ECON 121 Midterm #1

CHAPTER 2

World Trade: An Overview

What are the five largest trading partners with the U.S.?

Canada
China
Mexico
Japan
Germany

The largest economies in the EU undertake what?

The largest fraction of the total trade between the EU and the U.S.

The Gravity Model

Predicts that the volume of trade is directly related to the GDP of each trading partner and is inversely related to the distance between them

What else, besides size and distance, influence trade?

Culture, geography, multinational corporations, and the existence of borders

What has influenced trade the most in history?

Modern transportation and communication have increased trade, BUT political factors have influenced trade more in history

What did trade primarily consist of in the past?

Historically agricultural and mineral products made up most of trade.

What does most trade consist of today?

Manufactured goods

What activities have increasingly become important in world trade?

Multinational activities

What are some arguments for income inequality?

Multinational corporations and trade

Chapter 3

Labor productivity and Comparative Advantage

Comparative Advantage

A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than it is in other countries. A country with a a comparative advantage uses its resources most efficiently when it produces t

The Ricardian Model

Focuses only on differences in the productivity of labor across countries and explains gains from trade using the concept of comparative advantage.

Specialization according to the Ricardian Model

When countries specialize, the relative price of the produced good rises, income for workers who produce the good rises and imported goods are less expensive for consumers.

Trade according to Ricardian Model

Trade is predicted to benefit both high productivity and low productivity countries .

Wages according to the Ricardian Model

High productivity or low wages give countries a cost advantage that allow them to produce efficiently.

What prevents complete specialization?

Although empirical evidence supports trade based on comparative advantage, transportation costs and other factor prevent complete specialization in production.

Chapter 4

Specific Factors and Income Distribution

Effects of International trade

International trade often has strong effects on the distribution of income within countries -- produces losers as well as winners

Income distribution effects arise for two reasons

1) Factors of production cannot move costlessly and quickly from one industry to another
2) Changes in an economy's output mix have differential effects on the demand for different factors of production

International trade affects the distribution of income in the specific factors model

1) Factors specific to export sectors in each country gain from trade, while factors specific to import-competing sectors lose
2) Mobiles factors than can work in either sector may gain or lose

Trade nonetheless produces overall gains

Those who gain from trade could in principle compensate those who lose while still remaining better off than before

What are most economists opinions on the matter?

THey would prefer to address the problem of income distribution directly, rather than by restricting trade

Chapter 5

Resources and Trade: The Heckscher-Ohlin Model

Substitution of factors used in the production process generates a curved PPF

When an economy produces a low quantity of a good, the opportunity cost of producing that good is low.
When an economy produces a high quantity of a good, the opportunity cost of producing that good is high.

When an economy produces the most value it can from its resources what is the opportunity cost?

The opportunity cost of producing a good equals the relative price of that good in markets.

What happens to the real wage or real rental rate of a factor being used intensively when the relative price of that good increases?

The production of that good will increase.
While the real wage and real rental rates of other factors of production DECREASE.

What happens if the output price remains constant as the amount of a factor of production increases?

The supply of the good that uses this factor intensively increases and the supply of the other goods decreases

An economy exports goods that are?

Relatively intensive in its relatively abundant factors of production.

An economy imports goods that are?

Relatively intensive in its relatively scarce factors of production.

How are owners of factors impacted by trade?

Owners of abundant factors gain, while owners of scarce factors lose with trade.

How is a country as a whole predicted to be impacted by trade?

A country is predicted to be better off with trade, so winners could in theory compensate the losers within each country.

The Heckscher-Ohlin model predicts that output prices and factor prices will.....

Equalize, however neither occur in the real world

Is there empirical support of the Heckscher-Ohlin model?

Emperical support is weak except for cases involving trade between high-income countries and low/middle income countries or when technology differences are included.

Suppose cloth is more labor intensive than food production... then if Pc/Pf increases, then w/r increases.

The cost of production depends on input prices.
An increase in w affects price of cloth more than prices of food since cloth is labor intensive.
With competition, changes in wage and rental rate are therefore directly related to changes in the relative pr

( Stolper) Assuming that cloth is labor intensive in comparison to food, an increase in the relative price of cloth to food is predicted to

1) Raise income of workers relative to that of capital owners, w/r.
2) Raise the ratio of capital to labor services, K/L, used in both industries. Causing a raise in the MPL in both industries and lowers the MPK in both industries
3)Raise the real income

Rybczynski Theorem

If we hold output prices constant as the amount of a factor of production increase, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases.

Rybczynski Theorem in other words

An economy is predicted to be relatively efficient at producing goods that are intensive in factors of production in which the country is relatively well endowed.

Heckscher-Ohlin THEOREM

An economy is predicted to export goods that are intensive in its abundant factors of production and import goods that are intensive in its scarce factors of production.

Stolper Samuelson Theorem

An increase int he relative price of a commodity raises the returns of the factor used more intensively in the production of that commodity

Stolper Theorem when cloth is labor intensive

An increase in the relative price of cloth is predicted to raise the real income of workers and lower the real income of capital owners.

Leontief Paradox

Leontief found that U.S. exports were less capital-intensive than U.S. imports, even though the U.S. is the most capital abundant country in the world.

Why does we observe Leontief paradox?

Countries may not have a common technology. The US may have a special advantage in producing new products or goods made with innovative technologies