IE2016Q4

Question 1

What is the naïve gravity model?

Answer 1

Question 2

What is the full gravity model? (Theoretically derived)

Answer 2

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.

Question 3

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

Answer 3

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.

Question 4

What is a comparative advantage?

Answer 4

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

Question 5

What does a straight-lined PPF tell us?

Answer 5

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

Question 6

When does a country have an absolute advantage?

Answer 6

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.

Question 7

What is autarchy?

Answer 7

The state where no countries trade with each other.

Question 8

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

Answer 8

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

Question 9

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

Answer 9

• a_c / a_q

The nominator is taken from the horizontal axis.

Question 10

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

Answer 10

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.

Question 11

What is the conclusion of the Ricardian model?

Answer 11

• 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.

Question 12

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

Answer 12

Question 13

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

Answer 13

• 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

Question 14

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

Answer 14

• 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).

Question 15

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?

Answer 15

Question 16

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

Answer 16

- MPL_C / MPL_F

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

Question 17

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

Answer 17

• 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.

Question 18

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

Answer 18

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).

Question 19

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

Answer 19

• 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.

Question 20

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

Answer 20

The value of a worker’s product.

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

w = P_c*MPL_c = P_f*MPL_f

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

Derivative of profit = P_c*MPL_c - w = 0

Question 21

What is TTIP?

Answer 21

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

Question 22

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

Answer 22

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

Question 23

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

Answer 23

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).

Question 24

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

Answer 24

• 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.

Question 25

Why do countries trade in the specific factors model?

Answer 25

The abundance of factors; factor endowments.

Question 26

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

Answer 26

False.

Being abundant in a factor is like a comparative advantage.

Thus Home is abundant in K if:

K/T > K*/T*

Question 27

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

Answer 27

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.

Question 28

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

Answer 28

Yes.

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

Question 29

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

Answer 29

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

Thus, it is indeterminate.

Question 30

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

Answer 30

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.

Question 31

What does the Heckscher-Ohlin theorem say?

Answer 31

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.

Question 32

What does Rybczynski theorem say?

Answer 32

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.

Question 33

What does Stolper-Samuelson theorem say?

Answer 33

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

Question 34

What does factor-price equalization say?

Answer 34

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)

Question 35

What is an isovalue line and what does it show?

Answer 35

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.

Question 36

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

Answer 36

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.

Question 37

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

Answer 37

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).

Question 38

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

Answer 38

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.

Question 39

What does the Heckscher-Ohlin theorem predict?

Answer 39

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

Question 40

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

Answer 40

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.

Question 41

What is the Leontief paradox?

Answer 41

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.

Question 42

What is the conclusion on the Heckscher-Ohlin theory:

Answer 42

• 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.

Question 43

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

Answer 43

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

Question 44

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

Answer 44

• 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.

Question 45

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

Answer 45

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

Question 46

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

Answer 46

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

Question 47

What is the slope of an isovalue line?

Answer 47

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

Question 48

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

Answer 48

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

Question 49

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

Answer 49

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

Question 50

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

Answer 50

• 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.

Question 51

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

Answer 51

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

Question 52

What is biased growth and what are its drivers?

Answer 52

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.

Question 53

Why do countries trade in Heckscher-Ohlin model?

Answer 53

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

Question 54

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

Answer 54

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.

Question 55

How many factors are there in the standard HO model?

Answer 55

2 factors.

Question 56

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

Answer 56

Final goods (output).

Question 57

How many theorems are there in HO?

Answer 57

4 theorems.

Question 58

Name the theorems of HO

Answer 58

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

Question 59

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?

Answer 59

Pc/Pf will fall

Question 60

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).

Answer 60

Question 61

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.

Answer 61

Question 62

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

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

Answer 62

Home will go to autarchy

Question 63

What is export-biased and import-biased growth?

Answer 63

• 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

Question 64

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

Answer 64

• 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

Question 65

What are terms of trade (TOT)?

Answer 65

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

Question 66

Debate: Denmark should admit more immigrants

Answer 66

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

Question 67

What is immiserizing growth?

Answer 67

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.

Question 68

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.

Answer 68

• 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

Question 69

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

Answer 69

Constant returns to scale

Question 70

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

Answer 70

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.

Question 71

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

Answer 71

• 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)

Question 72

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

Answer 72

• 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.

Question 73

What characterizes industries with external economies of scale?

Answer 73

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.

Question 74

What characterizes industries with internal economies of scale?

Answer 74

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

Question 75

What are the three main advantages of clustering?

Answer 75

• Specialized suppliers
• Labor market pooling
• Knowledge spillover

Question 76

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

Answer 76

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.

Question 77

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

Answer 77

• 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.

Question 78

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

Answer 78

History coincidences.

First-mover advantages.

Question 79

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

Answer 79

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).

Question 80

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

Answer 80

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.

Question 81

What does dynamic increasing returns refer to?

Answer 81

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

Question 82

What is the infant industry argument?

Answer 82

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

Question 83

What is the poverty trap?

Answer 83

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.

Question 84

What does internal economies of scale imply?

Answer 84

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

Question 85

What does imperfect competition imply on prices?

Answer 85

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

Question 86

When will imperfect competition occur? (2 situations)

Answer 86

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

Question 87

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

Answer 87

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

Question 88

What affects the MR line?

Answer 88

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.

Question 89

What are the two assumptions of monopolistic competition?

Answer 89

• 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

Question 90

Explain the following equation:

Answer 90

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.

Question 91

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

Answer 91

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.

Question 92

What does this model show?

Answer 92

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.

Question 93

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

Answer 93

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))

Question 94

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

Answer 94

• 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.

Question 95

What is intra-industry trade?

Answer 95

Two-way exchanges of similar goods.

0. 97 = nearly equal import and export
1. 10 = unequal import/export (in this case import is much higher than export

Question 96

A firm with a lower marginal cost will do what?

Answer 96

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

Question 97

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

Answer 97

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

Question 98

What is the difference between horizontal and vertical FDI?

Answer 98

• 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

Question 99

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

Answer 99

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.

Question 100

What is offshoring?

Answer 100

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.

Question 101

What is the strong assumption behind partial equilibrium models?

Answer 101

Neither incomes nor other prices change.

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

Question 102

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

Answer 102

• 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.

Question 103

What are nontariff barriers?

Answer 103

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

Question 104

How is Home’s import demand curve derived?

Answer 104

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

Question 105

How is Foreigns’ export supply curve derived?

Answer 105

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

Question 106

What does MD = XS say?

Answer 106

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

Question 107

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

Answer 107

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

Question 108

Who wins and who lose when imposing tariffs?

Answer 108

• 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).

Question 109

How do you calculate and find consumer surplus graphically?

Answer 109

Length x width x 0.5

Question 110

How do you calculate and find producer surplus graphically?

Answer 110

Question 111

Explain who gains and who loses from an export subsidy

Answer 111

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.

Question 112

What are quota rents?

Answer 112

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

Question 113

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

Answer 113

Question 114

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

Answer 114

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.

Question 115

What is a VER?

Answer 115

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.

Question 116

What is a local content requirement?

Answer 116

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.

Question 117

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

Answer 117

• 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

Question 118

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

Answer 118

• 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.

Question 119

How is government revenue gain calculated?

Answer 119

Government revenue gain = tariff * Q

Question 120

In summary what are the effects of a tariff?

Answer 120

Question 121

In summary what are the effects of an export subsidy?

Answer 121

Question 122

In summary what are the effects of an import quota?

Answer 122

Question 123

In summary what are the effects of a VER?

Answer 123

Question 124

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

Answer 124

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

Question 125

What are the arguments for free trade?

Answer 125

• 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

Question 126

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

Answer 126

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.

Question 127

What are the arguments against free trade?

Answer 127

• 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.

Question 128

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

Answer 128

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.

Question 129

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

Answer 129

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

Question 130

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

Answer 130

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.

Question 131

What is the theory of the second best?

Answer 131

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.

Question 132

What are the advantages of international negotiation of tariffs?

Answer 132

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

Question 133

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

Answer 133

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)

Question 134

What was the primary focus of the Doha round?

Answer 134

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.

Question 135

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

Answer 135

• 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)

Question 136

What is trade creation and trade diversion?

Answer 136

• 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.

Question 137

What is trade creation?

Answer 137

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.

Question 138

What is trade diversion?

Answer 138

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.

Question 139

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

Answer 139

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.

Question 140

What is the strategy of import-substituting industrialization?

Answer 140

Encouraging domestic industries by limiting imports of manufactured goods.

Question 141

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

Answer 141

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

Question 142

Has trade liberalization of developing countries since 1985 proved successful?

Answer 142

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.

Question 143

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

Answer 143

Hong Kong, South Korea, Taiwan and Singapore.

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

Question 144

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

Answer 144

• 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.

Question 145

What is the argument behind subsidizing high-tech industries?

Answer 145

It is all about knowledge spillover to other industries.

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

Question 146

What are beggar-thy-neighbor policies?

Answer 146

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.

Question 147

What is the Brander-Spencer argument?

Answer 147

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.

Question 148

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

Answer 148

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

Question 149

What is the Kuznets curve?

Answer 149

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.

Question 150

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

Answer 150

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.

Question 151

What is the median voter theory?

Answer 151

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.

Question 152

What is the theory of collective action?

Answer 152

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

Question 153

What is GNP?

Answer 153

Gross National Product

Question 154

How do economists and statisticians divide GNP?

Answer 154

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

Question 155

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

Answer 155

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”

Question 156

What is national product equal to?

Answer 156

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

Question 157

What is the difference between GDP and GNP?

Answer 157

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

Question 158

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

Answer 158

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

Question 159

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

Answer 159

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.

Question 160

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

Answer 160

• 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.

Question 161

What is the current account balance?

Answer 161

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

CA = EX - IM

Question 162

How can a country keep running a trade deficit?

Answer 162

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

Question 163

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

Answer 163

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

Question 164

What is fiat money?

Answer 164

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.

Question 165

Debate: Sweatshops are bad for poor workers

Answer 165

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

Question 166

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

Answer 166

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.

Question 167

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

Answer 167

• Debit; when a native pays a foreigner
• Credit; when a foreigner pays a native

Question 168

What is official foreign exchange intervention?

Answer 168

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.

Question 169

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

Answer 169

S = Y - C - G

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

S = I (closed economy)

S - CA = I (open economy)

Question 170

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

Answer 170

Closed: by building up its capital stock.

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

Question 171

What is private saving and government saving?

Answer 171

Sp = Y - T - C

Sg = T - G

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

Question 172

What should you remember about every international transaction?

Answer 172

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.

Question 173

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

Answer 173

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

Question 174

What are the keywords regarding fluctuations of exchange rates?

Answer 174

• Depreciations and appreciations.
• Devaluation and revaluations.

Question 175

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

Answer 175

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.

Question 176

Who are the major actors in the foreign exchange market?

Answer 176

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

Question 177

What is a vehicle currency?

Answer 177

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.

Question 178

What is the difference between spot and forward exchange rates?

Answer 178

• 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.

Question 179

What is a foreign exchange swap?

Answer 179

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

Question 180

What is the real rate of return?

Answer 180

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

Question 181

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

Answer 181

• Risk
• Liquidity

But we are ignoring these factors in our equilibrium analysis.

Question 182

What is the rate of depreciation and rate of appreciation?

Answer 182

• 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.

Question 183

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

Answer 183

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

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

Question 184

What is the interest parity condition?

Answer 184

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)

Question 185

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

Answer 185

We expect it to appreciate further

Question 186

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

Answer 186

We expect it to depreciate further.

Question 187

Explain what will happen if we are in point 2?

Answer 187

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)

Question 188

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

Answer 188

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

Question 189

What does “Yield” refer to?

Answer 189

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

Question 190

What is money supply in international economics?

Answer 190

M1; the money supply by the central bank.

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

Question 191

What are the functions of money?

Answer 191

• 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)

Question 192

What three things determine the demand for money?

Answer 192

• 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

Question 193

What three things affect aggregate money demand and how?

Answer 193

• 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

Question 194

What is the money demand function?

Answer 194

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

Question 195

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

Answer 195

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

Question 196

When is the money market in equilibrium?

Answer 196

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

Question 197

What happens to the domestic currency when money supply increases?

Answer 197

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).

Question 198

How are prices determined in the long run?

Answer 198

P = Money supply / L(R, Y)

P = Money supply / Money demand

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

Question 199

What is the inflation rate equal to?

Answer 199

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

Question 200

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

Answer 200

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)

Question 201

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

Answer 201

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)

Question 202

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

Answer 202

• 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

Question 203

What is exchange rate overshooting?

Answer 203

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.

Question 204

Debate: Denmark should adopt the Euro

Answer 204

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

Question 205

Does the current account sum to zero?

Answer 205

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

Question 206

Does the balance of payments sum to zero?

Answer 206

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.

Question 207

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?

Answer 207

Question 208

What is the law of one price?

Answer 208

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.

Question 209

What is the theory of PPP?

Answer 209

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)

Question 210

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

Answer 210

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

Question 211

What is the idea of relative PPP?

Answer 211

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.

Question 212

How is the economy affected by ongoing money supply increases?

Answer 212

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.

Question 213

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

Answer 213

• 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

Question 214

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

Answer 214

• 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.

Question 215

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)).

Answer 215

• 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

Question 216

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

Answer 216

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

Question 217

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

Answer 217

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

Only two properties can be reached simultaneously.

Question 219

What does this equation say?

Answer 219

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.

Question 220

How can you show a comparative advantage?

Answer 220

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 a_c=1 and a_w=2 then a_c/a_w=1/2=0.5

Assume a_c*=2 and a_w*=1 then a_c*/a_w*=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).

Question 221

What does this equation regarding autarchy wage say? w=P_c/a_c=P_wa/_w

Answer 221

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 P_c=20, and it takes 2 hours to produce one unit of cheese, so a_c=2. Then the wage will be:

w=P_c / a_c= 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.

Question 222

Assume that ….

Which country has an absolute advantage in each good?

Answer 222

Cheese:

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

Wine:

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

Question 223

Assume that ….

[image here]

Which country has an comparative advantage in each good?

Answer 223

Cheese:

a_LC / a_LW < a_LC* / a_LW*→1/2< 6/3→0.5<2

So home has a comparative advantage in producing cheese-

Wine:

a_LW / a_LC < a_LW* / a_LC*→2/1 > 3/6→2<0.5

So foreign has a comparative advantage in producing wine.

Question 224

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

Answer 224

Another way of writing autarchy wage:

w=P_c a_c = P_w / a_w

Question 225

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

Answer 225

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

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

Question 226

How is trade costs and distance related to comparative advantage?

Answer 226

• 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.

Question 227

How do you calculate productivity in our international economics course?

Answer 227

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

Question 228

What is the pauper labor argument?

Answer 228

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.

Question 229

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

π=P_C* k/ a_C- r_kk=0

Answer 229

π=P_C* k/ a_C- r_kk=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.

Question 230

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

Answer 230

It says that, the relative supply is t / a_F, 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 / a_F=100 / 4=25 units of food.

The same is true for k / a_C.

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.

Question 231

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

Answer 231

Question 232

Specific factors model: Who gains from trade?

Answer 232

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

Question 233

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

Answer 233

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.

Question 234

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

Answer 234

• 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).

Question 235

Specific factors model: How can we also write this;

w = MPLc * Pc = MPLw * Pw ?

Answer 235

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

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

Question 236

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?

Answer 236

• Capital owners: Gain
• Land owners: Lose
• Labor: Indeterminate

Question 237

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?

Answer 237

Question 238

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

Answer 238

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.

Question 239

HO: What does the Heckscher-Ohlin theorem say?

Answer 239

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.

Question 240

HO: What does Rybczynski theorem say?

Answer 240

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.

Question 241

HO: What does Stolper-Samuelson theorem say?

Answer 241

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

Question 243

HO: What does factor-price equalization say?

Answer 243

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)

Question 244

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

Answer 244

• 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.

Question 245

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

Answer 245

• 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

Question 246

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

Answer 246

Question 247

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

Answer 247

1. Prices increase with distance p_ij=p_ijd_ij
2. Quality is proportional to price m_i / p_ij=k for all i
3. Number of goods is proportional to GDP (higher GDP means more goods) n_i=GDP / q
4. CES demand g_ij=n_i(m_i / p_ij) -⁰¹

Question 248

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

Answer 248

Exports halves if distance doubles.

Question 249

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

Answer 249

Indeterminate.

Two effects:

1. Remoteness rises for both countries - increases trade (R_j = 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.

Question 250

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

Answer 250

Increase in trade

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

Question 251

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

Answer 251

Trade increases.

Question 252

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

Answer 252

Trade decreases.

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

Question 253

What is remoteness?

Answer 253

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.

Question 254

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

Answer 254

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.

Question 255

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

Answer 255

Results in 4 times as much trade.

2*GPDi * 2*GDPj = 4*Xij

Question 256

Will the gravity model ever predict zero trade?

Answer 256

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

Question 257

What is the effect of a boarder?

Answer 257

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

Question 258

Standard trade model: where is our focus?

Answer 258

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

Question 259

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?

Answer 259

It does not make a difference on relative prices.

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

Question 260

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

Answer 260

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

Trade costs reduce both.

Question 261

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

Answer 261

• =PQ(L)-wL</sub>
• w=PMPL</sub>

Firms get 0 profit.

Question 262

What is the average cost in external economies of scale?

Answer 262

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

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

Question 263

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

Answer 263

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

Question 264

What are the three myths about gains from trade?

Answer 264

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.

Question 265

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

Answer 265

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

Question 266

What are terms of trade (TOT)?

Answer 266

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

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

Question 267

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

Answer 267

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.

Question 268

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

Answer 268

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

Question 269

Does absolute PPP imply relative PPP?

Answer 269

Yes

Question 270

Does relative PPP imply absolute PPP?

Answer 270

No

Question 271

Does Law of one price imply absolute PPP?

Answer 271

Yes

Question 272

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?

Answer 272

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.

Question 273

Why does PPP do so badly?

Answer 273

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

Question 274

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

Answer 274

• 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.

Question 275

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

Answer 275

• 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.

Question 276

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

Answer 276

• 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

Question 277

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?

Answer 277

Question 278

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

Answer 278

The market size increase.

Question 279

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

Answer 279

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.

Question 280

Aspiri: What does the naive gravity model predict?

Answer 280

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)

Question 281

Aspiri: What is included in distance? (d_ij)

Answer 281

• 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)

Question 282

Aspiri: What is g in the naïve gravity model?

Answer 282

A constant

Question 283

Aspiri: What is the definition of remoteness?

Answer 283

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

Question 284

Aspiri: How is remoteness defined?

Answer 284

(equation here)

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

If d_j goes up→R_j goes up

Question 285

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

Answer 285

(equation here)

Question 286

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

Answer 286

(equation here)

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

Question 287

Aspiri: What is the unit labour requirement?

Answer 287

a_L : ‘How many hours to produce one unit’

Question 288

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

Answer 288

MPL: ‘How many units produced in 1 hour’

Question 289

Aspiri: How are unit labour requirement and MPL related?

Answer 289

MPL=1 / a_L → inverse relationship

Also Al = 1 / MPL

Question 290

Aspiri: What is the definition of opportunity costs?

Answer 290

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:

a_LM / aLS

Shoes in terms of milk would be written as:

a_LS / a_LM

Question 291

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

Answer 291

1. Labour mobility
2. Zero profit

Question 292

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

Answer 292

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.

Question 293

Aspiri: What are the steps in the Ricardian model?

Answer 293

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

Question 294

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

Answer 294

Question 295

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

Answer 295

Step 1: Draw graph and type in known opportunity costs

Step 2: Draw staircase

Step 3: Consider the 5 cases of specialization

Question 296

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

Answer 296

Question 297

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?

Answer 297

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:

Question 298

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

Answer 298

To draw the demand curve, pick two (or more) values for Q_x+Q_x* / Q_y+Q_y* (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).

Question 299

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

Answer 299

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.

Question 300

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

Answer 300

Question 301

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

Answer 301

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)

Question 302

Aspiri: What is the difference between intensity and abundance?

Answer 302

• Intensity: Refers to goods
• Abundance: Refers to countries

Question 303

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

Answer 303

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

Question 304

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

Answer 304

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).

Question 305

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

Answer 305

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.

Question 306

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

Answer 306

Trade causes factor prices to converge.

Question 307

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?

Answer 307

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:

Question 308

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)

Answer 308

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).

Question 309

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)

Answer 309

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

They lose.

Question 310

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)

Answer 310

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

They win.

Question 311

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

Answer 311

• 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.

Question 312

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

Answer 312

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.

Question 313

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)

Answer 313

Question 314

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)

Answer 314

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

Question 315

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

Answer 315

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

Question 316

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

Answer 316

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

Question 317

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

Answer 317

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

Question 318

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

Answer 318

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.

Question 319

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

Answer 319

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)

Question 320

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

Answer 320

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.

Question 321

Aspiri: Exchange rate determination; What is E?

Answer 321

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.

Question 322

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

Answer 322

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.

Question 323

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

Answer 323

The uncovered interest parity condition:

Question 324

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?

Answer 324

Question 325

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?

Answer 325

Question 326

Aspiri: What does the Law of one price say?

Answer 326

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

Question 327

Aspiri: What does PPP say?

Answer 327

PPP is ABSOLUTE PPP.

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

Question 328

Aspiri: What does relative PPP say?

Answer 328

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