce a unit of a good with less labor than another country, we say that the first country has an absolute advantage in producing that good.

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7
Q

What is autarchy?

A

The state where no countries trade with each other.

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8
Q

Discussion: is FREE trade good for Denmark? (yes and no)

A

Yes:

  • Will increase the size of the total pie
  • Variety of goods increases
  • Prices for consumers decreases
  • Decreases risk of conflicts and wars due to increased cooperation between countries
  • No countries will ever be worse off but some will benefit more than others.

No:

  • The poorest part of the society will often lose their jobs through offshoring and their wages permanently drops.
  • The environment will be worse off due to transportation¨
  • You typically want to protect some industries such as defense and agriculture
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9
Q

What is the slope of the PPF line in the Ricardian model?

A
  • ac / aq

The nominator is taken from the horizontal axis.

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10
Q

How do you draw the Ricardian model? Visualize and explain the model

A

On the vertical part of the RS-line, both countries will specialize their production.

On the horizontal parts of the RS-line, one of the countries will produce both goods while the other will specialize in only one good.

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11
Q

What is the conclusion of the Ricardian model?

A
  • Single-resource; Labor
  • No income distribution.
  • Countries gain from trade (never worse off).
  • Countries produce what they are relatively good at, where they have a comparative advantage.
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12
Q

How does the world supply curve and demand curve look when we have multiple countries and how do you interpret the intersections?

A
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13
Q

What are the reasons behind free trades strong effects on distribution of income?

A
  • Resources cannot move immediately or without cost from one industry to another.
  • A shift in the mix of goods that a country produces will ordinarily reduce the demand for some factors of production, while raising the demand for others
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14
Q

What is difference in the specific factor model compared to the Ricardian model?

A
  • It takes multiple factors and factor mixes are different.
  • Technology is the same for all countries in the specific factor model (no comparative advantage from technology).
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15
Q

How do you draw the RS and RD curves of the two-specific factor model for autarchy and what happens when we open up to trade?

A
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16
Q

What is the slope of the production possibilities curve in the specific factor model and what does the PPF curve look like?

A

- MPLC / MPLF

In other words, the x-axis production factor variable in the denominator.

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17
Q

What happens if prices for goods increase proportionately and what happens if only one of the good’s prices increase?

A
  • Proportionately: wages increase with the same amount as prices and the share of labor between the two industries stay intact
  • Single good price increase: wages increase but less than prices increase in that industry. Why? Because labor will shift to the price-increasing industry and thus output in the other industry will decrease and dampen the increasing wage-effect (see picture) >>> the relative wage to cloth has decreased while the relative wage to food has increased. The relative price of clothes has increased and owners’ profits have increased.
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18
Q

What are the three main reasons to why economists do not generally stress the income distribution effects of trade?

A
  1. Income distribution effects are not specific to international trade. Every change in a nation’s economy, including technological progress, shifting consumer preferences, exhaustion of old resources and discovery of new ones, and so on, affects income distribution too.
  2. It is always better to allow trade and compensate those who are hurt by it than to prohibit the trade.
  3. Those who stand to lose from increased trade are typically better organized than those who stand to gain (because the former are more concentrated within regions and industries).
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19
Q

What is the general rule of thumb in regards to the specific factor model in an open economy?

A
  • Factors specific to export sectors in each country gain from trade, while factors specific to import-competing sectors lose.
  • Mobile factors that can work in either sector may either gain or lose.
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20
Q

What is autarchy wage + understand and explain the autarchy wage graph.

A

The value of a worker’s product.

We have to produce both goods so: W = Pc * MPLc = Pf * MPLf

w = Pc*MPLc = Pf*MPLf

Profit = Pc*Q(L, ?) - wL - r?

Derivative of profit = Pc*MPLc - w = 0

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21
Q

What is TTIP?

A

A bilateral trade agreement between Europe and America to reduce indirect trade barriers.

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22
Q

What happens if prices increase proportionately in the specific factors model regarding distribution of income?

A

There will be no labor allocation change and no one will therefore be hurt.

The new lines (P2f and P2c) are steeper.

Returns to factors:

W = Pc * MPLc = Pf * MPLf

Profit = Pc * Qc (K, Lc) – Rk*K – w*Lc

Derivative of profit with respect to k = Pc* MPK – Rk = 0

Rk = Pc* MPK

Rt = Pf * MPT

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23
Q

What happens if relative prices change in the specific factors model regarding distribution of income?

A

When relative prices change, the allocation of labor will change too.

In this case, prices of cloth relative to food increases by 7 %, which makes wages increase but with less than 7 %. Less than proportional increase in wage due to falling MPL

Workers can afford more food but fewer clothes. Therefore, the welfare effect on workers is indeterminate.

| Clothing | Food________|

Labor | w/Pc = MPLc | w/Pf = MPLf______|

Capital | Rk/Pc = MPK | Rk/Pf = MPK*(Pc/Pf)_|

Land | Rt/Pc = MPT*(Pf/Pc) | Rt/Pf = MPT_______|

MPK increases as L increases, while in this case MPT decreases as L decreases (assumption).

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24
Q

What are the 5 primary conclusions from the specific factor model?

A
  • Shows how factor prices can differ in equilibrium, even if technology is the same
  • Shows how trade can hurt some within a country
  • Everyone can still gain from trade, with the right redistribution
  • Factors specific to export gain from trade while factors specific to import lose.
  • In the short run and factors are fixed to the sectors they are in.
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25
Q

Why do countries trade in the specific factors model?

A

The abundance of factors; factor endowments.

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26
Q

True or false: a country is abundant of a factor if it has more of that factor than the other one.

A

False.

Being abundant in a factor is like a comparative advantage.

Thus Home is abundant in K if:

K/T > K*/T*

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27
Q

What are the main differences between the 2-good specific factor model and Ricardian model?

A

Technology is fixed in 2-good specific factor model whereas it is flexible in the Ricardian model.

The Ricardian model is only focusing on one factor; labor, whereas the 2-good factor model is taking multiple production factors into account.

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28
Q

Home is capital-abundant. Do Home capital owners gain from opening up to trade?

A

Yes.

Factors specific to export gain from trade while factors specific to import lose.

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29
Q

In 3-factor model, does labor gain from trade?

A

Their purchasing power is going to change, so it actually depends on their utility and choice criteria between goods.

Thus, it is indeterminate.

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30
Q

What is the main focus of the Heckscher-Ohlin model?

A

Resources; that countries have different resources to produce with.

Countries with relatively more of a resource will export goods for which that resource is more useful in production.

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31
Q

What does the Heckscher-Ohlin theorem say?

A

A country exports goods that are intensive in the factor they are abundant in, so Western Europe exports highskilled-labor intensive goods to Eastern Europe.

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32
Q

What does Rybczynski theorem say?

A

If country gets more of a resource, then the output of the good that uses that resource intensively will rise while the output of the other good will fall.

Ex: if Denmark got more labor, it would increase its production of textiles OR if unskilled Iraqis come to Denmark, Denmark will be more abundant in unskilled-labor intensive goods and produce more of that.

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33
Q

What does Stolper-Samuelson theorem say?

A

A rise in the price of a final good for which a particular resource is more useful in production will increase the payments to that resource

Ex: if the price of textiles goes up, Chinese workers get higher wages

When opening up to trade, owners of factors in which the country exports will gain from trade, so unskilled labor will benefit when China opens up to trade.

SS = Stolper Samuelson

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34
Q

What does factor-price equalization say?

A

Trade should cause resource prices to converge

Ex: Danish and Chinese workers should be paid the same real wages.

(This is not the case in the real world though)

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35
Q

What is an isovalue line and what does it show?

A

The isovalue line is a line showing the relative prices of two goods and thus has a slope of: -Pc/Pf (for cloth and food – the horizontal value as numerator).

The isovalue line helps us find the optimal production point.

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36
Q

What does labor-intensive or capital-intensive mean and how do we show this graphically?

A

If a good is labor-intensive as cloth in the graph below (CC), production of cloth will always use more labor relative to capital than will production of food (FF).

We can graph the relative factor demand curves (wages/rental cost of capital) and see which one if most labor-intensive.

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37
Q

What would happen in a case where cloth and food is produced, and suddenly the labor supply increases a lot?

A

The labor-intensive industry, in this case the clothing industry, will be able to produce much more, while the food industry (capital-intensive) only will be able to produce a little more.

Thus we have a new PPF and a new tangent line with a slope of: -Pc/Pf so that we produce less food and now much more clothing è An economy produces what it is good at (comparative advantage) AND has the resources to produce (Hecksher-Ohlin).

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38
Q

What does it mean to be labor-abundant or capital-abundant?

A

That a country has a lot of that resource; they have lot of labor, they are labor-abundant.

REMEMBER: this is a ratio number and is relative to another country. Not absolute quantities.

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39
Q

What does the Heckscher-Ohlin theorem predict?

A

The country that is abundant in a factor exports the good whose production is intensive in that factor.

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40
Q

What does the Heckscher-Ohlin theory predict about distribution of income?

A

Owners of a country’s abundant factors gain from trade, but owners of a country’s scarce factors lose.

In theory, however, there are still gains from trade, in the limited sense that the winners could compensate the losers, and everyone would be better off.

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41
Q

What is the Leontief paradox?

A

The fact that after the 25 years following WW2, USA imported more capital-intensive goods than it exported despite having the highest Capital per person ratio in the world.

In other words, the Leontief paradox (based on data) is contradicting the Heckscher-Ohlin theory.

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42
Q

What is the conclusion on the Heckscher-Ohlin theory:

A
  • Countries tend to export goods that are intensive in resources they are relatively abundant in.
  • The owner of abundant factors gain from trade, while the owner of scarce resources lose from trade.
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43
Q

How is Heckscher-Ohlin different from the specific factor model?

A

Heckscher-Ohlin is working in the long run where factors can move across sectors.

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44
Q

Which PPF are squared, straight-lined and which are curved?

A
  • Straight-line: Ricardian
  • Square: 2-specific factor model,
  • Curve: 3-specific factor model, HO, Standard
    • Downward sloping: producing less of one good, can produce more of the other goods
    • Curved: due to marginal product. A little less cloth gives you a lot more food in the beginning and the end you will have that to produce more food you will need to produce a lot less cloth.
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45
Q

How do you show an income effect and a substitution effect graphically in the standard model?

A

Doesn’t matter - it won’t be in the exam ;)

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46
Q

What is the difference between HO and Specific factors model? (Office hours with Jinkins)

A
  • Specific model; 3 factor-model: Qc(L,K) and Qf(L,T)
  • HO: Qc(L,K) and Qf(L,K)
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47
Q

What is the slope of an isovalue line?

A

-Pc/Pf (Pc because Qc is on the horizontal axis. IF this was Qf it would be –Pf/Pc)

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48
Q

Will we produce more or less cloth if the price of cloth increases and how can this be shown graphically?

A

Higher price of cloth = higher relative price (Pc/Pf) and more producers of cloth ➔ production of cloth increases and production of food decreases as more labor now work in the clothing industry.

The PPF curve has a slope of: - MPLf/MPLc

The isovalue lines (VV1 and VV2) have slopes of –Pc/Pf

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49
Q

How can indifference curves help show how much a country import and export of a good?

A

Value of production = price x Q of good 1 + price x Q of good 2 = consumption of good 1 + consumption of good 2

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50
Q

What is an income effect and what is a substitution effect?

A
  • Income effect: increase/decrease in welfare after a given change in the economy such as the relative price level
  • Substitution effect: change in consumption of goods after a given chance in the economy such as the relative price level.
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51
Q

What are the conclusion of the standard model in regards to price changes and welfare?

A

Terms of trade; the price of the exported good divided by the price of the imported goods.

P Export Good / P Import Good

  • Welfare increases if terms of trade rise (improve)
  • Welfare decreases if terms of trade fall (worsen)
    • A worsening of the terms of trade can NEVER make welfare fall below autarchy level.
    • BUT as worsening your terms of trade more and more, you will end up having export and import of the two goods opposite of your initial autarchy situation
    • When your terms of trade keeps worsen, you will end up back in autarchy consuming what you are producing
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52
Q

What is biased growth and what are its drivers?

A

When the production possibility frontier shifts out more in one direction than in the other.

PPF will shift out due to technological progress for that product or increased resources for the production of a given product.

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53
Q

Why do countries trade in Heckscher-Ohlin model?

A

Because some countries are abundant in some factors, and tend to produce those products that are intensive in those factors.

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54
Q

Why is the Heckscher-Ohlin model called a long-run model?

A

Because you can use both factors to produce both goods, and in specific you can only use one factor to produce one good. You can also train labor to work in another sector.

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55
Q

How many factors are there in the standard HO model?

A

2 factors.

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56
Q

What is allowed to move between countries in the standard HO model?

A

Final goods (output).

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57
Q

How many theorems are there in HO?

A

4 theorems.

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58
Q

Name the theorems of HO

A
  1. HO-theorem
  2. Rybczynski theorem
  3. Stolper-Samuelson theorem
  4. Factor price equalization
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59
Q

Suppose we have a standard trade model, and home exports clothes.

  1. Suppose home’s terms of trade worsen. What does that mean in terms of relative prices?
A

Pc/Pf will fall

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60
Q

Suppose we have a standard trade model, and home exports clothes.

2. Using home’s PPF, show that worsening terms of trade reduce achievable welfare at home.

When terms of trade worsen, we move from isovalue line 1 to isovalue line 2 (which is flatter), indifference curve 1 can no longer be attained, so we fall to indifference curve 2 (which is lower).

A
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61
Q

Suppose we have a standard trade model, and home exports clothes.

3. Using home’s PPF, show what happens to quantities exported and imported after terms of trade worsen.

A
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62
Q

Suppose we have a standard trade model, and home exports clothes.

4. What will eventually happen if home’s terms of trade worsen enough?

A

Home will go to autarchy

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63
Q

What is export-biased and import-biased growth?

A
  • Export-biased: growth that disproportionately expands a country’s production possibilities in the direction of the good it exports
  • Import-biased: growth biased toward the good a country imports
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64
Q

What is the conclusion regarding import- and export-biased growth?

A
  • Export-biased growth tends to worsen a growing country’s terms of trade, to the benefit of the rest of the world
  • Import-biased growth tends to improve a growing country’s terms of trade at the rest of the world’s expense.

Why? Price of the good you export /price of the good you import ➔ export-biased will increase the relative price whereas import-biased will decrease the relative price

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65
Q

What are terms of trade (TOT)?

A

Price of the good you export / price of the good you import

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66
Q

Debate: Denmark should admit more immigrants

A

For:

  • Dk needs young labor (growing elderly people)
  • Multicultural is good (this is definitely not proven though)
  • Increase trade through immigrants (shorter psychic distance; gravity model)

Against:

  • High unemployment rate of immigrants (eating the pie instead of growing it)
  • High crime rates
  • Cultural differences + building double societies instead of integrating
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67
Q

What is immiserizing growth?

A

Immiserizing growth is a theoretical situation first proposed by Jagdish Bhagwati, in 1958, where economic growth could result in a country being worse off than before the growth. If growth is heavily export biased it might lead to a fall in the terms of trade of the exporting country. In rare circumstances this fall in the terms of trade may be so large as to outweigh the gains from growth.

Strongly export-biased growth must be combined with very steep RS and RD curve so that the change in the terms of trade is large enough to offset the direct favorable effects of an increase in country’s productive capacity.

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68
Q

When there are increasing returns, large firms may have an advantage over small ones, so that markets tend to be dominated by one or few firms.

A
  • Technology depends upon scale and experience
  • Best to concentrate production
  • Drives countries to specialize even if ex-ante identical
  • Large countries have lower cost
    • Knowledge spillover
    • Specialized labor market
    • Specialized suppliers
  • Room for helpful government policy
    • Historical accident: industries can end up in the “wrong” = less efficient country
    • There can be equilibrium losses from trade
    • “Infant” industries may need early protection from competition
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69
Q

Are there constant, increasing or decreasing returns to scale in the Ricardian model?

A

Constant returns to scale

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70
Q

Name one reason why decreasing returns to scale might be reasonable in a multifactor model

A

Disproportionate amounts of one factor relative to another is ineffective.

Example: if producing 1 Irish coffee needs one unit of capital and one unit of labor, it is not beneficial to double our input/factor of labor if we don’t get more capital.

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71
Q

Name three possible reasons why increasing returns to scale might be reasonable

A
  • Specialized suppliers (expensive to be away from the specialized suppliers)
  • Labor market pooling (cheaper to recruit where the specialized labor is located)
  • Knowledge spillover (“coffee break conversations”)

(Lower AC as fixed costs are split out)

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72
Q

What is the difference between external and internal economies of scale?

A
  • External: when cost per unit depends on the size of the industry but not necessarily on the size of any one firm
  • Internal: when the cost per unit depends on the size of an individual firm but not necessarily on that of the industry.
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73
Q

What characterizes industries with external economies of scale?

A

No advantages to large firms since the differences are on industry level. Thus the market will typically be many small firms and be perfectly competitive.

External economies of scale also increase chances of clusters making the industry even more competitive through specialized suppliers, labor market pooling and knowledge spillover.

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74
Q

What characterizes industries with internal economies of scale?

A

Large firms have a cost advantage over small firms and lead to an imperfectly competitive market structure (monopoly or oligopoly)

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75
Q

What are the three main advantages of clustering?

A
  • Specialized suppliers
  • Labor market pooling
  • Knowledge spillover
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76
Q

How are prices affected by increasing demand in an industry with external economies of scale?

A

As demand (Q) increases, the average cost of production falls and therefore we have a forward-falling supply curve; the larger the industry’s output, the lower the price at which firms are willing to sell.

Higher demand, lower AC, lower price.

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77
Q

How is the economies of scale model different from that of the specific factor model in regards to pricing when opening up to trade?

A
  • Specific factor model: prices converge to somewhere between that of the two countries
  • Economies of scale (WITH increasing returns); prices decreases to somewhere even lower than that of the country with the lowest price before trade because production is at the same place so we have lower AC.
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78
Q

What explains why industry clusters sometimes end up the place that is not economically most beneficial and how do you explain that graphically?

A

History coincidences.

First-mover advantages.

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79
Q

What will happen in an industry with decreasing marginal costs and where will the equilibrium be?

A

We will have one gigantic firm ⇒ A monopoly.

Why? Producing more equals lower marginal costs.

(Decreasing AC)

The equilibrium will be at the intersection between the demand curve, D and the AC-curve (which is equal to your MC since the firms only produce one unit as they are so small).

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80
Q

How can countries be worse off by trading when there are economies of scale?

A

The average cost per unit when starting producing a good might be higher than the world price.

The start-up cost is larger than the current equilibrium cost.

However, if not trading and just supplying its domestic market, Thai-producers of watches would be able to supply the domestic demand with a lower price.

Thus, Thailand in this example is worse off by trading.

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81
Q

What does dynamic increasing returns refer to?

A

When costs fall with cumulative production over time rather than with the current rate of production.

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82
Q

What is the infant industry argument?

A

That temporarily protecting an industry to enable them to gain experience is favorable since it will help decrease AC and improve competitiveness.

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83
Q

What is the poverty trap?

A

The idea is, that to work effectively you need to eat food but to get food you need food but how will you get food, when you are not full and can work effectively?

Classic poverty trap.

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84
Q

What does internal economies of scale imply?

A

That a firm’s average cost of production decreases the more output it produces.

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85
Q

What does imperfect competition imply on prices?

A

If a firm in imperfect competition sells much more, the prices of its products (the prices of the industry) will decrease.

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86
Q

When will imperfect competition occur? (2 situations)

A

Derivative: P’(Q) Q + P(Q) - c’(Q) (MR - MC)

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87
Q

Why does a monopoly’s marginal revenue curve always lie below the demand curve and how do you find the profit of a monopoly?

A

Because to sell an additional unit, the firm must lower the price of ALL units (not just the marginal one).

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88
Q

What affects the MR line?

A

Marginal revenue = MR = P – Q/B

The gap between price and MR depends on sales, Q, and the slope parameter, B.

If Q is higher, MR is lower, because the decrease in price required to sell a greater quantity costs the firm more.

The greater is B, the more sales fall for any given increase in price and the closer the MR is to the price of the good.

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89
Q

What are the two assumptions of monopolistic competition?

A
  • Each firm has differentiated products so that consumers don’t shift their preferences due to small price changes
  • Each firm behaves as if it were a monopolist and ignores the impact of its own price on the prices of other firms
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90
Q

Explain the following equation:

A

Q = Quantity demanded for a firm in monopolistic competition.

S = Total output of the industry

N = number of firms

B = constant term representing the responsiveness of a firm’s sales to its price

P = the firm’s price

P= The average price charged by its competitors

This implies that if all firms charge the same price, each will have a market share of 1/n.

We assume S is unaffected by the average price.

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91
Q

AC = F/Q + c = (n * F/S) + c (Explain the latter part)

A

AC depends on the number of firms in an industry and that industry’s size.

The more firms, the less each firm produces and thus AC will be higher due to less economies of scale.

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92
Q

What does this model show?

A

Answer is three-fold

  • CC: the more firms, the higher costs (AC is higher since economies of scale is lower when more firms have to produce the same amount)
  • PP: the more firms, the lower prices will be due to increased competition (P = c + 1/(b*n)) ➔ the more firms, the lower the markup over MC.
  • In point E, the equilibrium number of firms in the industry is achieved. Here firms have profit maximized at the price P2 that is equal to their average cost, AC2 ➔ a long-run equilibrium.
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93
Q

What happens to the equilibrium price and quantities of firms if the size of the market increases?

AC = F/Q + c = (n * F/S) + c

A

The CC-curve changes as S increases.

  • Lower equilibrium price
  • More firms
  • More varieties for consumers

The PP-curve Is not affected; (P = c + 1/(b*n))

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94
Q

What properties does economies of scale add to our arguments for international trade being beneficial?

A
  • Product differentiation and international economies of scale lead to trade between similar countries with no comparative advantage differences between them (intra-industry trade)
  • Consumers benefit from a greater variety of products at a lower price as firms can take advantage of economies of scale.
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95
Q

What is intra-industry trade?

A

Two-way exchanges of similar goods.

  1. 97 = nearly equal import and export
  2. 10 = unequal import/export (in this case import is much higher than export
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96
Q

A firm with a lower marginal cost will do what?

A
  • Set a lower price
  • At a higher markup over marginal cost
  • Produce more output
  • Earn higher profits
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97
Q

When does entry stop in a market with internal economies of scale?

A

When expected profits across all potential cost levels, Ci, are driven to zero.

In external; firms enter until profits for all firms are driven to zero

Make sure you can explain this

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98
Q

What is the difference between horizontal and vertical FDI?

A
  • Horizontal: investment in affiliates who replicates the production process elsewhere in the world
  • Vertical: break up their production chain and perform some parts of that chain in their foreign facilities.
    • Outsourcing
    • Offshoring
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99
Q

What is the proximity-concentration trade-off in regards to FDI?

A

That investing in production facilities closer to the customer is beneficial as transport cost are lower (+ trade barriers avoided) BUT at the same time doing so is bad economically as you don’t gain as much from economies of scale.

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100
Q

What is offshoring?

A

Instead of outsourcing completely, the corporation still owns the foreign-based subsidiary and thus makes trade within the corporation itself and keeps full control and has lower risk of doing business.

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101
Q

What is the strong assumption behind partial equilibrium models?

A

Neither incomes nor other prices change.

Welfare only affected by consumption or sale of the single good.

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102
Q

What is the difference between specific tariffs and ad valorem tariffs?

A
  • Specific: fixed charge added for each unit imported: P = P* + t
  • Ad valorem: fraction of the value added to each unit imported: P = P* (1 + t) ⇒ 0,25 % tariff on the value of imported cars: 0,25.
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103
Q

What are nontariff barriers?

A
  • Import quotas
  • Export restraints (usually imposed on the importing country’s request)
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104
Q

How is Home’s import demand curve derived?

A

Graph to the right: X-axis; the difference between the quantity that domestic consumers demand and the quantity domestic producers supply.

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105
Q

How is Foreigns’ export supply curve derived?

A

Graph to the right: X-axis; the difference between the quantity that foreign produce and the quantity foreign supply.

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106
Q

What does MD = XS say?

A

That we are in equilibrium in the world market meaning that:

Domestic demand - Domestic supply (Import demand) = Foreign supply - Foreign demand (Export supply) ⇒ D - S = S* - D

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107
Q

How does an import tariff affect the equilibrium in Home, Foreign and in the World market?

A

You can mark the world-market equilibrium with P-autarchy and P*-autarchy where the lines intersects the y-axis.

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108
Q

Who wins and who lose when imposing tariffs?

A
  • Consumers lose in the importing country (price increases) while prices decrease in the exporting country. Thus, consumers in the importing country lose, and those in the exporting country win.
  • Suppliers/producers in the importing country gain, while those in the exporting country lose (looking at how much the suppliers are paid for their products).
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109
Q

How do you calculate and find consumer surplus graphically?

A

Length x width x 0.5

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110
Q

How do you calculate and find producer surplus graphically?

A
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111
Q

Explain who gains and who loses from an export subsidy

A

Exporting country: producers gain, consumers are hurt and the government loses.

Export subsidies worsens the terms of trade because it lowers the price of the export in the foreign market from Pw to Ps* ⇒ The cost will always be bigger than its benefits.

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112
Q

What are quota rents?

A

The profits received/earned by the holders of import licenses.

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113
Q

Explain who gains and losses from a tariff in terms of the importing country’s perspective

A
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114
Q

Explain who gains and losses from an import quota and what the difference is from a import tariff

A

Home market: Producers gain, consumers are hurt and the license holder will earn quota rents.

The difference from import tariffs is, that here the licensee will earn some money instead of the government. Money will go to the foreign producers instead of domestic government.

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115
Q

What is a VER?

A

A voluntary export restraint; a quota on trade imposed from the exporting country’s side (typically on request of the importer).

The effects are exactly the same as for an import quota.

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116
Q

What is a local content requirement?

A

A regulation that requires some specified fraction of a final good to be produced domestically.

Producers’ point of view: same protection as an import quota

Consumers/firms that must buy domestically: allows firms to import more, as long as they also buy more domestically.

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117
Q

When do suppliers sell domestically, and when do they sell in foreign?

A
  • Sellers only sell abroad if the foreign price is greater than the domestic price plus the tariff.
  • Sellers only sell domestically if the foreign price is less than than the domestic price plus the tariff
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118
Q

Depending on the size of two countries’ economies, who will have steep and who will have flat MD and XS curves?

A
  • Flat for the big economy: The big economy’s supply or demand is affected a lot in quantities when prices change ⇒ Very elastic.
  • Steep for the small economy: The small country’s economy is affected relatively little in quantities supplied and demanded when prices change ⇒ Inelastic.
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119
Q

How is government revenue gain calculated?

A

Government revenue gain = tariff * Q

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120
Q

In summary what are the effects of a tariff?

A
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121
Q

In summary what are the effects of an export subsidy?

A
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122
Q

In summary what are the effects of an import quota?

A
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123
Q

In summary what are the effects of a VER?

A
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124
Q

Why is imports quotas, VERs and export subsidies ALWAYS worse than import tariffs?

A

Simply because the government revenue gain is given out to a third-party making these trade policy tools more costly than import tariffs.

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125
Q

What are the arguments for free trade?

A
  • Restrictions on trade causes net losses so from a cost-benefit point of view the benefits are simply outweighed by the costs.
  • Other costs:
    • Free trade will make the world benefit from economies of scale
    • Access to bigger markets are more beneficial for entrepreneurs which will drive more innovations.
    • Rent-seeking costs
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126
Q

On average, how much would countries gain from moving to completely free trade?

A

Only about 1 % since tariffs are usually really small and import quotas etc. rare. Protection level is generally low.

The real gains are bigger when taking economies of scale etc. into account but it is hard to estimate.

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127
Q

What are the arguments against free trade?

A
  • In some cases, there is a terms of trade argument for tariffs (almost only for bigger countries that can affect world price). This also holds for export in some situations such as with Saudi Arabia’s oil export restrictions.
    • Be aware that these gains will be on other countries expense who will very likely want a friendly talk.
  • The argument of domestic market failure; consumer and producer surplus might not be the best way to measure the actual cost and benefits of free trade. A tariff might yield extra social benefits than those examined in the consumer and producer surplus
  • Theory of the second best; this is not directly against free trade, but states the fact that restrictions can be beneficial if the markets do not act properly.
  • Politically, the opportunity of protecting industries cause lobbyism by influential groups.
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128
Q

Arguments against free trade: What is the argument of domestic market failure?

A

Consumer and producer surplus might not be the best way to measure the actual cost and benefits of free trade.

A tariff might yield extra social benefits than those examined in the consumer and producer surplus.

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129
Q

Arguments against free trade: What is the theory of the second best?

A

This is not directly against free trade, but states the fact that restrictions can be beneficial if the markets do not act properly.

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130
Q

What are domestic market failures and how do you see the marginal social benefit graphically?

A

A market in the country is not doing its job right. This could be:

  • The labor market is not clearing
  • The capital market is not allocating resources efficiently

It is often a question of marginal social benefit from the learning curve. Protecting industries will keep the industry running and it might improve its productivity through technological innovations etc.

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131
Q

What is the theory of the second best?

A

The idea that a hands-off policy is desirable only if all markets are working properly. If they are not, a government intervention that appears to distort incentives in one market may actually increase welfare by offsetting the consequences of market failures elsewhere.

For example, if the labor market is malfunctioning and fails to deliver full employment, a policy of subsidizing labor-intensive industries, might turn out to be a good idea.

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132
Q

What are the advantages of international negotiation of tariffs?

A
  • Mutual agreement helps mobilize support for freer trade
  • Negotiated agreements on trade can help governments avoid destructive trade wars.
133
Q

How many rounds of international trade agreements have been signed and what is the latest signed round?

A

8 rounds.

Uruguay Round in 1994.

  • Decreasing average tariffs with 40 % (from 6.3 to 3.9 %)
  • Decreasing protectionism on clothing and agricultural industries

Forming WTO

  • Adding service trade to the agreement (GATT was only products)
  • Property rights, patents, copyrights (TRIPS)
134
Q

What was the primary focus of the Doha round?

A

The Doha round from 2001 (to absolute failure in 2010) focused again on reducing tariffs but primarily focused on the agriculture industry, which is the industry of highest political importance.

135
Q

What are the two ways that two or more countries agreeing to establish free trade can do so?

A
  • Free trade area: no tariffs between borders (NAFTA countries can charge different tariff rates from imported goods from for example China)
  • Custom union: have to agree on tariff rates (all EU countries must charge the same tariff rate on each imported good from countries outside the region)
136
Q

What is trade creation and trade diversion?

A
  • Trade diversion: when a trade agreement (typically regional) divert part of world trade into trade with regional countries. Mercosur (Argentina, Brazil, Uruguay and Paraguay) tripling their trade in 4 years as an example. The increased trade came at the expense of other trade so that the net effects on the economies involved probably were negative. Joining an agreement leads to the replacement of low-cost imports from outside the zone with higher-cost goods from member nations.
  • Trade creation: trade agreements that increases international trade by lowering trade barriers. Joining an agreement leads to replacement of high-cost domestic production by imports from other members of agreement.
137
Q

What is trade creation?

A

Trade agreements that increases international trade by lowering trade barriers. Joining an agreement leads to replacement of high-cost domestic production by imports from other members of agreement.

138
Q

What is trade diversion?

A

When a trade agreement (typically regional) divert part of world trade into trade with regional countries.

Mercosur (Argentina, Brazil, Uruguay and Paraguay) tripling their trade in 4 years as an example.

The increased trade came at the expense of other trade so that the net effects on the economies involved probably were negative. Joining an agreement leads to the replacement of low-cost imports from outside the zone with higher-cost goods from member nations.

139
Q

How did countries look at economic growth in relation to trade policies after WW2?

A

There was a strong belief that the road for economic growth was a strong manufacturing sector.

Thus to develop strong manufacturing industries, governments temporarily supported these new industries until they had grown strong enough to meet international competition (The infant industry argument).

As of historic fact, both Japan and USA’s strong manufacturing industries started out under protection.

However, it does not always hold as of the case with India and Pakistan who have protected their manufacturing industries for decades without luck simply because the protection has caused lack of competition and thus productivity progress.

140
Q

What is the strategy of import-substituting industrialization?

A

Encouraging domestic industries by limiting imports of manufactured goods.

141
Q

What might be some of the reasons that the infant industry argument of trade policy protectionism does not hold?

A

Poor manufacturing industries is not just due to lack of experience but rather lack of:

  • Skilled labor
  • Entrepreneurs
  • Managerial competences
  • Social organization
  • Reliable supplies of electricity etc.

Import-quotas can help an inefficient sector survive, but it cannot directly make that sector more efficient

142
Q

Has trade liberalization of developing countries since 1985 proved successful?

A

Yes and no - it might be indeterminate.

Trade (import/export) as percentage of GDP has increased a lot for developing countries and the trade barriers has decreased a lot causing increased bonds between countries of the world.

Looking at actual numbers however, many Latin American countries now grow faster than with import-protection, India and China has been growing faster but economists have found that only a limited share of the growth can be allocated to trade liberalization.

India and China + the Asian Tigers are though the best examples of why free trade should be beneficial.

143
Q

Who are the four original Asian Tigers and which countries have followed?

A

Hong Kong, South Korea, Taiwan and Singapore.

Many countries has followed up whereas India and China are most important.

144
Q

What are the two main market failures in industrial countries that economists have found?

A
  • The inability of firms in high-technology industries to capture the benefits of that part of their contribution to knowledge that spill over to other firms
  • The presence of monopoly profits in highly concentrated oligopolistic industries.
145
Q

What is the argument behind subsidizing high-tech industries?

A

It is all about knowledge spillover to other industries.

As goes for the military who have developed multiple technologies used across many industries today.

146
Q

What are beggar-thy-neighbor policies?

A

Basically just any strategic policy.

What does it mean? That we through trade policies increase our welfare on other countries’ expense and thus risk causing a trade war.

147
Q

What is the Brander-Spencer argument?

A

That only a limited number of firms can act in an industry (related to game theory)

Thus in some cases, government subsidies can give the necessary advantage over other firms so that they do not enter.
The idea is highly criticized as you will have to move resources from one industry to another no matter what.

148
Q

Debate: What are the arguments for and against the statement that international trade hurts the environment?

A

For:

  • International trade increases production and output so that pollution increases with the increase in production and consumption
  • Due to international trade, pollution heavy industries often tend to move to countries with few regulations. Example: the shipbreaking industry is highly focused in pollution haven, Alang in India.

Against:

  • Countries and consumers change their production and consumption mix as they grow richer towards products that reduce the environmental impact ⇒ Example: The US now focus on services rather than goods and tends to use less energy and raw material
  • Growing wealth tend to lead to growing political demands for environmental quality
  • Pollution is a negative externality of interest to all countries in the world. Thus, international trade gives the more environment-conscious countries more influence on other countries by the possibility of imposing trade-policies hurting polluting countries ⇒ For example carbon-doxide tariffs
149
Q

What is the Kuznets curve?

A

A theory backed by empirical evidence that as countries grow richer, they first increases pollution and afterwards decreases their environmental (per GDP dollar) impact as they become developed.

Thus, again the increased GDP (production and output) will still hurt the environment as people become richer.

150
Q

In comparison, how much could the world gain from opening up for labor mobility compared to trade of goods (merchandise trade) and capital?

A

Jinkins stemmer radikale venstre, så det er her er nok fint at vide. Kan give ham et smil på læben, hvis man på en eller anden måde kan få det med i eksamen.

151
Q

What is the median voter theory?

A

That parties take policy positions (such as a tariff position) to maximize support.

If two parties, both will be placed exactly such as they get ½ of the votes each.

t* is always median in equilibrium.

152
Q

What is the theory of collective action?

A

Collective action is about sharing your voice.

Political campaign funding is together with the median voter theory what make politicians win elections.

  • Policies with large aggregate loss but small individual loss are difficult to change ⇒ Fx. US sugar consumers or EU consumers of agricultural products. ⇒ These WON’T SHARE THEIR VOICE
  • Small groups with concentrated losses are more willing to pay effort fixed cost ⇒ Fx. US sugar producers or EU farmers. ⇒ THESE WILL SHARE THEIR VOICE
153
Q

What is GNP?

A

Gross National Product

154
Q

How do economists and statisticians divide GNP?

A
  • Consumption
  • Investment (by companies - NOT private consumers investments in stock fx.)
  • Government purchases
  • Current account balance (net exports with foreigners)
155
Q

What is the definition of GNP and what does it say?

A

The value of all final goods and services produced by the country’s factors of production and sold on the market in a given time period

  • The value; in common terms - normally the domestic currency
  • Final goods and services - only FINAL goods and services
    • Final goods can also be investments
  • By the country’s factors of production; use of the country’s labor, land, or capital.
    • Does not have to be produced domestically (within the border of the country)
  • Sold on the market in a given time period; Only final goods in the given time period
    • Used textbooks fx do NOT count ⇒ that is “exchange”
156
Q

What is national product equal to?

A

National income.

National income = GNP - depreciation + unilateral transfers (but we just say national income = GNP)

The value of all final goods and services produced by the country’s factors of production and sold on the market in a given time period

157
Q

What is the difference between GDP and GNP?

A

GNP adds/subtracts whether Danes receive more income from their overseas investments than foreign nationals receive from their investments in Denmark.

GNP = GDP + net transfers received

Only count stuff produced by factors owned by nationals

Measure of stuff produced

158
Q

Why is savings not necessarily equal investments in an open economy?

A

As in an open economy, a trade deficit will make the country “dissave” ⇒ reduce their foreign wealth by exporting less than they import.

159
Q

What is the output equation in an open and closed economy?

A

Y = C + I + G

Y = C + I + G + EX - IM

Think of Y as fixed. Why is that? Fx if you decrease Import, Y (output) does not increase.

160
Q

What is important to remember regarding import with GNP vs. GDP?

A
  • Import with GNP; whenever some of the intermediate goods (/factors used) in producing the final good are foreign/foreigned owned.
  • Import with GDP; whenever the product is produced on the other side of a border.
161
Q

What is the current account balance?

A

The difference between exports of goods and services and imports of goods and services:

CA = EX - IM

162
Q

How can a country keep running a trade deficit?

A

By having a positive inflow of capital; other countries lending to you ⇒ This is the case for US.

163
Q

What are the components of the balance of payments? (not on the exam Jinkins said in class)

A

Current account balance:

  • Import and export
  • Net income: Income of financial assets for domestic and population foreign population (income received – income paid; salaries, income from financial investments, dividends etc.)
  • Net unilateral transfers/Net transfers received (negative for developed countries; it is donor money for emerging markets) aids, donations, workers’ remittances
  • Capital account

The financial account:

  • Value of assets (foreigners lending money to the country)
  • Buying assets overseas
  • Official reserve transactions: on behalf of the central bank
  • Net capital flows/capital account balance

Net errors and omissions = Statistical discrepancy

Current account + capital account = Financial account

164
Q

What is fiat money?

A

Fiat money is currency that a government has declared to be legal tender, but is not backed by a physical commodity.

The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith.

165
Q

Debate: Sweatshops are bad for poor workers

A

For:

  • Some things are not okay such as forcing companies to not give workers 12-hours workdays (by laws in Denmark fx).
  • Foxconn’s suicide nets really show how bad sweatshops are for workers.
  • Domestic regulations, why not foreign?
  • We can step in and help them (government intervention); minimum wage, maximum 10-hour workdays etc.
  • Sweatshops are terrible
  • People don’t always make good choices
  • Small changes in regulations won’t shut down factories

Against:

  • They chose to work there themselves
  • Alternatives are worse; no jobs
  • Increased regulations will make capital investments more beneficial and thus jobs will end up being eliminated; example of minimum wage in California of jump from USD 10 to 15 for fast food workers made the fast food chains invest in automated ordering, which eliminated many jobs.
  • Migration not possible politcally
  • Better regulations not possible
  • Close down factories
166
Q

Question 3, slide 29) Bookstore sells sweatshirt made in China to a CBS student. Is this part of GNP?

A

Let’s assume the bookstore buys sweatshirt for $10 and sell it for 100$, the $10 dollar is not counted toward GNP, but $90 (the markup) is counted in the GNP as consumption.

167
Q

What are the two types of transactions (debit/credit)?

A
  • Debit; when a native pays a foreigner
  • Credit; when a foreigner pays a native
168
Q

What is official foreign exchange intervention?

A

Any central bank transaction in private markets for foreign currency assets used to change the amount of money in circulation (money supply) and affect the foreign exchange rates.

169
Q

What is national saving and what is it equal to? (closed + open economy)

A

S = Y - C - G

Y = C + I + G (+CS) so I = Y - C - G (- CA)

S = I (closed economy)

S - CA = I (open economy)

170
Q

How can economies save up money? (open and closed)

A

Closed: by building up its capital stock.

Open: by building up its capital stock AND by acquiring foreign wealth by running a trade surplus

171
Q

What is private saving and government saving?

A

Sp = Y - T - C

Sg = T - G

S = Y - C - G = (Y - T -C) + (T-G) = Sp + Sg

172
Q

What should you remember about every international transaction?

A

That it always enters the balance of payments twice.

Thus, the double bookkeeping system should be used and both a crediting and debiting should be made.

173
Q

What is the nominal exchange rate? (direct and indirect)

A

Indirect:

The price of the domestic currency in terms of foreign currency⇒ Number of units of foreign currency per unit of domestic currency.

EURO/DKK = 0.13

Direct:

The foreign currency in terms of the domestic currency ⇒ Number of units of home currency per one unit of foreign currency.

DKK/EURO = 7.45

174
Q

What are the keywords regarding fluctuations of exchange rates?

A
  • Depreciations and appreciations.
  • Devaluation and revaluations.
175
Q

What is the real exchange rate and how do you calculate it?

A

The price of domestic goods in terms of foreign goods, denoted by ∈. The real exchange rate determines your choice between consuming domestic or foreign goods.

∈ = EP/(P* (the foreign price))

When increasing, domestic goods are becoming more expensive relative to foreign goods and NX decrease (Marshall-Lerner)

When the real exchange rate = 1 ⇒ We have perfect PPP (however, there are many reasons to why this don’t hold in practice).

Examples:

Selling bike at P = 4000 DKK ⇒ exchanging into euros and get 520 euros ⇒ go to Germany where the price of a new bike is 260 euros (P^*). Thus EP/P^* = 520/260=2. or (4000x0.13)/260 = 2.

176
Q

Who are the major actors in the foreign exchange market?

A
  • Commercial Banks (especially with interbank trading)
  • Multinational corporations
  • Nonbank financial institutions
    • Pension funds
    • Insurance companies
    • Hedge funds
  • Central banks
177
Q

What is a vehicle currency?

A

A currency is one that is widely used to denominate international contracts made by parties who do not reside in the country that issues the vehicle currency.

Number one is USD, number two is Euro closely followed up by number 3 the Japanese Yen.

178
Q

What is the difference between spot and forward exchange rates?

A
  • Spot ⇒ Spot-on exchange rates are the exchange rate agreed right now on the spot when making a deal.
  • Forward exchange rates are quoted in transactions - example: we have a future transaction in 30 days and want to make sure that we get a certain exchange rate to secure profits.
179
Q

What is a foreign exchange swap?

A

A spot sale of a currency combined with a forward repurchase of that currency.

180
Q

What is the real rate of return?

A

The expected real rate of return: the rate of return computed by measuring asset values in terms of some broad representative basket of product that savers regularly purchase.

In other words, the expected return in terms of actual purchasing power in the future; REAL return.

(Value tomorrow - Value today) / Value today ⇒ The good old: (Ee - E) / E

181
Q

Why do savers not always prefer the asset with the highest real rate of return?

A
  • Risk
  • Liquidity

But we are ignoring these factors in our equilibrium analysis.

182
Q

What is the rate of depreciation and rate of appreciation?

A
  • Rate of depreciation: the percentage increase in fx. The dollar/euro exchange rate over a year ((Future exchange rate - Current exchange rate)/Current exchange rate) ⇒ (Ee - E)/ E ⇒ Ee is higher than E.
  • Rate of appreciation; simply the opposite. It does not matter whether we measure returns in terms of one currency or the other as long as we measure them both in terms of the same currency ⇒ (Ee - E) / E ⇒ Ee is lower than E.
183
Q

How do you calculate the expected rate of return? (in this case on a euro deposit measured in terms of dollars)

A

Today’s interest rate + ((Future exchange rate - current exchange rate)/current exchange rate)

Interest rate + ((Ee - E) / E)

184
Q

What is the interest parity condition?

A

The condition stating that the expected returns on deposits of any two currencies are equal when measured in the same currency.

Otherwise we would have arbitrage.

The expected returns have to be equal

Interest (i) = Interest foreign (i*) + ((Ee- E)/E)

185
Q

What do we expect the future exchange rate to be if the currency is appreciation now?

A

We expect it to appreciate further

186
Q

What do we expect for the currency if it is depreciating now?

A

We expect it to depreciate further.

187
Q

Explain what will happen if we are in point 2?

A

In 2; the expected return on dollar deposits is higher than that of euro deposits.

All euro deposits owners will want to buy dollar deposits instead but the owners of dollar deposits will not be willing to sell at the current exchange rate as it will give them a lower rate of return.

Thus, the euro deposit owners will offer a better exchange rate, which will bring the dollar/euro exchange rate down (euros become cheaper in terms of dollars)

188
Q

What happens to the dollar if FED increases the interest rate on deposits and how can this be shown graphically?

A

The dollar will appreciate and the green line will shift up/to the right and the new equilibrium will be in point 1’.

189
Q

What does “Yield” refer to?

A

Rate of return on an investment - usually on government debt.

190
Q

What is money supply in international economics?

A

M1; the money supply by the central bank.

We do not go into detail in how the money supply is set.

191
Q

What are the functions of money?

A
  • Medium of exchange (instead of trade on a mutual coincidence of wants basis. Need Coca Cola, and you need a haircut).
  • Unit of account (compare prices easily)
  • Store of value (an asset - the most liquid)
192
Q

What three things determine the demand for money?

A
  • The expected return the asset offers compared with the returns offered by other assets
    • Increase in interest rate, demand for money will fall
  • (The riskiness of the asset’s expected returns)
  • The asset’s liquidity
    • A rise in the average value of transactions carried out by a household or firm causes its demand for money to rise
193
Q

What three things affect aggregate money demand and how?

A
  • The interest rate (R)
    • Increasing interest rate, decreasing money demand
  • The price level (P)
    • Increasing price level, increasing money demand (A rise in the average value of transactions carried out by a household or firm causes its demand for money to rise)
  • Real national income (GNP = Y)
    • When GNP increases, the demand for money increases given the price level, as more goods and services will be purchased
194
Q

What is the money demand function?

A

R = interest rate ⇒ money demand decreases, as R increases

Y = GNP ⇒ Money demand increases, as R increases

P = Price level ⇒ Money demand increases as P increases

195
Q

What is the aggregate real money demand function and how does the graph look?

A

Money demand / Price level = L(R, Y)

  • Double prices ⇒ Doubling in money demand
  • Recession in the economy = Y decreases = Money demand decreases
  • Interest rate up = better to hold illiquid assets = Money demand decreases
196
Q

When is the money market in equilibrium?

A

When Money supply / Price level = L(R, Y)

  • Punkt 3: I If more demand than supply for money:
    • People will promise more money in the future for money today
    • As interest rates rise, people less willing to hold money
  • Punkt 1: If more supply than demand for money:
    • People with money will buy bonds for lower interest rate
    • As interest rates fall, people more willing to hold money
197
Q

What happens to the domestic currency when money supply increases?

A

If money supply increases ⇒ The interest rate will decrease (money market).

When interest rate decreases, less capital inflow ⇒ less demand for USD and USD depreciates such that E(USD/EUR) increases (The price of 1 Euro will increase to make the interest parity condition hold).

198
Q

How are prices determined in the long run?

A

P = Money supply / L(R, Y)

P = Money supply / Money demand

Increase in money supply causes a proportional increase in the price level

199
Q

What is the inflation rate equal to?

A

Change in P / P = (Change in money supply / money supply) - (Change in money demand / money demand)

200
Q

How does a change in money supply affect the long-run levels of interest rate and real output?

A

A change in the money supply have no effect on the long-run values of the interest rate or real output.

Why? In the long-run, output levels are determined by the economy’s endowments of labor and capital and not money supply.

(Think back to macroeconomics long-run equilibrium - it’s about capital and human capital)

201
Q

How does a change in money supply affect the long-run exchange rate level?

A

All else equal, a permanent increase in a country’s money supply causes a proportional long-run depreciation of its currency against foreign currencies.

Similarly, a permanent decrease in a country’s money supply causes a proportional long- run appreciation of its currency against foreign currencies.

(picture is example of increase in money supply)

202
Q

For what 3 reasons will price adjust in the medium-/long run? (one of the reasons is directly related to money supply increases)

A
  • Excess demand for output and labor (as interest rate decreases, people invest more in Y = C + I + G + CA) ⇒ Labor demand increases ⇒ Wages increase ⇒ Prices increase
  • Inflationary expectations (Pe > P)
  • Raw materials prices
203
Q

What is exchange rate overshooting?

A

When the exchange rates immediate response to a disturbance is greater than its long-run response ⇒ What happens when money supply increases.

For example 15-13D where the depreciation after a money supply rise is more significant than the actual long-run effects.

204
Q

Debate: Denmark should adopt the Euro

A

Yes:

  • Will get influence on monetary policy
  • Price transparency
  • Currency risk elimination
  • Eliminating transaction fees
  • Arguing that there will be no loss of cultural heritage

No:

  • Investments flowing into Denmark due to the 2.25 + - pegging
  • Insurance: having our own currency is like having a small lifeboat on the big ship. With the Euro we will be sinking with the rest of the Euro-zone.
  • Worked well so far
  • The Euro-zone and EU is quite unpopular in Denmark already.
  • We get price transparency and very low transaction fees with the solution we have now.
  • Costs of changing to a new currency
205
Q

Does the current account sum to zero?

A

Yes. Import and export between countries is a zero-sum game.

206
Q

Does the balance of payments sum to zero?

A

Yes. Capital inflow and outflow from one country to another is a zero-sum game. Either you get more capital inflow than you have capital outflow, or you don’t.

207
Q

Assume we are USA: What happens in the well-known money market and foreign exchange market graph if the money supply if ECB increases money supply?

A
208
Q

What is the law of one price?

A

The law stating that in competitive markets free of transportation costs and official barriers to trade, identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency.

209
Q

What is the theory of PPP?

A

That a fall in domestic PPP (rise in domestic prices) will be followed by a proportional currency depreciation.

Absolute PPP (this does definitely not hold in the real world)

210
Q

What is the difference between the law of one price and the PPP theory?

A
  • Law of one price: applies to individual commodities
  • PPP theory: applies to the general price level
211
Q

What is the idea of relative PPP?

A

Here we say that the change in the exchange rate between two currencies over any period equals the difference between the percentage changes in national price levels.

If absolute PPP holds (which it doesn’t in the real world), then relative PPP would also hold. However, if relative PPP hold, then absolute PPP does not have to hold.

212
Q

How is the economy affected by ongoing money supply increases?

A

Other things equal, money supply growth at a constant growth rate eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level (Yn) or the long-run relative prices of goods and services.

213
Q

What might explain why the empirical evidence does not support the PPP theory?

A
  • Transport costs and restrictions to trade DO EXIST (assumption of the model that they do not)
  • In the real world we also have monopolistic and oligopolistic markets
  • The inflation data reported in different countries are based on different commodity baskets.
  • Firms engaging in “pricing to market” strategies
214
Q

How can long-run values of real exchange rates change? (two ways)

A
  • An increase in world relative demand for one country’s output (this also implies rising prices for both traded and non-tradable goods) causes a long-run real appreciation of that country’s currency and vice versa.
  • A relative expansion of a country’s output (from increased production due to productivity improvements) causes a long-run real depreciation of that country’s currency.
215
Q

Assuming that all variables start out at their long-run level, what are the most important determinants of long-run swings in nominal exchange rates? (conclusion of chapter 16 (and 15)).

A
  • Shifts in relative money supply levels ⇒ only effect is an increase in all dollar prices INCLUDING the dollar price of the euro
  • Shifts in relative money supply growth rates ⇒ permanent increased money supply growth rate raises the long-run inflation rate (Fisher effect), raises the interest rate and the real money demand declines (depreciation of dollar), price in US rises ⇒ the purely monetary change brings a long-run nominal exchange shift in line with relative PPP.
  • A change in relative output demand ⇒ A rise in the relative demand for a country’s products, lead to a long-run nominal appreciation (rise in the relative price of products due to increased demand)
  • A change in relative supply ⇒ excess supply leads to lower prices and thus a real depreciation
216
Q

What is the difference between the euro/dollar interest rates equal to? (nominal interest rates)

A

The sum of two components, namely

  1. The expected rate of real dollar depreciation against the euro and
  2. The expected inflation difference between the US and Europe (in pure PPP theory only the inflation has influence
217
Q

What are the three desirable properties of an international monetary regime and what is the trilemma?

A
  1. Exchange rate stability
  2. Monetary Policy Autonomy
  3. Freedom of financial flows

Only two properties can be reached simultaneously.

218
Q
A
219
Q

What does this equation say?

A

What it says: Production Possibility Frontier (PPF) for home country

Amount of hours it takes to produce one unit of cheese multiplied by units of cheese you produce + amount of hours it takes to produce one unit of wine multiplied by units of wine you produce has to be equal to or less than the amount of labour home country has.

I.e. you cannot use more labour than you have.

220
Q

How can you show a comparative advantage?

A

What it says:

Home has a comparative advantage in producing cheese.

It says that the relative time you spend on cheese to wine is less in home than in foreign.

Assume ac=1 and aw=2 then ac/aw=1/2=0.5

Assume ac*=2 and aw*=1 then ac*/aw*=2/1=2

I.e. home country has to sacrifice (0.5) relatively less to produce one more unit of cheese than foreign country (2).

221
Q

What does this equation regarding autarchy wage say? w=Pc/ac=Pwa/w

A

What it says:

It says that the wage is equal to the price of one unit of cheese divided by the amount of hours it takes to produce one unit of cheese.

Assume that the price of one unit of cheese is 20 DKK, so Pc=20, and it takes 2 hours to produce one unit of cheese, so ac=2. Then the wage will be:

w=Pc / ac= 20 / 2=10

I.e. the autarchy wage is the value of a worker’s product.

It also says that the wage has to be the same for wine-workers, because there is free movement between sectors.

222
Q

Assume that ….

Which country has an absolute advantage in each good?

A

Cheese:

aCL < aCL*→1<6=home has an absolute advantage in producing cheese

Wine:

aCW < aCW*→2<3=home has an absolute advantage in producing wine

223
Q

Assume that ….

[image here]

Which country has an comparative advantage in each good?

A

Cheese:

aLC / aLW < aLC* / aLW*→1/2< 6/3→0.5<2

So home has a comparative advantage in producing cheese-

Wine:

aLW / aLC < aLW* / aLC*→2/1 > 3/6→2<0.5

So foreign has a comparative advantage in producing wine.

224
Q

What does this say; Pc/Pw = Ac/Aw?

A

Another way of writing autarchy wage:

w=Pc ac = Pw / aw

225
Q

Which countries are said to be more likely to gain from trade in the Ricardian model?

A

Countries with bad technology (low productivity). In other words, developing countries.

Remember that all countries weakly gains from trade in the Ricardian model.

226
Q

How is trade costs and distance related to comparative advantage?

A
  • Goods with a small comparative advantage, will be produced in both countries, if the trade costs / distance is high, as these costs outweigh the gains from the comparative advantage
  • Goods with a large comparative advantages will still be specialized in one of the countries.
227
Q

How do you calculate productivity in our international economics course?

A

(Factory output value - Factory input value) / Number of employees

228
Q

What is the pauper labor argument?

A

That trade with low wage countries hurt high wage countries.

This in somewhat true in the short-run for low-skilled workers who lose their jobs, but in the long-run the high wage country as well as the low-skilled worker who will educate themselves also gain.

229
Q

What is the firm’s problem and what does it say?

π=PC* k/ aC- rkk=0

A

π=PC* k/ aC- rkk=0

It says that your profit is equal to the price of clothes times the amount of clothes you can produce given the capital you have, minus the rent of capital times the capital you use. And it has to be equal to zero, because you don’t have any profits.

230
Q

Specific factors model: What is the relative supply for home in autarchy?

A

It says that, the relative supply is t / aF, which means how many units of food you can supply of the land you have. So if you have 100 arches of land and it takes 4 hours to produce one unit of food, you will get t / aF=100 / 4=25 units of food.

The same is true for k / aC.

So the whole term tells you how many units of food you can supply relative to the amount of clothes you can supply.

So, if you can produce 25 units of food, and 5 units of food, then the term will be 25 / 5=5, which will be you relative supply of food to clothes. I.e. you supply 5 times more food than clothes.

231
Q

Specific factors model: What is the relative supply when opening up to trade?

A
232
Q

Specific factors model: Who gains from trade?

A

Those who own the factor in which a country is relative abundant.

233
Q

Specific factor model: What did Paul Samuelson mean when he wrote the article “Ohlin was right”?

A

Ohlin said; If technology is shared, factor prices (Rk, Rt and w) will equalize across countries if factors can move, but not if only goods are traded.

In the real world however, factor prices differ a lot between countries. For example, the real wage of production workers in Nigeria is not equal to the real wage of Danish production workers.

234
Q

Specific factors model: What is the difference between the wage-equation for the 2-specific and 3-specific factors model?

A
  • 2-Specific: w = Pc/ac = Pf/aw (Price of good / hours spent on producing one unit of that good)
  • 3-Specific: w = MPLc * Pc = MPLw * Pw (Marginal product of labor in producing the good * the price of the good).
235
Q

Specific factors model: How can we also write this;

w = MPLc * Pc = MPLw * Pw ?

A

-(Pc / Pf) = -(MPLc / MPLf)

With this we can find the equilibrium wage by drawing a tangent line to the PPF.

236
Q

Assume capital (k) is used to produce clothing ( c) and land (t) is used to produce food (f), who will gain from trade in the 3-specific factor model if Pc/Pf increases?

A
  • Capital owners: Gain
  • Land owners: Lose
  • Labor: Indeterminate
237
Q

Specific factor model: How can we graphically show that all can get better off in the specific factor model with the right distribution of income?

A
238
Q

Using a simple MPLc curve, who gains from trade when the price of clothing (Pc) increases?

A

The capital owners will gain as w/Pf decreases as Pf increases, (and the landowners will lose as Pf decreases relative to w (w / Pf)).

Labor input increases in clothing and decreases in food production.
Note that the vertical axis is (w/Pc) and horizontal axis is labor input.

239
Q

HO: What does the Heckscher-Ohlin theorem say?

A

A country exports goods that are intensive in the factor they are abundant in, so Western Europe exports highskilled-labor intensive goods to Eastern Europe.

240
Q

HO: What does Rybczynski theorem say?

A

If a country gets more of a resource, then the output of the good that uses that resource intensively will rise while the output of the other good will fall.

Ex: if Denmark got more labor, it would increase its production of textiles OR if unskilled Iraqis come to Denmark, Denmark will be more abundant in unskilled-labor intensive goods and produce more of that.

241
Q

HO: What does Stolper-Samuelson theorem say?

A

A rise in the relative price of an output intensive in a factor will increase the real returns to that factor, and decrease returns to the other factor ⇒ A rise in the price of a final good for which a particular resource is more useful in production will increase the payments to that resource

Ex: if the price of textiles goes up, Chinese workers get higher wages

When opening up to trade, owners of factors in which the country exports will gain from trade, so unskilled labor will benefit when China opens up to trade.

SS = Stolper-Samuelson

242
Q
A
243
Q

HO: What does factor-price equalization say?

A

Trade should cause resource prices to converge

Ex: Danish and Chinese workers should be paid the same real wages.

(This is not the case in the real world though)

244
Q

HO: Name the 4 Heckscher-Ohlin theorems and what they stand for.

A
  • Heckscher-Ohlin
    • A country exports goods that are intensive in the factor they are abundant in, so Western Europe exports highskilled-labor intensive goods to Eastern Europe.
  • Stolper-Samuelson:
    • A rise in the relative price of an output intensive in a factor will increase the real returns to that factor, and decrease returns to the other factor
    • Ex: if the price of textiles goes up, Chinese workers get higher wages
    • When opening up to trade, owners of factors in which the country exports will gain from trade, so unskilled labor will benefit when China opens up to trade.
  • Rybchinsky:
    • If a country gets more of a resource, then the output of the good that uses that resource intensively will rise while the output of the other good will fall.
    • Ex: if Denmark got more labor, it would increase its production of textiles OR if unskilled Iraqis come to Denmark, Denmark will be more abundant in unskilled-labor intensive goods and produce more of that.
  • Factor-price equalization:
    • Trade should cause resource prices to converge
    • Ex: Danish and Chinese workers should be paid the same real wages.
245
Q

HO: What are the main problems of the HO model?

A
  • Proofs of the theorems require that both goods are produced in both countries.
  • The model assumes technology is the same everywhere
  • The model assumes that Capital cannot move
  • Output goods have the same price everywhere
246
Q

Standard trade model: how many countries, goods, and factors + how is the technology in the standard trade model?

A
247
Q

What are the four assumption for the theoretically grounded gravity equation?

A
  1. Prices increase with distance pij=pijdij
  2. Quality is proportional to price mi / pij=k for all i
  3. Number of goods is proportional to GDP (higher GDP means more goods) ni=GDP / q
  4. CES demand gij=ni(mi / pij) -01
248
Q

In the theoretical gravity, how much will exports fall if distance double when Ø=1?

A

Exports halves if distance doubles.

249
Q

What will happen with trade between DK and SE if we move Sweden into the middle of the Atlantic Ocean?

A

Indeterminate.

Two effects:

  1. Remoteness rises for both countries - increases trade (Rj = equation here)
  2. Distance increase - decreases trade (equation here)

However, we expect remoteness in Denmark to be affected much less, and therefore, we expect that Denmark will export relative less to Sweden than they will import from Sweden.

250
Q

What will happen with trade between DK and SE if we move Continental Europe into the middle of the Atlantic Ocean?

A

Increase in trade

  1. Remoteness of both countries rises
  2. Distance remains the same
251
Q

What will happen with trade between DK and SE if Denmark’s GDP grows?

A

Trade increases.

252
Q

What will happen with trade between DK and SE if China’s GDP grows?

A

Trade decreases.

Remoteness in both Denmark and Sweden falls. Hence, a reduction in trade between DK and SE.

253
Q

What is remoteness?

A

It measures the country’s set of alternatives. I.e. how many countries are around the country itself. If the country has many countries around (i.e. many alternatives) the remoteness falls. Hence, trade with each country falls a bit also.

It is the reason why, when we move Sweden into the Atlantic Ocean, that the remoteness rises for both countries, because Denmark do not have Sweden as close anymore, and Sweden will not have any European countries close anymore. However, Sweden’s set of alternatives decreases much more than Denmark’s set of alternatives. That is the reason we would expect a fall in the ratio of imports to Denmark from Sweden to exports from Denmark to Sweden.

254
Q

Why is Australia-New Zealand trade higher than Austria-Portugal trade when the distance and GDP is almost the same?

A

Because remoteness is much higher in Australia and New Zealand (i.e. few set of alternatives). Austria and Portugal have a lower remoteness because they have a lot more alternatives of trading-partners.

255
Q

In the naïve grative model, what happens if you double GDP of both countries?

A

Results in 4 times as much trade.

2*GPDi * 2*GDPj = 4*Xij

256
Q

Will the gravity model ever predict zero trade?

A

No, because the right-hand side is only positive numbers, so will never be zero. However, zero trade exist between Swaziland and Haiti

257
Q

What is the effect of a boarder?

A

The same as an increase of distance by 2,500 - 4,000 km.

258
Q

Standard trade model: where is our focus?

A

We focus on demand, whereas we in the other trade models has focused on supply and just made a curved demand curve.

259
Q

Standard trade model: Regarding biased growth; does it make a difference on prices, whether it is country A that is growing rather than country B?

A

It does not make a difference on relative prices.

Biased growth is focused on which good gets biased growth - NOT the country.

260
Q

Economies of scale: What is extensive margin and intensive margin?

A
  • Extensive margin: Number of firms exporting (only 18 % of American firms)
  • Intensive margin: How much each firm exports

Trade costs reduce both.

261
Q

What is the firm’s problem? (external economies of scale)

A
  • =P</sub>Q(L)-wL
  • w=P</sub>MPL

Firms get 0 profit.

262
Q

What is the average cost in external economies of scale?

A
  • π=P*Q-C(Q)*
  • oπ / oQ=P-C’(Q)*
  • → P=C’(Q)*

Average cost is equal to price (because of zero profits)

263
Q

How do the price-setting of firms affect their market share?

A

If all firm charge same price, they will have 1/n market share

P=P→Q=S / n

Because, when P=P, then (P-P)=0, so→ bx(P-P)=0, and we have that:

Q=S[1/n-0], which is that same as Q=S*1n→Q=S/n

If they charge lower price, then they will have higher market share

P>P→Q

If they charge higher price, they will have lower market share

P

S/n

264
Q

What are the three myths about gains from trade?

A
  1. Free trade is beneficial only if your country is strong enough to stand up to foreign competition.
  2. Foreign competition is unfair and hurts other countries when it is based on low wages (pauper labor argument).
  3. Trade exploits a country and makes it worse off if its workers receive much lower wages than workers in other nations.
265
Q

Specific factor: When will your PPF be squared, and when will it be bowed?

A

Squared: In autarchy, the PPF will be squared, as you can produce given the factors you have. So if you have 100 acres of land, you can only produce with this land, but it does not limit how much clothes you can produce with your capital.

Bowed: when trading

266
Q

What are terms of trade (TOT)?

A

Price of the good you export / price of the good you import

Remember: A worsening of TOT can never make to below autarchy!

267
Q

Is export-biased growth good or bad for Terms of Trade?

A

Bad! If supply of the good you export rises, then price rises, and Price of export / price of import (aka Terms of Trade) falls!

However, productivity growth usually increases income, even though it worsens TOT.

268
Q

Is import-biased growth good or bad for Terms of Trade?

A

Good! If supply of the good you import rises, then price rises, and Price of export / price of import (aka Terms of Trade) rises!

269
Q

Does absolute PPP imply relative PPP?

A

Yes

270
Q

Does relative PPP imply absolute PPP?

A

No

271
Q

Does Law of one price imply absolute PPP?

A

Yes

272
Q

There are many zeros in international trade data – for instance Swaziland has no trade with Haiti. Is there hope for a gravity equation to match these zero trade flows?

A

A gravity equation will never match a zero trade flow, because the right hand side of the gravity equation consists of strictly positive numbers multiplied together.

273
Q

Why does PPP do so badly?

A
  1. Trade barriers and non-tradable products (EXPLAINS WHY ABSOLUTE PPP PERFORMS POORLY)
    • Trade barriers (tariffs) cause a wedge in prices
    • Non-tradables enter the consumption basket
  2. Imperfect competition + Price-adjustments to markets
  3. Differences in measures of average prices for baskets of goods and services
    • Different “baskets” in countries
    • Different “baskets” over time in the same country
274
Q

What are the short-run and long-run effects of an increase in the money supply?

A
  • Short-run: As money supply increases, real money supply increases as PRICES are fixed and thus, R (interest rate) decreases and E increases (home currency depreciates)
  • Long-run: In the long-run (medium run in macroeconomics), real money supply returns to its initial level as PRICES increase.
    • Thus, a 10 % increase in money supply equals a 10 % increase in inflation in the long-run (medium run in macro).
    • E will be below its initial level due to overshooting.
    • R is back to initial level + (GNP) ⇒ Neutrality of money.
275
Q

Can a permanent change in the money supply affect the long-run exchange rate?

A
  • YES - the exchange rate E will not go back to its initial level due to either overshooting (Money supply increase) or undershooting (Money supply decrease).

The interest rate (R ) will be at its initial level, (GNP will also) and money market will be back at initial equilibrium ⇒ Neutrality of money.

276
Q

How does money supply, interest rates and output levels affect the exchange rate in the long run?

A
  • Money supply; permanent rise in money supply = permanent and proportional depreciation of that currency.
  • Interest rates: increased interest rate = decreases money demand = increase in the long-run price level ⇒ depreciation of currency. NOTE: this is the opposite of the short-run where an increase in interest rate is said to make the currency appreciate
  • Output levels: increased output = increased money demand = fall in long-run price level = appreciation of currency
277
Q

In equilibrium we have that P = AC (profit = 0). How can you show that P = MC and how do supply and demand look for constant, decreasing and increasing returns to scale?

A
278
Q

Aspiri: other topics (3); What happens when in an internal scale model, when a market opens to trade? Who benefits?

A

The market size increase.

279
Q

Aspiri: other topics (4); What might a CA surplus imply in the case of Germany?

A

CA Surplus = X > IM

That also means that Savings > investments (CA = S > I = X > IM).

A CA surplus can imply many things. In the case of Germany used in the question, the savings may be higher than investments due to the aging population, who save up to keep a certain standard of living during retirement.

280
Q

Aspiri: What does the naive gravity model predict?

A

The naive gravity model predicts that trade between two countries depends on only two factors, which is the size of the two economies (GDPi and GDPj) and the distance between the two countries (Dij)

Two things:

  • Size of the economy (positively)
  • Distance between the economies (negatively)
281
Q

Aspiri: What is included in distance? (dij)

A
  • Transportation costs
  • Time it takes to ship
  • Transaction costs
  • Cultural distance
  • Communication costs
  • ‘Other variables’
    • Border effect
    • Technology
    • Cultures and language (e.g. relating to colonies)
282
Q

Aspiri: What is g in the naïve gravity model?

A

A constant

283
Q

Aspiri: What is the definition of remoteness?

A

Remoteness is how far away a country is, and the more isolated you are the more you trade with your neighbour

284
Q

Aspiri: How is remoteness defined?

A

(equation here)

Remoteness is the sum of the GDP of all countries divided by distance

If dj goes up→Rj goes up

285
Q

Aspiri: What happens when all economies GDP double in the theoretically derived gravity model?

A

(equation here)

286
Q

Aspiri: What happens to Xij if a country, z increases its economy’s growth rate?

A

(equation here)

As the size of country Z’s economy increases, GDP-world increases ⇒ Rj decreases ⇒ Xij decreases.

287
Q

Aspiri: What is the unit labour requirement?

A

aL : ‘How many hours to produce one unit’

288
Q

Aspiri: What is definition of Marginal Product of Labour (MPL)?

A

MPL: ‘How many units produced in 1 hour’

289
Q

Aspiri: How are unit labour requirement and MPL related?

A

MPL=1 / aL → inverse relationship

Also Al = 1 / MPL

290
Q

Aspiri: What is the definition of opportunity costs?

A

The number of good x that could have been produced with the resources used to produce good y.

Rule to remember: when you say: ‘costs of x in terms of y’, then remember that the first good mentioned, i.e. x, will be over the second good mentioned, i.e. y.

Milk in terms of shoes would be written as:

aLM / aLS

Shoes in terms of milk would be written as:

aLS / aLM

291
Q

Aspiri: What are the two assumptions in the Ricardian model?

A
  1. Labour mobility
  2. Zero profit
292
Q

Aspiri: Ricardo: What are the relative prices equal to in AUTARCHY?

A

The relative price of good1 in terms of good2 (Pgood1/Pgood2) is equal to the opportunity cost of good1 in terms of good2 (agood1/agood2). AUTARCHY.

293
Q

Aspiri: What are the steps in the Ricardian model?

A

Step 1: Find the PPF for both countries (either with algebra or by finding intersection)

Step 2: Construct the world relative supply curve

Step 3: Determine the world demand equilibrium

294
Q

Aspiri: How do you find the PPF with by finding intersections?

A
295
Q

Aspiri: What are the three steps to draw the world relative supply curve (RS)?

A

Step 1: Draw graph and type in known opportunity costs

Step 2: Draw staircase

Step 3: Consider the 5 cases of specialization

296
Q

Aspiri: What are the 5 cases of specialization in the Ricardian model?

A
297
Q

How do we find demand and what do we do in case the demand function is written inversely of the relative prices of our graph?

A

Demand is usually given. If on our graph, the relative prices are Px/Py and the demand function given is: Dy/Dx = Px/Py we are all good to go.

However, it is more likely that the demand curve will be inverse of our graph’s relative prices.

For example as Dx / Dy = pyw / pxw = Qx+Qx* / Qy+Qy* (where our graph says Px/Py on the vertical axis)

So you have to find the inverse of the price relation, and you get that by:

298
Q

Aspiri: Ricardo; Assuming pxw / pyw = 1 / Qx+Qx* / Qy+Qy* is our demand function, how do we draw it?

A

To draw the demand curve, pick two (or more) values for Qx+Qx* / Qy+Qy* (your horizontal axis) and insert into the demand function to get your vertical axis value, the relative prices associated with the chosen relative demand-values.

Note: of course remember to draw the RD curve through the equilibrium value found earlier (your RS value, which you of course also set into the demand function).

299
Q

Aspiri: Ricardo; how can you show the gains from trade?

A

After having determined which country will specialize in what (if both specialize in something. One country could for example still produce both goods), you calculate each country’s NEW PPF by calculating what it can produce of the good it specializes in, and what the country can trade those units of that good into.

[attached image here]

REMEMBER TO ILLUSTRATE THE FINDINGS TOO BY DRAWING A NEW WORLD-PPF FROM THE NUMBERS CALCULATED.

300
Q

Aspiri: Ricardo; when trading, how can you calculate whether the wages in the two countries are equal or not?

A
301
Q

Aspiri: What is the primary difference between HO and the specific factor model?

A

HO is a long-run model where all factors can be used in the production of all goods.

  • Specific with land + capital for cloth and food: Qfood = (T, L) and Qcloth = (K, L)
  • HO with land + capital for cloth and food:
    • Qfood = (T, L) and Qcloth = (T, L)
    • Qfood = (K, L) and Qcloth = (K, L)
302
Q

Aspiri: What is the difference between intensity and abundance?

A
  • Intensity: Refers to goods
  • Abundance: Refers to countries
303
Q

Aspiri: HO; what does the HO-theorem say (1 of the 4 theorems)?

A

“Countries abundant in a factor will export the good intensive in that factor.

304
Q

Aspiri: HO; what does the Rybczynski-theorem say (1 of the 4 theorems)?

A

If a country’s relative amount of a factor increases, then the output of the good intensive in that factor will rise, while the output of the other good will fall (also in absolute terms).

305
Q

Aspiri: HO; what does the Stolper-Samuelson-theorem say (1 of the 4 theorems)?

A

A rise in the relative price of an output intensive in a factor will increase the relative returns to that factor, and decrease returns to the other factor.

306
Q

Aspiri: HO; what does the factor-price-equalization-theorem say (1 of the 4 theorems)?

A

Trade causes factor prices to converge.

307
Q

Aspiri: 3-Specific; When we worked with the Ricardian model, we learned about the following equation. How can it be used to find the equilibrium wage level when we don’t know the labor requirements?

A
  1. We realize that 1/alx is the same as MPLx.
  2. We now calculate the wage in terms of one of the goods. We choose good x
    • Wx = MPLx
  3. We now divide both sides of the equation with Px to get:
308
Q

Aspiri: 3-Specific; When we worked with the Ricardian model, we learned about the following equation. How can it be used to find the equilibrium wage level when we don’t know the labor requirements? (THE BLOMBERG-WAY THIS TIME)

A

This is good to know ⇒ By far the easiest way to find the equilibrium wage. However, the other method (another flashcard) is more in-depth with the explanation.

No matter which method is chosen, this will help spot the equilibrium wage quickly (good for double-checking or time-saving).

309
Q

Aspiri: 3-specific; If more workers start working in bacon-production and bacon is produced with land and labor will the capital owners win or lose? (capital used for TV-production)

A

Labor moved away from TV-production ⇒ MPLtv increases ⇒ Wage in TV increases ⇒ MPK decreases (wage expenses increase = lower margin).

They lose.

310
Q

Aspiri: 3-specific; If more workers start working in bacon-production and bacon is produced with land and labor will the landowners win or lose? (capital used for TV-production)

A

Labor moved towards bacon-production ⇒ MPLb decreases ⇒ Wage in bacon decreases = MPT increases (wage expense decrease = higher margin).

They win.

311
Q

Aspiri: 3-specific; what is the general rule for who wins and who loses?

A
  • Factors specific to a country’s exporting sector whose relative price increases, will gain from trade
  • Factors specific to a country’s importing sector, whose relative price decreases, will lose from trade.
  • Mobile factor (Labor) is ambiguous ⇒ depending on their consumption-choice.
312
Q

Aspiri: Jenkins special (2-specific): Explain why the equation hold and what you base that on:

A

Assumption:

Technology is the same for all countries so that ac = ac* and af = af*

+

Math:

If we divide an inequality by the same unit, we don’t change the inequality.

313
Q

Aspiri: Jenkins special (2-factor specific); Assume we have two factors, land and capital and two goods, food (f) and cloth (c ). How much can the owners of land and owners of capital consume in each good? (consumption)

A
314
Q

Aspiri: Jenkins special (2-factor specific); Assume we have two factors, land and capital and two goods, food (f) and cloth (c ). How are the owners of land and capital consume affected by an improvement in the technology to produce food? (we are in autarchy)

A
  • Land owners: ambiguous (as ambiguous in cloth consumption)
  • Capital owners: better off (as better off in food consumption)
315
Q

Aspiri: Jinkins special (2-specific); What is the firm’s problem and what do we use it for?

A

Used to show the number of a good (x) that can be bought from 1 input of a factor (in this case capital, k).

316
Q

Aspiri: Trade policy; when working with MD-XS-curves, what does the slope indicate?

A
  • The size of the economies
  • The country with the steepest curve will be most affected by the tariff.
317
Q

Aspiri: Trade policy; what assumption is important to state when imposing a tariff?

A

That the country imposing the tariff is large enough to affect world prices ⇒ Pt = Pt* + t (you start out by calculating Pt* and then add + tariff to P).

If extremely small and can’t affect world prices, then: Pt = Pworld + t

318
Q

Aspiri: Trade policy; What is the primary difference between import tariffs and the other trade policy tools?

A

Using the other trade policy tools, the gain will not go to the government but instead someone else, which might be domestic producers or a foreign country’s producers ⇒ Higher cost.

319
Q

Aspiri: Trade policy; why do all countries have a positive optimal tariff?

A

Since all countries can marginally affect the world prices Pw, all countries do in theory have an optimal tariff where E > B + D.

(it would not be the case, if we assume that a country is extremely small so it cannot affect world prices)

320
Q

Aspiri: Trade policy; Why don’t all countries impose their “optimal positive tariff”?

A

Because the concept of all countries having an optimal positive tariff is based on taking all other countries tariffs as given.

In the real world, imposing a tariff can lead to a trade-war so we end up in a “race to the bottom”. Therefore, we have organizations such as WTO to make long-term agreements avoiding trade-wars.

321
Q

Aspiri: Exchange rate determination; What is E?

A

E = Home currency / Foreign currency ===> E(DKK/USD)

⇒ The amount of Home currency it takes to buy 1 foreign currency.

⇒ That is E(DDK/USD) = 6.5.

322
Q

Aspiri: Exchange rate determination; what has happened if E increased?

A

If E has increased, our own currency has DEPRECIATED relative to the foreign currency.

It has become more expensive to buy 1 USD or 1 EURO or 1 GBP etc.

323
Q

Aspiri: Exchange rate determination; What is the exchange rate determined by in the short run?

A

The uncovered interest parity condition:

324
Q

Aspiri: Exchange rate determination; If domestic interest rate is given as 7 % and foreign interest rate is 5 % and the current exchange rate is 5, how would you find the expected exchange rate?

A
325
Q

Aspiri: Exchange rate determination; If domestic interest rate is given as 6 % and foreign interest rate is 5 % and the expected exchange rate is 5.1, how would you find the exchange rate?

A
326
Q

Aspiri: What does the Law of one price say?

A

Adjusted for different exchange rates, the prices of goods in different countries must be the same (Individual goods).

327
Q

Aspiri: What does PPP say?

A

PPP is ABSOLUTE PPP.

The prices of a basket of goods must be the same across countries when adjusted for different exchange rates.

328
Q

Aspiri: What does relative PPP say?

A

The percentage change in exchange rates between two currencies equal the percentage difference in prices.