abundant.” Discuss.
The gains from trade depend on comparative rather than absolute advantage. As to poor countries, what matters is not the absolute abundance of factors, but their relative abundance. Poor countries have an abundance of labor relative to capital when compared to more developed countries.
4. The U.S. labor movement — which mostly represents blue-collar workers rather than
professionals and highly educated workers — has traditionally favored limits on imports form less-affluent countries. Is this a shortsighted policy of a rational one in view of the interests of union members? How does the answer depend on the model of trade?
In the Ricardo’s model, labor gains from trade through an increase in its purchasing power. This result does not support labor union demands for limits on imports from less affluent countries.
In the Immobile Factors model labor may gain or lose from trade. Purchasing power in terms of one good will rise, but in terms of the other good it will decline.
The Heckscher-Ohlin model directly discusses distribution by considering the effects of trade on the owners of factors of production. In the context of this model, unskilled U.S. labor loses from trade since this group represents the relatively scarce factors in this country. The results from the Heckscher-Ohlin model support labor union demands for import limits.
5. There is substantial inequality of wage levels between regions within the United States.
For example, wages of manufacturing workers in equivalent jobs are about 20 percent lower in the Southeast than they are in the Far West. Which of the explanations of failure of factor price equalization might account for this? How is this case different from the divergence of wages between the United States and Mexico (which is geographically closer to both the U.S. Southeast and the Far West than the Southeast and Far West are to each other)?
When we employ factor price equalization, we should pay attention to its conditions: both countries/regions produce both goods; both countries have the same technology of production, and the absence of barriers to trade. Inequality of wage levels between regions within the United States may caused by some or all of these reasons.
Actually, the barriers to trade always exist in the real world due to transportation costs. And the trade between U.S. and Mexico, by contrast, is subject to legal limits; together with cultural differences that inhibit the flow of technology, this may explain why the difference in wage rates is so much larger.
6. Explain why the Leontief paradox and the more recent Bowen, Leamer, and
Sveikauskas results reported in the text contradict the factor-proportions theory.
The factor proportions theory states that countries export those goods whose production is intensive in factors with which they are abundantly endowed. One would expect the United States, which has a high capital/labor ratio relative to the rest of the world, to export capital-intensive goods if the Heckscher-Ohlin theory holds. Leontief found that the United States exported labor-intensive goods. Bowen, Leamer and Sveikauskas found that the correlation between factor endowment and trade patterns is weak for the world as a whole. The data do not support the predictions of the theory that countries' exports and imports reflect the relative endowments of factors.
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7. In the discussion of empirical results on the Heckscher-Ohlin model, we noted that
recent work suggests that the efficiency of factors of production seems to differ internationally. Explain how this would affect the concept of factor price equalization. If the efficiency of the factors of production differs internationally, the lessons of the
Heckscher-Ohlin theory would be applied to “effective factors” which adjust for the differences in technology or worker skills or land quality (for example). The adjusted model has been found to be more successful than the unadjusted model at explaining the pattern of trade between countries. Factor-price equalization concepts would apply to the effective factors. A worker with more skills or in a country with better technology could be considered to be equal to two workers in another country. Thus, the single person would be two effective units of labor. Thus, the one high-skilled worker could earn twice what lower skilled workers do and the price of one effective unit of labor would still be equalized.
Chapter 6
1. For each of the following examples, explain whether this is a case of external or internal
economies of scale:
a. Most musical wind instruments in the United States are produced by more than a
dozen factories in Elkhart, Indiana.
b. All Hondas sold in the United States are either imported or produced in Marysville,
Ohio.
c. All airframes for Airbus, Europe’s only producer of large aircraft, are assembled in
Toulouse, France.
d. Hartford, Connecticut is the insurance capital of the northeastern United States. External economies of scale: Cases a and d. The productions of these two industries concentrate in a few locations and successfully reduce each industry's costs even when the scale of operation of individual firms remains small. External economies need not lead to imperfect competition. The benefits of geographical concentration may include a greater variety of specialized services to support industry operations and larger labor markets or thicker input markets.
Internal economies of scale: Cases b and c. Both of them occur at the level of the individual firm. The larger the output of a product by a particular firm, the lower its average costs. This leads to imperfect competition as in petrochemicals, aircraft, and autos.
2. In perfect competition, firm set price equal to marginal cost. Why isn’t this possible
when there are internal economies of scale?
Unlike the case of perfectly competitive markets, under monopoly marginal revenue is not equal to price. The profit maximizing output level of a monopolist occurs where marginal revenue equals marginal cost. Marginal revenue is always less than price under imperfectly competitive markets because to sell an extra unit of output the firm must lower the price of all units, not just the marginal one.
3. It is often argued that the existence of increasing returns is a source of conflict between
countries, since each country is better off if it can increase its production in those industries characterized by economies of scale. Evaluate this view in terms of both the monopolistic competition and the external economy models.
Both internal economies of scale (which may lead to monopolistic competition) and external
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economies of scale could lead to increasing returns.
By concentrating the production of each good with economies of scale in one country rather
than spreading the production over several countries, the world economy will use the same amount of labor to produce more output.
In the monopolistic competition model, the concentration of labor benefits the host country. The host country can capture some monopoly rents. But the rest of the world may hurt and have to face higher prices on its consumption goods.
In the external economies case, such monopolistic pricing behavior is less likely since imperfectly competitive markets are less likely.
4. Suppose the two countries we considered in the numerical example on pages 132-135
were to integrate their automobile marker with a third country with an annual market for 3.75 million automobiles. Find the number of firms, the output per firm, and the price per automobile in the new integrated market after trade.
FAC?? cX1P?c? bnSX?nS????n? ?n?15.8FbP?AC2
However, since you will never see 0.8 firms, there will be 15 firms that enter the market, not
16 firms since the last firm knows that it can not make positive profits. The rest of the solution is straight-forward. Using X=S/n, output per firm is 41,666 units. Using the price equation, and the fact that c=5,000, yields an equilibrium price of $7,000.
5. Evaluate the relative importance of economies of scale and comparative advantage in
causing the following:
a. Most of the world’s aluminum is smelted in Norway or Canada. b. Half of the world’s large jet aircraft are assembled in Seattle.
c. Most semiconductors are manufactured in either the United States or Japan. d. Most Scotch whiskey comes from Scotland.
e. Much of the world’s best wine comes from France.
a. The relatively few locations for production suggest external economies of scale in production. If these operations are large, there may also be large internal economies of scale in production.
b. Since economies of scale are significant in airplane production, it tends to be done by a small number of (imperfectly competitive) firms at a limited number of locations. One such location is Seattle, where Boeing produces.
c. Since external economies of scale are significant in semiconductor production, semiconductor industries tend to be concentrated in certain geographic locations. If, for some historical reason, a semiconductor is established in a specific location, the export of semiconductors by that country is due to economies of scale and not comparative advantage.
d. \scotch whiskey can only come from Scotland. The production of scotch whiskey requires a technique known to skilled distillers who are concentrated in the region. Also,
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soil and climactic conditions are favorable for grains used in local scotch production. This reflects comparative advantage.
e. France has a particular blend of climactic conditions and land that is difficult to reproduce elsewhere. This generates a comparative advantage in wine production.
6. There are some shops in Japan that sell Japanese goods imported back from the United
States at a discount over the prices charged by other Japanese shops. How is this possible?
The Japanese producers employ price discrimination across United States and Japanese
markets, so that the goods sold in the United States are much cheaper than those sold in Japan. It may be profitable for other Japanese to purchase these goods in the United States, incur any tariffs and transportation costs, and resell the goods in Japan. Clearly, the price differential across markets may lead to such profitable chance.
7. Consider a situation similar to that in Figure 6-9, in which two countries that can
produce a good are subject to forward-falling supply curves. In this case, however, suppose that the two countries have the same costs, so that their supply curves are identical.
a. What would you expect to be the pattern of international specialization and trade?
What would determine who produces the good?
P,C P,C External Economics and Specialization External Economics and Specialization
AC AC D Q AC AC D Q
Suppose two countries that can produce a good are subject to forward-falling supply curves and are identical countries with identical curves. If one country starts out as a producer of a good, i.e. it has a head start even as a matter of historical accident, then all production will occur in that particular country and it will export to the rest of the world. b. What are the benefits of international trade in this case? Do they accrue only to the
country that gets the industry?
Consumers in both countries will pay a lower price for this good when external
economies are maximized through trade and all production is located in a single market. In the present example, no single country has a natural cost advantage or is worse off than it would be under autarky.
8. It is fairly common for an industrial cluster to break up and for production to move to
locations with lower wages when the technology of the industry is no longer rapidly improving—when it is no longer essential to have the absolutely most modern machinery, when the need for highly skilled workers has declined, and when being at the cutting edge of innovation conveys only a small advantage. Explain this tendency of industrial clusters to break up in terms of the theory of external economies.
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External economies are important for firms as technology changes rapidly and as the
“cutting edge” moves quickly with frequent innovations. As this process slows, manufacturing becomes more normal and standard and there is less advantage brought by external economies. Instead, firms look for low cost production locations. Since external economies are no longer important, firms find little advantage in being clustered and it is likely that low-wage locations will be chosen.
CHAPTER7
1. The marginal product of labor in Home is 10 and in Foreign is 18. Wages are higher in Foreign, so workers migrate there to the point where the marginal product in both Home and Foreign is equated. This occurs when there are 7 workers in each country, and the marginal product of labor in each country is 14.
2. There is no incentive to migrate when there is factor price equalization. This occurs when both countries produce both goods and when there are no barriers to trade (the problem assumes technology is the same in the two countries). A tariff by country A increases the relative price of the protected good in that country and lowers its relative price in the country B. If the protected good uses labor relatively intensively, the demand for labor in country A rises, as does the return to labor, and the return to labor in the country B falls. These results follow from the Stolper-Samuelson theory, which states that an increase in the price of a good raises the return to the factor used intensively in the production of that good by more than the price increase. These international wage differentials induce migration from country B to country A.
3. The analysis of intertemporal trade follows directly the analysis of trade of two goods. Substitute \ The relevant relative price is the cost of future consumption compared to present consumption, which is the inverse of the real interest rate. Countries in which present consumption is relatively cheap (which have low real interest rates) will \which present consumption is relatively dear (which have high real interest rates). The equilibrium real interest rate after borrowing and lending occur lies between that found in each country before borrowing and lending take place. Gains from borrowing and lending are analogous to gains from trade--there is greater efficiency in the production of goods intertemporally.
4. Foregoing current consumption allows one to obtain future consumption. There will be a bias towards future consumption if the amount of future consumption which can be obtained by foregoing current consumption is high. In terms of the analysis presented in this chapter, there is a bias towards future consumption if the real interest rate in the economy is higher in the absence of international borrowing or lending than the world real interest rate. a. The large inflows of immigrants means that the marginal product of capital will rise as more workers enter the country. The real interest rate will be high, and there will be a bias towards future consumption. b. The marginal product of capital is low and thus there is a bias towards current consumption.
c. The direction of the bias depends upon the comparison of the increase in the price of oil and the world real interest rate. Leaving the oil in the ground provides a return of the increase in the price of oil whereas the world real interest rate may be higher or lower than this increase. d. Foregoing current consumption allows exploitation of resources, and higher future consumption. Thus, there is a bias towards future consumption.
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