Chapter 2 : Proplem
1. The gravity model is often used not only to explain trade between two countries but also
to investigate the reasons why they don’t. Illustrate this anomaly with suitable examples and
reasons.
2. Ireland and Belgium have very similar trading patterns. Both trade considerably more with
the United States than with the European Union (EU), even though they are EU members
and are closer to the EU common market than the American market. Explain this anomaly
using the gravity model.
3. Equation (2-1) says that trade between any two countries is proportional to the product of
their GDPs. Does this mean that if the GDP of every country in the world doubled, world
trade would quadruple?
4. Over the past few decades, East Asian economies have increased their share of world GDP.
Similarly, intra–East Asian trade—that is, trade among East Asian nations—has grown as a
share of world trade. More than that, East Asian countries do an increasing share of their
trade with each other. Explain why, using the gravity model.
5. A century ago, most British imports came from relatively distant locations: North America,
Latin America, and Asia. Today, most British imports come from other European countries.
How does this fit in with the changing types of goods that make up world trade?
Chapter 8: Proplem
1. In perfect competition, firms set price equal to marginal cost. Why can’t firms do this
when there are internal economies of scale?
2. Suppose the two countries we considered in the numerical example on pages 208–212
were to integrate their automobile market with a third country and a fourth country, which
have an annual market for 2 million and 1 million automobiles, respectively. Find the number
of firms, the output per firm, and the price per automobile in the new integrated market
after trade
. 3. Suppose that fixed costs for a firm in the automobile industry (start-up costs of factories,
capital equipment, and so on) are $7.5 billion and that variable costs are equal to $20,000
per finished automobile. Because more firms increase competition in the market, the market
price falls as more firms enter an automobile market or specifically, P = 20,000 + 2007n,
where n represents the number of firms in a market. Assume that the initial size of the U.S.
and the European automobile markets are 400 million and 650 million people, respectively
. a. Calculate the equilibrium number of firms in the U.S. and European automobile markets
without trade.
b. What is the equilibrium price of automobiles in the United States and Europe if the
automobile industry is closed to foreign trade? 230 PART ONE ■ International Trade Theory
c. Now suppose the United States decides on free trade in automobiles with Europe. The
trade agreement with the Europeans adds 533 million consumers to the automobile market,
in addition to the 300 million in the United States. How many automobile firms will there be
in the United States and Europe combined? What will be the new equilibrium price of
automobiles?
d. Why are prices in the United States different in (c) and (b)? Are consumers better off with
free trade? In what ways?
4. Go back to the model with firm performance differences in a single integrated market (pp.
206–208). Now assume a new technology becomes available. Any firm can adopt the new
technology, but its use requires an additional fixed-cost investment. The benefit of the new
technology is that it reduces a firm’s marginal cost of production by a given amount.
a. Could it be profit maximizing for some firms to adopt the new technology but not profit
maximizing for other firms to adopt that same technology? Which firms would choose to
adopt the new technology? How would they be different from the firms that choose not to
adopt it?
b. Now assume there are also trade costs. In the new equilibrium with both trade costs and
technology adoption, firms decide whether to export and also whether to adopt the new
technology. Would exporting firms be more or less likely to adopt the new technology
relative to nonexporters? Why?
5. In the chapter, we described a situation where dumping occurs between two symmetric
countries. Briefly describe how things would change if the two countries had different sizes.
a. How would the number of firms competing in a particular market affect the likelihood that
an exporter to that market would be accused of dumping? (Assume the likelihood of a
dumping accusation is related to the firm’s price difference between its domestic price and
its export price: the higher the price difference, the more likely the dumping accusation.)
b. Would a firm from a small country be more or less likely to be accused of dumping when
it exports to a large country (relative to a firm from the large country exporting to the small
country)?
6. Which of the following are foreign direct investments?
a. A Chinese company pays $6.49 million for a stake in the Hilton.
b. A Russian businessman buys $44 billion on FOREX.
c. An American company buys another American company; stockholders in the bought U.S.
company sell their shares on FOREX. d. A Turkish company builds a factory in Ethiopia and
manages the factory as a contractor to the Turkish government
. 7. For each of the following, specify whether the foreign direct investment is horizontal or
vertical; in addition, describe whether that investment represents an FDI inflow or outflow
from the countries that are mentioned.
a. Vodafone (a U.K.-based company) plans to improve its network and services in Romania
after the results in this market lagged behind other countries.
b. General Electric (an American company) buys Alstom (another American company) energy
assets. CHAPTER 8 ■ Firms in the Global Economy: Export and Foreign Sourcing Decisions
231
c. Exxon (an American company) plans the construction of new delayed coker unit in
Belgium.
d. Petro China (a Chinese company) plans to invest in global oil and natural gas assets in a
venture in Western Australia
. 8. If there are internal economies of scale, why would it ever make sense for a firm to
produce the same good in more than one production facility?
9. Most firms in the apparel and footwear industries choose to outsource production to
countries where labor is abundant (primarily, Southeast Asia and the Caribbean)—but those
firms do not integrate with their suppliers there. On the other hand, firms in many capital-
intensive industries choose to integrate with their suppliers. What could be some differences
between the labor-intensive apparel and footwear industries on the one hand and capital-
intensive industries on the other hand that would explain these choices?
10. Consider the example of industries in problem 9. What would those choices imply for the
extent of intra-firm trade across industries? That is, in what industries would a greater
proportion of trade occur within firm
Chapter 9 : Problem
1. Home’s demand curve for books is D = 50 - 10P. Its supply curve is S = 10 + 10P. Derive and
graph Home’s import demand schedule. What would the price of books be in the absence of
trade?
2. Now add Foreign, which has a demand curve D* = 60 - 10P and a supply curve S* = 20 +
10P.
a. Derive and graph Foreign’s export supply curve and find the price of books that would
prevail in Foreign in the absence of trade.
b. Now allow Foreign and Home to trade with each other, at zero transportation cost. Find
and graph the equilibrium under free trade. What is the world price? What is the volume of
trade?
3. Home imposes a specific tariff of 1.5 on books imports.
a. Determine and graph the effects of the tariff on the following: (1) the price of books in
each country; (2) the quantity of books supplied and demanded in each country; (3) the
volume of trade
. b. Determine the effect of the tariff on the welfare of each of the following groups: (1)
Home import-competing producers; (2) Home consumers; (3) the Home government
. c. Show graphically and calculate the terms of trade gain, the efficiency loss and the total
effect on welfare of the tariff.
4. Suppose Foreign had been a much smaller country with domestic demand. D* = 8 - 2P, S*
= 4 + 2P. (Notice that this implies the Foreign price of books in the absence of trade would
have been the same as in Problem 2). Recalculate the free trade equilibrium and the effects
of a 1.5 specific tariff by Home. Relate the difference in results to the discussion of the small-
country case in the text.
5. What would be the effective rate of protection on bicycles in China if China places a 50
percent tariff on bicycles, which have a world price of $200, and no tariff on bike
components, which together have a world price of $100?
6. For a company that produces candy canes, sugar is 70 percent of its ingredient costs. The
United States limits the imports of sugar to protect cane farmers, which has led to an
increase in the price of sugar by about 25 percent relative to what it would be otherwise.
Suppose your country, however, allows free trade in candy canes, which are made with sugar
that accounts for approximately 65 percent of its cost. What is the effective rate of
protection on the process of turning sugar into candy canes?
7. Return to the example of Problem 2. Starting from free trade, assume that Foreign offers
exporters a subsidy of 1.5 per unit. Calculate the effects on the price in each country and on
welfare, both of individual groups and of the economy as a whole in both countries. 262
PART TWO ■ International Trade Policy
8. Use your knowledge about trade policy to evaluate each of the following statements:
a. “Tariffs on imported goods will increase domestic price, leading to high unemployment.”
b. “High tariffs and quotas can result in trade wars between nations.”
c. “Smartphone manufacturing jobs are heading back to the U.S. because wages started to
rise in China. As a result, we should implement tariffs on smartphones equal to the
difference between the U.S. and China’s wage rates.”
9. The nation of Cologne is “large,” but unable to affect world prices. It imports chocolate at
the price of $20 per box. The demand curve is: D = 700 - 10P. The supply curve is S = 200 + 5P.
Determine the free trade equilibrium. Then calculate and graph the following effects on an
import quota that limits imports to 50 boxes:
a. The increase in the domestic price.
b. The quota rents
. c. The consumption distortion loss.
d. The production distortion loss.
10. If tariffs are already in place as a trade policy, why might a country choose to apply
nontariff barriers also as another way to control the amount of trade that they conduct with
other countries?
11. Suppose workers involved in manufacturing are paid less than all other workers in the
economy. What would be the effect on the real income distribution within the economy if
there were a substantial tariff levied on manufactured goods?
Chapter 10 : Problem
1. “For a small country like the Philippines, a move to free trade would have huge
advantages. It would let consumers and producers make their choices based on the real costs
of goods, not artificial prices determined by government policy; it would allow escape from
the confines of a narrow domestic market; it would open new horizons for entrepreneurship;
and, most important, it would help to clean up domestic politics.” Separate and identify the
arguments for free trade in this statement. 300 PART TWO ■ International Trade Policy
2. Which of the following are potentially valid arguments for tariffs or export subsidies, and
which are not? Explain your answers.
a. “Dairy producers earning in Wales are at their lowest peak despite an overall rise in farm
business incomes.”
b. “The more ecologically certified foods European Union requires, the higher the price of
these products will be on common market.”
c. “US soybean exports to China and India don’t just mean increased wealth for farmers—
they mean increased wealth for everyone in the value chain.”
d. “The PET industry continued to sustain U.S. recycling programs; this shows the strength of
the PET recycling market in the face of significant global economic slowdown and a drop in
virgin feedstock prices.”
e. “The price of coal has been stable, but the production dropped 10.3 percent, and workers
have been forced to look for other jobs.”
3. A small country can import a good at a world price of 5 per unit. The domestic supply
curve of the good is S = 10 + 10P. The demand curve is D = 600 - 5P. In addition, each unit of
production yields a marginal social benefit of 15.
a. Calculate the total effect on welfare of a tariff of 10 per unit levied on imports.
b. Calculate the total effect of a production subsidy of 10 per unit.
c. Why does the production subsidy produce a greater gain in welfare than the tariff?
d. What would the optimal production subsidy be?
4. Suppose demand and supply are exactly as described in Problem 3, but there is no
marginal social benefit to production. However, for political reasons, the government counts
a dollar’s worth of gain to producers as being worth $5 of either consumer gain or
government revenue. Calculate the effects on the government’s objective of a tariff of 10 per
unit.
5. Upon Poland’s entering the European Union, suppose it is discovered that the cost of
automobile production in Poland is €20,000 while it is €30,000 in Germany. Suppose the EU,
which has a customs union, has an X percent tariff on automobiles and the costs of
production are equal to Y (valued in euros) in Japan. Comment on whether the addition of
Poland to the European Union would result in trade creation or trade diversion under the
following scenarios
: a. X = 50, and Y = :18,000
b. X = 100, and Y = :18,000
c. X = 100, and Y = :12,000
6. “China gives its aluminum industry an unfair advantage through underpriced loans and
other illegal government subsidies. These kinds of policies have disadvantaged American
manufacturers and contributed to the global glut in aluminum, steel and other sectors.”
Discuss both the economics and the political economy of this viewpoint.
7. Give an intuitive explanation for the optimal tariff argument.
8. If governments make trade policies based on national economic welfare, is the problem of
trade warfare still represented by a Prisoner’s Dilemma game as in CHAPTER 10 ■ The
Political Economy of Trade Policy 301 Table 10-3? What is the equilibrium solution to the
game if governments formulate policy in this way? Would they ever choose the strategy of
protectionism?
9. Norway banned the imports of agricultural biotech products and developed extremely
restrictive policies for crops derived from agricultural biotech, which are not related to the
protection of health, food safety, or the environment. These policies are made to protect
domestic agricultural interests, as Norway cares a lot about rural employment and subsidizes
small farms to help them remain competitive with imported goods. Comment on this trade
policy approach
Chapter 11 : Problem
1. Which countries appear to have benefited the most from international trade during the
last few decades? What policies do these countries seem to have in common? Does their
experience lend support for the infant industry argument or help to argue against it?7
2. Why do you think the problems with the infant industry argument are criticized by many
economists? Explain why the example of Asian countries creates controversies in this matter.
3. Country A currently imports solar panels at $30,000 each. The government is using only 10
percent of the program as domestic content, exporting clean energy to neighboring
countries. Country B imports solar panels also at $25,000 each, but uses 70 percent of the
program as domestic content. If both countries produced solar panels home, the costs would
have reached $25,000 for country A and $20,000 for country B, but there would have been
an initial shakedown period during which solar panels would cost $35,000 for country A to
produce and $40,000 for country B to produce.
a. Suppose each country must go through a shakedown period of high costs on its own,
before accessing any financial support from abroad. Under what circumstances would the
existence of the initial high costs justify infant industry protection?
b. Now suppose that both countries bring infant industry argument for protecting this
industry. Explain which country will be successful in preserving this argument and why
. 4. From Figure 11-3, we observe that South Korea, China, and India experienced major
changes in their economic policies during the 1960s. What would account for the differences
in their development paths?
5. What were some of the reasons for the decline in the import-substituting industrialization
strategy in favor of a strategy that promotes open trade?
Chapter 12 : Problem
1. What are the disadvantages of engaging in strategic trade policy even in cases in which it
can be shown to yield an increase in a country’s welfare?
2. It’s widely believed that space exploration will become commonplace in the near future
and that there will be huge strides in satellite use. Does this mean that the United States
should have policies designed to ensure that they are the leaders in the space exploration
sector?
3. Many European policy analysts criticize the European Union and its member states for
heavily subsidizing basic research. Instead, they say that applied research should be
encouraged to generate competitive advantages for European companies. Explain.
4. What are the key assumptions that allow strategic trade policy to work in the Brander-
Spencer example of Airbus and Boeing?
5. Some retailers in developing countries sell products from developed countries with high
wages, but assure customers that these goods are produced under high standards of quality.
Is demanding that kind of guarantee the same as applying a subsidy on exports? Is there any
way it can benefit consumers overseas?
6. What is the main critique against the WTO with respect to environmental protection? How
does the WTO justify its position on trade disputes that involve environmental issues?
7. France, in addition to its occasional stabs at strategic trade policy, pursues an active
nationalist cultural policy that promotes French art, music, fashion, cuisine, and so on. This
may be primarily a matter of attempting to preserve a national identity in an increasingly
homogeneous world, but some French officials also defend this policy on economic grounds.
In what sense could some features of such a policy be defended as a kind of strategic trade
policy? CHAPTER 12 ■ Controversies in Trade Policy 341
8. Many countries have value-added taxes—taxes that are paid by producers, but are
intended to fall on consumers. (They’re basically just an indirect way of imposing sales taxes.)
Such value-added taxes are always accompanied by an equal tax on imports; such import
taxes are considered legal because like the value-added tax, they’re really an indirect way of
taxing all consumer purchases at the same rate. Compare this situation to the argument over
carbon tariffs. Why might defenders argue that such tariffs are legal? What objections can
you think of?
9. Our usual models of trade assume that jobs lost in one industry will be offset by jobs
gained in other industries. The Autor et al. paper argued, however, that communities that
lose manufacturing jobs to imports end up losing other jobs as well. Is this a contradiction?