ECON1269 – International Trade: ASSIGNMENT 3

Section A: Answers for Multiple Choice Questions

Question A1:

The correct answer of this question is D – “The absolute value of autarky prices are negatively correlated with free trade prices.”

In general, a country will only trade if they benefit from free trade such as the cheaper prices for import products or higher prices for the export products. If we choose A, the prices are the same but the time that a country uses to produce is different, and then a country will also trade so they get the same product at a lower price. If the answer is B, then the consumer will trade to get a cheaper price rather than using the domestic product. Then the country will trade in a free trade environment. If the answer is C, the country may want to export their product rather than use it domestically only in order to gain more benefit from the same amount of product. Only the answer D left. To explain, autarky prices are negatively correlated with free trade means in whatever conditions, the prices will not change and free trade will not benefit the country than the autarky. Therefore, the country does not want to trade as undersupply and demand control, the price is at its equilibrium in free trade.

Question A2:

The correct answer of this question is D – “Operate under increasing returns to scale”.

According to Melitz (2003), most efficient firms will increase their productivity. As export will increase fixed cost, less efficient firm will not benefit from export because they cannot survive the increased fixed cost from the export. Therefore, in free trade, the less efficient firm will not decide to export. On the other hand, the most efficient firms have to increase less than the less efficient ones when they export. With export, productivity will increase more and more to satisfy the new market. The most efficient one then will gain more benefits and profit while the less efficient companies will only lose and will exit the market. The share price of the most efficient company will then increase as well as the productivity because of the exit of less efficient companies who do not export the goods. Therefore, the answer is D. The diagram below will demonstrate the effect of Melitz.

Question A3:

The correct answer of this question is B – “Owners of A will benefit”.

A pure specific factors model with two sectors which is also called the immobile factors model has a few assumptions to make the model work. First, the model assumes that land (A) and capital (K) are fixed while the movement between labor is specific to each other. Then the market is perfectly competitive. As the tariff is imposed on wheat (W), which means the import goods are W for the country. Furthermore, the price of W will increase while the demand is the same. This makes the price in the market to goes up which means a benefit for their owners of A. Additionally, the wages of the labor for W production will be decreased which means the owner will pay less for the same amount of production. The result is that the owner of A will benefit from the tariff on W. On the other hand, the labor does not move between industries and the wages of labor in the production of cars (C) will not be affected by the tariff because the price and demand of the industry are the same. Therefore, the answer is B.

Question A4:

The correct answer of this question is C – “Neither owners of K nor owners of A will benefit.”

In a mixed specific factor model which is a development of Heckscher-Ohlin from the Ricardo Viner model and is also called as specific factors model, there are a few assumptions that should be made in order to the model to work (Gandolfo & Giancarlo 2014). First, the number of labor is fixed and only moves between the two industries. Secondly, the wages between the industries are the same. In this case, the mixed specific factors model under the tariff can be described in the below diagram (Note: For any tariff imposes on import, there is an export tax that has exactly the same effects).

As we can see in the diagram, with the tariff, the price will rise up and increase. And the equilibrium also shifts from A to C where the labor of wheat will increase which means the owners of A will have to pay more for the labor. On the other hand, the wages of C also increase as wages is the same between the industries. For these reasons, neither owners of K nor owners of A will benefit from the tariff, using the mixed specific factors model for the two sectors.

Question A5:

The correct answer of the question is B – “The tariff revenue exceeds the sum of production and consumption distortion loss.”

Social welfare is a sum of total consumption surplus/losses and production surplus/losses and gain from the tariff. In the case the tariff revenue exceeds the sum of production and consumption; this means the total gains from the tariff exceed the social welfare. The following diagram will demonstrate the gains and losses of the market.

Under this situation, the consumer surplus is – (A + B + C +D) which means a loss while the production surplus is A. The social welfare is now included the tariff revenue which is G and C. Social welfare has now resulted into G – (B + C). The tariff revenue exceeds the sum of production and consumption distortion loss mean that means G is bigger than B and C. For that reason, social welfare is positive and means it benefits from the tariff.

Section B: Short answers

Question B1:

In this case, I think that the import and export food between Ghana and Côte d’Ivoire can be explained using the comparative advantage. As the two countries have similar conditions in their economy, the cost to produce a product cannot be the same. As there are flows of foods from Ghana to Côte d’Ivoire, there are differences between production cost which made the price of some import foods from Ghana become cheaper.

For the case of Switzerland, it is clearly unexplainable the export of food from Ghana as they have different countries’ advantages. From the given information, Switzerland may have a comparative advantage in terms of capital while Ghana has an advantage in terms of food because the Switzerland population is less low than Ghana and the Swiss land area is also smaller. Therefore, importing goods from Ghana would be cheaper for Swiss people as agriculture is usually preferred as labor-intensive. In comparative advantage, the two countries should be able to produce the same product and the importing country produce it at a higher cost. For the case of Switzerland, absolute advantage theory can be used to explain why Switzerland imports from Ghana.

Question B2:

Import Substitution Industrialization (ISI) is a policy in which a government restricts international trade to let the domestic company to produce substitute products with the belief that the industry will develop in the future. This policy is usually used to protect the infant industry which is at the early stage of development and will overcome foreign competitors in the future when the industry mature. Restriction can be a tariff, quota. In the case of Ghana, ISI can be helpful to nurture a new industry in which Ghana thinks that they have the advantage of developing such an industry. Furthermore, ISI needs the resource that may be Ghana does not have at the moment such as scientists, skilled workers…

Learning by doing is the process of developing a new industry in which by creating new products with failure until the product reaches the advantages. For ISI, learning by doing let Ghana learn the expertise in an industry from the lack of competitors from a foreign country. With learning by doing, the domestic market of Ghana of the industry will have a higher price because of the cost increase to cover the failure product. The government should interfere when they mature industry is not good enough in comparison with agriculture.

Question B3:

When Switzerland adopt a voluntary export restraint (VER), Ghana’s welfare will be affected by the policy as below:

In this case, presume that Switzerland is a large country in which the price of goods in Switzerland may influence the price of the global market.

With the VER, the price will be increased as see in the diagram. Ghana will not benefit from the VER as the supply is now lower than the demand. Therefore, the consumer surplus (A+B+C+D) in the market will decrease while producer surplus (A) will increase. However, the total loss /gain of national welfare is the sum of producer surplus and consumer surplus. In this case, it is a loss of total (B+C+D) from the diagram. This means the policy will not work as Ghana’s president has presumed. Therefore, as a consultant from the World Bank, we should advise him not to issue such a proposal. Ghana should choose other policies to make the ISI works as expected such as tariffs, quotas.

Question B4:

As discussed in the above question, as the price of goods from Switzerland increase, the domestic manufacturing company in Ghana will need more labor to produce more to satisfy the market. In such a case, the situation of Ghana can be explained using the Heckscher-Ohlin model. Under the model, there are some assumptions that should be used that is the labor can only move between the manufacture and agriculture.  In addition, the wage between the industries is the same. In such an assumption, In which when the price increase, the labor will move from agriculture to manufacturing. This is similar to the tariff effect on the market.

With the movement of labor, the number of labor in agriculture will have to work more to satisfy the current demand of the market and for export. Under the Heckscher-Ohlin model, the total number of labor is fixed. From those assumptions, in order to increase production, the efficiency of Ghana’s farms will grow up to cover the movement of labor. Under free trade, the export products will gain aggregate efficiency over time. For those reasons, it is reasonable that the efficiency of Ghana farms will increase.

Question B5:

In the case that Ghana repatriates migrants from Europes, the effect of this policy should depend on the number of engineers and their expertise. If the number is large enough, Ghana’s comparative advantage would be to accelerate the process of shifting from agriculture to manufacturing. With repatriated engineers, the process of learning by doing would be accelerated and take less time for labor in the new industry to reach the level of comparative advantage in the new expertise. With the increased speed of developing a new industry, Ghana would be able to become a capital intensive country sooner than the plan without repatriating migrants. The period of VER will also be reduced. However, the wages for those new repatriate engineers would be higher in comparison with the local engineer. Therefore, in a short term, before the ISI brings the manufacture to a mature stage, the manufacturing company should bear the higher wage and lower the marginal profit.