TD test

Question 1

Smith advocates increasing customs taxes

Answer 1

False, Adam Smith was an advocate for free trade and argued against protectionism, including the use of customs taxes, which he believed would hinder economic growth and lead to higher prices for consumers.

Question 2

Smith believes that a country’s growth can only come from government intervention

Answer 2

False, Adam Smith believed in the power of free markets and competition to drive economic growth, and he argued that government should play a limited role in the economy.

Question 3

According to Smith, the division of labor is a factor in growth

Answer 3

True. According to Adam Smith, the division of labor is a key factor in economic growth and increased productivity. He argued that by dividing the production process into smaller, more specialized tasks, workers could become more efficient and productive, leading to higher levels of output and economic growth.

Question 4

According to Smith, the pursuit of individual interest leads to the general interest

Answer 4

True. Smith believed that the pursuit of individual self-interest would lead to greater efficiency, innovation, and competition in the economy, which would benefit everyone.

Question 5

According to Smith, the division of labor can be applied at the international level

Answer 5

True. Smith argued that the international division of labor was similar to the division of labor within a country and that it could lead to greater specialization, innovation, and competition in the global economy.

Question 6

According to Ricardo’s theory, countries should specialize in producing the good for which they have a comparative advantage. This means that…countries should specialize in those productions where they are most efficient compared to other countries

Answer 6

True, as countries should specialize in producing the goods in which they are most efficient compared to other countries, meaning that they can produce those goods at a lower opportunity cost than other countries.

Question 7

According to Ricardo’s theory, countries should specialize in producing the good for which they have a comparative advantage. This means that countries should specialize in those productions in which they are the most efficient or the least badly compared to other countries

Answer 7

False, as a country’s comparative advantage is not based on being the most efficient or the least badly compared to other countries, but rather on the concept of opportunity cost.

Question 8

According to Ricardo’s theory, countries should specialize in producing the good for which they have a comparative advantage. This means that countries need to protect their infant industries

Answer 8

False, as Ricardo argued against protectionism and for free trade.

Question 9

According to HOS trade theory, international trade specialization depends on

Answer 9

the relative factor endowments of each country

Question 10

International trade in the HOS model is considered

Answer 10

a perfect substitute to the exchange of factors of production between countries

Question 11

The Stolper-Samuelson theorem establishes that the increase in the relative price of a good

Answer 11

increases the real returns to the factor more intensely used in its production and reduces the returns to the other factor

Question 12

In 1953, Russian economist Wassily Leontief demonstrated that

Answer 12

US exports were more labor intensive and less capital intensive than US imports

Question 13

How can we describe factor endowments?

Answer 13

Endowments of factors such as labor and capital. Trade in the HOS model can be explained through the initial endowments available to each country:
Labor rich countries should therefore specialize in labor-intensive productions while capital rich countries in capital-intensive productions.

Question 14

Discuss the Leontief paradox. What are the implications for the HOS model?

Answer 14

Despite the United States being capital abundant, Leontief demonstrated that US exports were more labor than capital intensive compared to US imports. This contradictory finding was also made for several other developed nations. This finding largely undermines the HOS theory and plays in favor more Ricardian model where technological differences can better explain comparative advantage.

Question 15

T/F: Ricardo’s principle of comparative advantage states that the attractiveness of trade is clear when compared to prices under autarky. HOS contradicts this statement by arguing that the motive for trade springs from differences in factor endowments between countries. Explain.

Answer 15

False. Differences in factor endowments do not contradict the Ricardian model, which explains comparative advantage from the perspective of differences in productivity. Rather it adds an additional layer. In HOS, different factor endowments explain how prices shift from autarky to free trade, providing an argument in favor of trade.

Question 16

T/F: Country A has 200 units of capital and 250 units of labor, while country B has 100 units of capital and 100 units of labor. Capital-rich country A has an incentive to export vehicles, which are capital intensive, and to import textiles which are labor intensive. However, country B has no incentive to trade with country A because it has an equal measure of capital and labor. Explain.

Answer 16

False. What matters are relative and not absolute endowments in factors of production. Country B is relatively rich in capital compared to country A. As a result country A is relatively rich in labor. If we assume similar technologies and consumer behavior then country B has an interest in importing textiles, while country A has an interest in importing vehicles.

Question 17

According to Rybczynski’s theorem, the growth of a factor of production involves

Answer 17

an increase in the production of the good intensive in this factor and a decrease in the production of the other good

Question 18

The increase in one of the factors of production (i.e. capital) of a good will have what effect on the production of this good according to Rybczynski’s theorem?

Answer 18

Increase

Question 19

Rybczynski’s theorem considers that immigration will lead to lower wages.

Answer 19

False

Question 20

We speak of a factor price amplification effect when

Answer 20

Changes to factor prices alters the price of goods

Question 21

Explain how trade can actually increase poverty, in the form of “Immiserizing growth” as discussed by Indian economist Jagdish Bhagwati

Answer 21

International trade based on the specialization of nations can lead to impoverishing growth for some nations.
Indeed, when a country has a comparative advantage in a good, it will be able to increase the production and exports of this good, this can lead to a fall in the price of the exported good if the supply of the good is greater than its demand.
- Excess supply: the firm are obliged to sell the good at a low price
- Rising production leads to a deterioration in the terms of trade, which translates into a loss of income.
- When this loss of income is not offset by higher sales, the country becomes poorer while producing more.

Question 22

Describe the concept of “Dutch disease” in economics, what is its origin?

Answer 22

The “Dutch disease” affects certain oil producing countries. This paradox leads to too much specialization of activities in countries rich in natural resources (due to low production costs), which creates a dependence of these countries on these activities.
Thus, the economy of these countries risks being severely weakened in the face of an economic shock affecting these activities.
Dutch disease has its origins in the crisis in the Netherlands in the 1960s following the discovery of a natural gas deposit in the North Sea.
-the abundance of energy resources - a trade surplus - an appreciation of the exchange rate - a drop in exports.

Question 23

The new theories of international trade respond to the observation that:

Answer 23

• there is a gap between trade theory and the reality of international trade
• protectionism can in some cases be beneficial for a country, especially to stimulate local production
• A large part of international trade takes place between developed countries with very similar factor endowments

Question 24

Among the explanatory factors of intra-industry trade are:

Answer 24

• market structure
• research and development
• economies of scale

Question 25

In the Krugman (1979) model, economies of scale :

Answer 25

are sufficient to justify the benefits of trade

Question 26

In oligopolistic competition models trade gains come from:

Answer 26

reducing the distortion between price and marginal cost

Question 27

Describe the notion of “intra-industry trade” between countries. Why does this phenomenon disrupt traditional international trade theories (i.e. Smith, Ricardo and HOS)?

Answer 27

Traditional theories of international trade emphasize the differences between nations in terms of productivity or factor endowments as a source of competitive advantage.
In reality, however international trade develops intensively between the most developed nations whose factor endowments differ little.
“Intra-industry trade” concerns the export and import by a country of the same good, and its share of trade is non-negligible between developed countries.

Question 28

Imperfect competition and increasing returns to scale.

Answer 28

One type of imperfect competition is monopoly, a situation in which there are many buyers and only one supplier.

In this case, the dynamics of supply and demand are not respected. The firm is a price maker and chooses the price and quantity that maximises profit.

There is also the case of monopolistic competition, where a small number of firms act not only on the price of their product but also on its quality. In this case, products are differentiated.

Increasing returns to scale refer to a situation where as the scale of production increases, the cost per unit of output decreases, leading to greater efficiency and profitability.

Question 29

What are internal versus external economies of scale?

Answer 29

We speak of internal economies of scale specific to a firm: the average cost of production decreases with the increase in the quantity produced by the firm, independently of the total quantity of the good produced in the sector.
The term external economies of scale refers to the cost structure of the sector: the average cost decreases as the size of the sector increases.

Question 30

According to Adam Smith, a country that sells a product cheaper than all other countries has a comparative advantage in that product

Answer 30

False, a country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than another country

Question 31

Country A has an absolute advantage over country B for two goods. According to Adam Smith’s trade theory there is no justification for trade

Answer 31

False, even if Country A can produce both goods at a lower cost than Country B, it may still be more efficient for Country A to specialize in producing the good in which it has a greater absolute advantage, while Country B specializes in producing the other good

Question 32

For Ricardo, free exchange of goods is not profitable for all nations.

Answer 32

False, for Ricardo, free exchange of goods is profitable for all nations because it allows each country to specialize in producing the goods in which it has a comparative advantage and trade with other countries for goods in which it has a comparative disadvantage.

Question 33

The opportunity cost for one additional unit of product X is equal to:

Answer 33

The amount of product Y that must be sacrificed or used to produce an additional unit of product X.

Question 34

When two countries decide to engage in trade, the price of the same product Y produced in both countries will:

Answer 34

converge towards a unified price

Question 35

What is absolute advantage and what is comparative advantage?

Answer 35

Adam Smith: Absolute advantage is the ability of a nation to produce a good or service using fewer resources than another nation In other words, absolute advantage is a measure of productivity. Each nation should therefore specialize in the products that it produces most efficiently.

David Ricardo: Even where a nation has no absolute advantage, it can specialize in the production of goods for which it has a lower oppurtunity cost compared to other nations. A nation should therefore specialize in the production of goods where it has a relatively higher level of productivity.
International trade is always mutually beneficial as soon as countries differ

Question 36

What is an important limit to Adam Smith’s theory of international trade?

Answer 36

The major limitation of Adam Smith’s theory is that if a nation possesses no absolute advantage in the production of any good, there is no point in specialization for the purposes of trade.

Question 37

To what extent is trade between nations beneficial to all involved?

Answer 37

Trade is beneficial from the Ricardian perspective as it allows nations to specialize in the production of certain goods. Economies of scale means that nations that specialize can exchange these goods with other countries, reaping the benefits of trade. In tangible terms, specialization means:
* Spreading fixed costs over a larger quantity of goods produced
* Lower unit production costs
* Learning for greater efficiency. Trade also facilitates the transfer of technology, which means that nations can learn from others and build more sophisticated industries.

Question 38

When a firm has a monopoly…

Answer 38

Profit maximum = MR = MC

Question 39

When a firm is perfectly competitive …

Answer 39

Profit maximum is price = MC

Question 40

Why would coutries trade?

Answer 40

• Successful integration into international trade leads to economic growth and higher incomes.
• facilitates the exchange of technology, raw materials, capital and labour factors
• Reduces inequalities between countries
• provides access to goods that do not exist locally
• enables buying cheaper products
• enables buying better quality products

Question 41

What is Smiths theory?

Answer 41

Each country has an interest in specializing in the production of the good for which it has an absolute advantage.

Countries do not have access to the same production techniques and for a given sector, they have different labor productivities. A country has an AA in a sector if the labor productivity in that sector is higher than that of the other country in the same sector.

Smith shows that international specialization leads to a better allocation of resources between sectors at the international level and allows more to be produced overall with the same resources.

Question 42

What is Ricardo’s theory?

Answer 42

Comparative Advantage

To determine who holds a CA in which sector, it is necessary to compare the opportunity costs of an asset between two countries.

A comparative advantage consists in benefiting from a relative lower price in one good due to a relative higher productivity (from technological differences)

Shows a mutual gain as long as countries specialize along their comparative advantages.

Opportunity cost:The opportunity cost of a good expresses the number of units of the other good that must be given up in order to produce one unit of the good in question.

Question 43

Is it possible to have a CA without an AA?

Answer 43

Yes

Question 44

What determines the international specialization of countries?

Answer 44

CA

Question 45

a firm in monopolistic competition will set a price equal to:

Answer 45

the point of intersection between average cost and demand

Question 46

Internal economies of scale are incompatible with… and compatible with…

Answer 46

Incompatible with the principle of perfect competition
and Compatible with monopolistic competition

Question 47

With external economies of scale, we can show that:

Answer 47

Trade is beneficial even if two countries are endowed with the same factors, technology and productivity

The two countries always benefit from trade

Question 48

In Krugman’s model, product differentiation is :

Answer 48

Horizontal

Question 49

In the reciprocal dumping model, it is shown that:

Answer 49

The benefits of trade depend partly on transport costs

Each firm discriminates between its domestic and foreign market

Question 50

Economic analysis has found that intra-industry trade should be correlated

Answer 50

Positively with the smaller distance separating countries

Question 51

As more firms enter the market and competition increases prices fall (PP curve). Why does average total cost (ATC) increase for each firm?

Answer 51

As more firms enter the market, the quantity sold by each firm reduces, which increases average total production cost (TC/q).

Question 52

Explain why absolute advantage should not impede specialization

Answer 52

Even if a country has an absolute advantage in producing all goods or services, it can still benefit from specialization and trade

Question 53

Differences between HO and Ricardian model

Answer 53

The HO model considers two factors of production whereas Ricardo considers only one factor in his analysis of comparative advantage.

According to the HO model, countries do not completely stop producing the goods they import, but they produce them in smaller quantities.

Question 54

What does the Stolper-Samuelson theory state?

Answer 54

When the price of a good increases, the real wage of the factor of production that is used intensively in the production of that good will increase, while the real return on the other factor of production will decrease.

Question 55

The HOS model

Answer 55

• Countries will export goods that use their abundant factor intensively, and import goods that use their scarce factor intensively.
• It assumes that factors of production are mobile within a country, but immobile between countries, meaning that capital and labor cannot easily move between countries.
• It also assumes that production functions are the same across countries, and that trade occurs in a frictionless, perfectly competitive market.
• Allows for partial specialization and mutual gains

Question 56

Krugman’s New Trade Theory

Answer 56

Suggests that firms that specialize in producing differentiated products can create a “monopolistic competition” in which each firm has a degree of market power and can charge a higher price than the marginal cost of production. This creates an incentive for firms to increase production and lower their costs, which can lead to economies of scale

Question 57

Rybczynski’s theorem

Answer 57

The theorem states that an increase in the endowment of one factor of production (e.g., labor) will increase the production of the good that uses that factor intensively and decrease the production of the other good

For example, suppose a country increases its endowment of labor. According to Rybczynski’s theorem, this will lead to an increase in the production of the labor-intensive good and a decrease in the production of the capital-intensive good. As a result, the relative price of the labor-intensive good will decrease, and the relative price of the capital-intensive good will increase.

Question 58

Economies of Scale

Answer 58

Refer to the cost advantages that arise when the scale of production increases. In other words, as a firm produces more units of a product, the cost per unit of output decreases, leading to greater efficiency and profitability.

Question 59

Oligopolistic competition

Answer 59

A market structure characterized by a small number of firms that dominate the market.
In an oligopoly, each firm’s actions affect the behavior of the other firms in the market.
The firms are interdependent, meaning that they must take into account the actions of their competitors when making decisions.

Question 60

Who was David Ricardo?

Answer 60

Broker, economist, Member of Parliament (1819-1823)
Argues in favor of free trade in British parliament

Question 61

What gains are there from Ricardo’s model?

Answer 61

Global gain

Instead of countries trading factors of production, they trade goods to achieve efficiency. This leads to a concentration of production in countries where workers are relatively more productive, which results in an increase in global output.

Mutual gain

There is a mutual gain from international trade as long as the global price is between the two autarky prices

Question 62

Complete specialization

Answer 62

Each country focuses on the production of the good on which it as a comparative advantage, and abandons the other good (as long as demand functions allows it).
* The two countries gain from trade, but the gain is not necessarily identical.
* The greater the difference between autarky and global price, the greater the gain.

Question 63

Origins of gains from trade

Ricardo

Answer 63

Ricardo (and TTT) goes against Mercantilism perception that gains from trade comes from exports.

• Gains from trade comes from imports, which are more efficiently produced elsewhere, allowing us to focus on what we’re productive at.
• Contrary to the political focus put on trade imbalances

Question 64

Empirically testing the Ricardian Model

Answer 64

Difficult to test empirically because it assumes a simplified world with only two countries, two goods, and no trade costs. This does not accurately reflect the complexities of the real world.

Also may not explain all types of trade flows, as it focuses on the exchange of goods that are different between countries that are different.

Question 65

Empirical Issue in estimating Ricardo’s theory

Answer 65

• Missing production.
• How to measure productivity if specialization already complete? - Good not produced.
• Also issue with non tradable goods.

Question 66

Limits to Ricardo’s Theory

Answer 66

Hardly adaptable to multi country & multi-industry model
* Only one production factor
* Other sources of comparative advantage than labor productivity?

Ricardian model implies complete specialization patterns if mutual benefits
to trade.
* But partial specialization more frequent in reality

Question 67

Production capabilities frontiers

Answer 67

Ricardo’s model: linear
- constant returns to scale
- constant marginal productivities

HOS model: concave
- constant returns to scale
- different factor intensities
- decreasing marginal productivities

Question 68

What happens to factor prices when 2 countries engage in free trade?

Answer 68

leads to international convergence of factor
prices as long as both countries haven’t reached complete specialization.

Question 69

Why only convergence in factor prices if partial specialization?

HOS Theory

Answer 69

HOS theory- free trade of goods leads to international convergence of factor prices as long as both countries haven’t reached complete specialization.

Convergence occurs as a result of redeployment of factors between sectors.

If complete specialization reached. No more redeployment.

It is not trade itself that leads to factor prices’ convergence. But
redeployment.

Partial specialization allows countries to trade with other countries for goods that use their scarce factor(s) of production intensively

Question 70

Leontief Paradox : possible explanations

Answer 70

Technologies in the U.S and in the rest of the world are not identical.
* contrary to HOS assumption. Perhaps it uses labor more efficiently than others.
* HOS weren’t considering other factors. (land, etc.)
* Nor heterogeneous factors (K et L) : e.g : skilled/unskilled labor
* Creates frictions at factors redeployment.

Question 71

By introducing two factors that are imperfect substitutes, HOS predicts..

Answer 71

Imperfect substitutes - means that they cannot be used interchangeably with one another in the production process

HOS theory predicts that factor prices will be endogenous (relative prices of factors in each sector will vary according to their endowments and relative specialization)

This process of reallocation of factors takes time, so equilibrium is reached before complete specialization.

Question 72

Are traditional trade theories sufficient to explain international trade?

Answer 72

No
The majority of trade takes place between similar countries

• TTTs seem verified when we restrict trade to highly different countries
• But not when explaining trade between similar countries

Question 73

Inter v Intra Industry Trade

Answer 73

• Trade in different goods : inter
• Trade in similar goods : intra

Question 74

Classifications in Intra-industry trade

Answer 74

The classification systems provide a standardized method for categorizing products based on their characteristics, which helps to facilitate trade negotiations and agreements, as well as the monitoring of trade flows.
This is why we have a lot more data on international trade than domestic trade.

Harmonized System (HS) - HS codes are used to classify products based on their characteristics, such as their composition, function, and intended use. This allows countries to easily identify and track the products being traded and to apply the appropriate tariffs or quotas based on the category of the product.

Question 75

What would be the consequence of using a very detailed classification (where only exact same products are in the same category) ?

Answer 75

Could provide more granular information about trade flows, but it can also create challenges in comparing data, increase administrative burdens, and impact trade negotiations.

Question 76

Different goods VS differentiated goods

Answer 76

Different goods : Do not involve the same lines of production (e.g.wheat/cars)
* Differentiated goods : Similar goods that only vary on some characteristics, but require the same lines of production
* Vertical differentiation : quality / perfomance differences.
* Horizontal differentiation : subjective criteria (e.g. color)

Question 77

Intra-industry Trade : International comparisons

Answer 77

• IIT is more frequent in most developed countries
• IIT is more important (and grew more) for intermediate and final goods than for primary goods.
• Particularly noticeable for EU countries

Question 78

Can we Disentangle Vertical From Horizontal IIT trade flows?

Answer 78

Can disentangle vertical If the unit price of exports and imports differ much, there must be a substantial quality difference between goods.

Otherwise, the differentiation should be horizontally made.

Question 79

Innovation and Trade - relationship

Answer 79

Clear link between countries spending the most in R&D and export performance
Could be read in terms of Comparative Advantages : Innovation generates a comparative advantage
But these R&D countries also largely trade in IIT. Innovation generates IIT gains.

Question 80

New Trade Theories

Answer 80

• focus on trade in similar goods between
  similar countries
• Krugman (1979), Lancaster (1980), Helpman (1981)
• Increasing returns to scale gives incentives for countries to specialize into
  some goods and trade for others, even in absence of any differences between countries.

Question 81

The Krugman model

Answer 81

Based on monopolistic competition.

Krugman insists on giving firms some importance, while they were absent from TTTs.
* Focus on Intra-Industry Trade : only one industry is considered.
* Several domestic firms compete, but they each have some monopolistic power on their own variety of good
- Gives firms some market power, they are therefore “price-makers”
* Firms benefit from Internal Increasing Returns : the more they produce, the lower their average costs.
* Consumer demand for variety is also important in determining international trade, as new firms producing new varieties can attract demand away from existing firms. If the price of one firm’s product increases, some consumers may shift their demand to its competitors.

Question 82

In NTT we may find…

Answer 82

• Global gain from trade as there is an increase in quantity compared to autarky.
• However, it may not always lead to optimal production if the entry into the market is delayed. This can lead to some countries losing out, particularly the infant industry
• Possibility of firms exiting the market - if there is full employment, this is not an issue. However, if the redeployment of laid-off workers faces frictions, it can lead to unemployment.

Question 83

What is the most important characteristic about exporters according to Melitz?

Answer 83

Productivity - efficiency in turning inputs into output

Question 84

The Melitz Model

Answer 84

• expands the Krugman model
• explains why some firms choose to export their products while others do not
• firms face fixed costs associated with exporting their products. Firms that choose to export must pay these costs upfront, regardless of the quantity of goods they export. This means that firms must be able to generate enough revenue from exporting to cover these fixed costs.
• also assumes that firms differ in their productivity levels.
• predicts that the most productive firms will be the ones that choose to export, while less productive firms will focus on the domestic market

Question 85

Free Trade in Melitz

Answer 85

• the Melitz model is different from previous models because it focuses on the effects of deepening free trade, rather than just comparing autarky to free trade.
• the Melitz model shows that increased trade openness can make it easier for firms to access foreign markets, but it also means increased competition from highly productive foreign firms, which can make survival more difficult for local firms.

Question 86

Melitz: Free trade and exit of firms.

Answer 86

In the Melitz model, free trade can lead to the exit of some firms from the domestic market because increased competition from highly productive foreign firms raises the level of productivity needed for survival.

Differs from Krugman model, which did not include the possibility of firms exiting the market.

At the same time, free trade makes it easier for firms to become exporters to foreign markets. This is because reduced foreign access costs make it easier for firms to access foreign markets and compete with foreign firms.

Question 87

Melitz v Krugman

Answer 87

Both the Melitz and Krugman models show that increased trade can lead to an increase in total output and average productivity, but the Melitz model also has some new results.

First, the Melitz model predicts that increased productivity leads to higher wages for workers.

Second, the Melitz model predicts that increased competition from foreign firms can lead to a decrease in profitability for purely domestic firms.

Question 88

Foreign direct investment (FDI)

Answer 88

involves a company from one country investing in and managing operations in another country. This can be done through mergers and acquisitions, establishing a subsidiary, or through joint ventures with a local company in the host country.

Question 89

Why are FDI’s hard to measure?

Answer 89

• Lack of data: Data on FDI can be difficult to obtain, especially in developing countries
• There is no universal definition of FDI, and different countries may have different definitions of what constitutes an FDI.
• FDI can take many forms and each of these investment types has different reporting requirements and may be recorded differently by different countries
• Complex ownership structures

Question 90

Two modes of FDIs

Answer 90

• Greenfield: When a firms creates a new entity abroad
• Merger and acquire (M&A) (or “brownfield”): Ownership transfer of an existing firm.
  
  • M&A fasten the production process, but at a higher cost.
  • Large “deals” foster FDI volatility

Question 91

Entry modes of firms into
foreign markets during an FDI :

Answer 91

• Wholly Owned Subsidiary (WOS) - a company owns 100% of the shares of another company.
• Joint-Venture: shared ownership and control with another “parent-firm”

Question 92

Why Firms have started to do more and more FDIs since the 1980s? and not earlier?

Answer 92

• ICT: New technologies : allows a better coordination of internationally spread activities, at a decreasing costs
• Openness: Rising openness of worlds’ market to trade and capital flows.
• Decreasing Trade costs.
  ⇒ It suddently became technically and legally possible, and economically interesting for firms to consider investing abroad.

Question 93

Dunning (1980): Internationalization of firms requires three “advantages”

Answer 93

• Ownership: Firms should own a “specific asset” other don’t.
• Without this advantage, firms would not have an incentive to invest overseas
• A high productivity can be seen as a specific asset of the firm.
• Location: The host country should offer something that domestic production doesn’t have.
• Better (direct) access to local consumers and Cheaper production
• Internalization: The investing firm should be incentivised to internalize the process rather than going though arm’s length trade
  (outsourcing to a foreign independent contractor).

Question 94

Helpman’s expansion of Melitz Model

Answer 94

Helpman extended the Melitz model to explain why some firms choose to engage in FDI rather than exporting their products to foreign markets. They proposed a proximity-concentration tradeoff, where firms can choose to reach foreign consumers either through FDI or exports.

• FDI allows firms to establish a physical presence in a foreign market, which reduces the unit transport costs of their products
• Exporting involves concentrating production in a single domestic plant, which lowers fixed costs but increases transport costs.

Most productive firms would choose FDI

Less productive firms would export their products (lower fixed costs)

Question 95

2 main motives of FDIs

Answer 95

Horizontal FDI: When a firm invests in a foreign market to avoid trade costs and overcome the proximity-concentration dilemma. This is a market-driven motive.

Vertical FDI: This is when a firm invests in a foreign market to take advantage of lower production costs. This is a production-driven motive.

Both types of FDI can either substitute for or complement trade.

Question 96

Evolution of FDI motives

Answer 96

• Historically, horizontal FDI, which aim to avoid trade costs, has been the most common type of FDI. The stock of FDI is largely composed of horizontal FDI.
• However, recent FDI flows show a shift in FDI motives, with destinations becoming more diverse, especially outside of OECD countries.
• In addition, there is an increasing share of FDI going to developing countries, while the share going to developed countries is decreasing.

Question 97

Why are vertical FDI usually done by the most productive firms?

Answer 97

• Requires a significant amount of resources and capabilities - the investing firm needs to have a high level of knowledge and expertise in that stage of production.
• Cost per unit of gain is only worth it at a big production scale
• Can be risky - only the most productive firms with strong risk management capabilities are likely to be able to successfully navigate these risks

Question 98

Are FDIs good for the origin country?

Answer 98

• Positive effect : FDIs can increase the efficiency and competitiveness of domestic firms
• Negative effect : FDIs can lead to capital flight, which can cause job destruction if companies move operations offshore.

Question 99

Evolution of Trade Theories

Answer 99

Mercantilism (16th to 18th century): This was the first systematic theory of international trade, which argued that a country’s wealth could be measured by its holdings of gold and silver

Classical Trade Theories (18th and 19th century): Adam Smith and David Ricardo developed theories of international trade based on the principle of comparative advantage.

Neoclassical theories of trade, including the Heckscher-Ohlin theory and the Stolper-Samuelson theorem, emphasized the role of factor endowments, such as labor and capital, in determining patterns of trade. These theories suggested that countries would specialize in producing goods that used their abundant factors of production and import goods that used their scarce factors.

New trade theories, (Melitz and Krugman) such as the monopolistic competition model and the product differentiation model, challenged the assumption of perfect competition and suggested that economies of scale, product differentiation, and strategic behavior could drive international trade.

Recent developments in trade theory have focused on issues such as globalization, outsourcing, and the impact of trade on income distribution. There has been increased attention paid to the role of trade in creating winners and losers, and the need for policies to support workers who are negatively impacted by trade.

Question 100

Globalization

Answer 100

Refers to the increasing integration of national economies and the convergence towards a global market of goods, capital, and services.

However, this process is not yet complete and is influenced by factors such as trade barriers and differing preferences around the world.

Globalization can bring about changes in a country’s labor demand, wages, and international trade, including increased competition and new markets, as well as fluctuations in interest and exchange rates due to capital flows.

Question 101

Specialization

Answer 101

Specialization refers to a situation where one country exports more of a certain good than other countries.
This specialization usually reflects the country’s ability to produce that good efficiently.

Benefits - increased efficiency and economies of scale

Risks - increased vulnerability and lower diversification. Some specialization patterns may even result in negative consequences, such as the Dutch disease.

Question 102

Infant industry

Answer 102

Refers to a new and developing industry in a country that may not yet have a comparative advantage in that industry.

In order to become competitive, the industry may require protection and support from the government in the form of subsidies or tariffs on imported goods.

With time, the infant industry will become more efficient and competitive, and the government can remove the protectionist measures.

Question 103

Stages of Globalisation

Answer 103

16th-17th century: International trade began to increase with the establishment of imperial frameworks like the East India Company, but it still only accounted for a small percentage of global GDP.

“First globalization”: From 1820 to 1914, Western Europe saw a significant increase in international trade due to the industrial revolution and the dissociation of production and consumption locations, allowing for specialization and trade. This accounted for up to 14% of world GDP.

“Second globalization”: From 1945 to 1990, the US and USSR led the world in increased trade of industrial and agricultural goods. There was a greater involvement of the rest of the world, leading to the end of the North/South economic divide. This period saw the development of an institutional framework of international trade, and it was associated with a strong worldwide economic growth.

“Third globalization”: From 1990 to the present day, there has been a change in the nature of globalization, known as the “Second Unbundling” by Baldwin (2006). There has been a fragmentation of production processes and the development of global value chains, leading to a rise in trade volume, productivity, and catching up of developing countries, especially China. However, this period also saw an increase in within-country inequalities and vulnerability to risks.

Question 104

What indicator is used for intra-industry trade and what does it measure?

Answer 104

The Grubel-Lloyd (GL) index is commonly used as an indicator for intra-industry trade.

It measures the proportion of two-way trade (exports and imports) in a given industry that is intra-industry trade, i.e., the trade of similar products within the same industry.

The index ranges from 0 to 1, with 0 indicating only inter-industry trade and 1 indicating only intra-industry trade.

Question 105

Intra-industry trade: Explanation for demand and supply side

Answer 105

Demand side: Love of Variety” hypothesis.
- Consumers demand a variety of goods, and as a result, firms produce a variety of differentiated products.

Supply side: Economies of scale
- Allows firms to produce more efficiently as they increase the scale of production, then they can sell their products at lower prices, which makes their products more attractive to consumers in other countries. This leads to the export of similar products to other countries

Question 106

Globalisation Indexes

Answer 106

• KOF Globalization Index: This index is based on three main dimensions of globalization: economic, social, and political. It takes into account indicators such as trade, capital flows, foreign direct investment, tourism, and internet usage.
• Global Connectedness Index (GCI): This index measures the degree of international flows of trade, capital, information, and people. It takes into account indicators such as the number of exports and imports, the amount of foreign investment, and the number of international phone calls and internet traffic

Question 107

Scarcity of exporting firms in a country

Answer 107

lack of access to information
lack of resources to overcome export barriers
lack of economies of scale
preference to focus on the domestic market

Question 108

Who believed that if countries were more open to trade, the share of exporting firms would increase?

Answer 108

Melitz

Question 109

Recent evolution of FDI flows

Answer 109

• Characterized by a decline in recent years
• Global FDI flows decreased by 35% in 2020, reaching the lowest level in decades - attributed to the economic impact of the COVID-19 pandemic
• Have been characterized by a shift in their geographic distribution, with developing economies becoming more important as recipients of FDI
• Has been an increase in the importance of cross-border mergers and acquisitions (M&A) as a source of FDI.

Question 110

Explain how IDEs are multidimensional.

Answer 110

International direct investments
- can be inbound (investment made by foreign companies in the domestic market) or outbound (investment made by domestic companies in foreign markets).
- can be motivated by various factors such as resource seeking, market seeking, strategic asset seeking , efficiency seeking or diversification
- can be made through different modes of entry such as greenfield investment, mergers and acquisitions, joint ventures or licensing

Question 111

How is the relative share of developing countries changing in FDI destinations?

Answer 111

• Increasing in recent years
• Developing countries are becoming more attractive FDI destinations because of their large and growing markets, abundant natural resources, and low labor costs
• This trend reflects the strategy of Multinational Corporations (MNCs) to diversify their investments and expand their operations in new markets.

Question 112

Nations engage in intra-industry trade for two main benefits:

Answer 112

Fosters product development, innovation, and skill development
Economies of scale

Question 113

Perfect competition vs imperfect competition

Answer 113

Perfect competition refers to a market structure in which there are many small firms that are producing homogenous goods. No single firm has the ability to influence the price of the product, and all firms are price-takers. No barriers to entry and exit.

Imperfect competition refers to a market structure in which firms have some degree of market power, which allows them to influence the price of the product. Imperfect competition includes various market structures, such as monopolistic competition, oligopoly, and monopoly

Question 114

The Gravity Equation

Answer 114

• predicts the volume of trade between two countries based on their economic sizes and the distance between them.
• suggests that the costs of trade increase with distance, which can help explain why countries tend to trade more with nearby countries than with distant ones.