Section 15

Question 1

NAFTA

Answer 1

North American Free Trade Agreement
Avocados :)
Shoes :(

Question 2

Comparative advantage

Answer 2

Comparative advantage: the comparison among producers of a good according
to their opportunity cost. A producer is said to have a comparative advantage in
the production of a good if the opportunity cost is lower than of another
producer

Question 3

The theory of comparative advantage

Answer 3

The theory of comparative advantage: countries should specialize in producing
the goods with the lowest opportunity cost, produce a surplus of goods, and then
trade with other nations.

Question 4

Interdependence and Gains From Trade

Answer 4

▪ Allowing some trade is better than not allowing any.
➢ But it does not say that everything that happens in the international economy
makes everyone better off.
➢ Some people will gain others could also lose.

Question 5

New Trade Theory

Answer 5

▪ Models of trade based on comparative advantage (e.g. Ricardian model) use the
assumptions of constant returns to scale, homogenous products and perfect
competition.
▪ New trade theory: models that assume increasing returns to scale, network effects, products differentiation, love of variety, transport costs, environmental
costs, imperfect competition etc.
▪ Welfare conclusions on the effects of trade policies can be different.
➢ “These new models call into doubt the extent to which actual trade can be
explained by comparative advantage; they also open the possibility that
government intervention in trade via import restrictions, export subsidies, and so
on, may under some circumstances be in the national interest after all.”

Question 6

Effects of Trade 1

Answer 6

▪ If the government allowed the country to import and export olive oil, what
would happen to the price and quantity of olive oil sold in the domestic
market?
▪ Who would gain from free trade of olive oil and who would lose, and would the
gains exceed the losses?
▪ Should a tariff (a tax on olive oil imports) or an import quota (a limit on olive oil
imports) be part of the new trade policy?

Question 7

Effects of Trade 2

Answer 7

▪ The effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good.
▪ The world price refers to the price that prevails in the world market for that good.
➢ If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporter of the good
(Pdomestic < Pworld).
➢ If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an
importer of the good (Pdomestic > Pworld).

Question 8

Trade Policies

Answer 8

▪ World trade create conflicts between the interests of consumers and the interests of producers.
▪ Cheap imports benefit consumers but hurt domestic producers.
▪ Export subsidies benefit the producers but hurt the consumers.
▪ The economics of commercial policy analyzes the costs and benefits of different
instruments.

Question 9

Possible Trade Policies

Answer 9

Possible Trade Policies:
 Tariff: tax on goods produced abroad and sold domestically
 Tariffs raise the price of imported goods above the world price by the amount of the tariff
 Import Quota (=Kontingent): limit on the quantity of a good that can be produced abroad and sold domestically (government sell import licenses)

Question 10

Arguments for Restricting Trade

Answer 10

 Jobs
 National Security (increases dependence on other countries)
 Infant Industry (New industries need trade restrictions to get started)
 Unfair Competition (Free trade is only desirable if all countries have the same rules (good job
safety, no child exploitation, same environmental standards and taxes…))
 Environment and trade

▪ Some of these arguments have some merit; economists generally believe that
free trade is usually the better policy.
▪ However, free trade strategies should be designed and implemented in order to
be sustainable from an environmental and social point of view.

Question 11

Interesting Use of Commercial Policy Instruments

Answer 11

Starting point: a good
commercial policy (Tariff, Quota,..)
should pass a double test:
* The policy instrument must
work in the sense that it
brings about a socially
desirable objective.
* It must do so at a lower
cost, in terms of welfare,
than any other available
instrument.

▪ Example mountain farmers: Society may want
to protect the livelihood of farmers in the Alps
with a tariff on milk.
▪ Society feels that these people, with their
traditional, stable way of life and with their
activities in the Alps contribute to maintain and
improve common natural resources and
traditions.
▪ Is this the best instrument (import tariff on
milk)?
- Not really ➔ this is a second-best
argument/solution because there is a better
way of protecting mountain farmers at a lower
cost for consumers ➔ subsidy system