Econ 342 International Trade Fall Due Wednesday Oct 26 th

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1 Please use complete sentences when answering all questions. Also in your written answers, you must explicitly refer to your labels on your graph when possible. Internal economies of scale 1. Distinguish between intra-industry trade and inter-industry trade. 2. (Optional) The following table provides data on Japanese imports and exports of seven product groups for Product Japanese import Japanese exports ($ millions) ($ millions) Perfume Electric microcircuits 24,381 16,238 Automobiles 62,146 4,576 Photographic cameras a. For each product, calculate the IIT share (Intra-industry trade share). Perfume Electric microcircuits Automobiles Photographic cameras b. Which product(s) above have the highest IIT share? 1

2 3. In a model explaining intra-industry trade with monopolistic competition market structure. What is the basis for trade? Discuss both the role of product differentiation and the role of economies of scale. 4. In 2005, the U.S. imported $305.8 million worth of golf clubs and exported $318.7 million. Assume that the global market for golf clubs is monopolistically competitive, where each country produces a differentiated product and exhibits internal economies of scale. a. Based on the information above, is the global golf club industry characterized by inter-industry trade or intra-industry trade? b. Assume U.S. firms are in a long run equilibrium in autarky. Under the above assumptions, consider the incomplete diagram below. Complete this diagram and carefully label it to show the profit maximizing price and quantity for a typical golf club firm in the U.S. Explicitly refer to labels on your graph in a brief explanation of the profit maximizing quantity, price and zero profits. $ MC ATC Q of Golf Clubs c. Suppose the U.S. engages free trade. Does the price elasticity of demand for the typical golf club firm become relatively more elastic or inelastic? Why? d. Show the long run effect of free on the graph (reflecting your answer in c). Explicitly refer to labels on your graph in a brief explanation of the new profit maximizing quantity, price and zero profits in the long run. 2

3 e. Now consider the entire golf club industry (market). Draw and label a new graph of the U.S. golf club industry that shows, in autarky: 1. The relationship between average cost of a typical firm and the number of firms in the industry and 2. The relationship between typical price and the number of firms in the industry. f. Briefly explain why: The Average Cost curve above is upward sloping. The Price curve above is downward sloping. g. Where on your graph is the long run domestic, autarky equilibrium? How do you know? h. What happens to the size of the market when the US opens its boarders to trade? Show the impact of trade on your graph above. Use your graph to explain the gains from trade. 3

4 5. (optional) In March of 2010, the New York Times reported that Cadbury (British company), was the world s second largest confectioner. 1 Let s consider the Cadbury brand chocolate in particular. Assume the global market for chocolate is monopolistically competitive, where each country produces a differentiated product and exhibits internal economies of scale. a. Assume the chocolate market in the U.K. is in a long run equilibrium in autarky. Under the above assumptions, label the graph to show and explain the profit maximizing level of output, price and economic profits for Cadbury. $ Cadbury ATC MC MR1 D1 Q of milk chocolate b. Suppose the U.K. engages free trade in chocolate. Show the long run effect of this event on the graph. Explicitly refer to the labels on your graph in briefly explanation of how free trade i. Changes the shape of the demand curve for Cadbury. ii. Results in a new profit maximizing level of output, price and profits. iii. What are the gains from trade 1 Incidentally, the point of the article was to discuss the fact that in March of 2010 Cadbury was taken over by Kraft Foods (American company). For now, consider it a U.K. firm. 4

5 c. Now consider the entire chocolate industry (market). Draw and label a new graph of the U.K. chocolate industry that shows, in autarky: 1. The relationship between average cost of a typical firm and the number of firms in the industry and 2. The relationship between typical price and the number of firms in the industry d. Briefly explain why the average cost curve slopes upward and why the typical price curve slopes downward. e. If there is free trade, what happens to the size of the market? What will be the impact on the average cost curve above? Show it and briefly explain the gains of free trade in the U.K. industry (market) for chocolate in terms of the price of a typical chocolate bar (P) and the number of chocolate bar varieties (N). 5

6 6. Wenzhou, China is where the large majority (70-90%) of the world s cigarette lighters are produced. In fact, according to Paul Krugman, many of China s manufactured exports are produced by highly localized industries whose geographical concentration shows clear evidence of the importance of external economies. 2 Suppose Malaysia would like to enter into the cigarette lighter industry. Further suppose that the industry average total cost for any given level of output is lower for Malaysia than for China. Construct and carefully label a graph to show and carefully explain in words how external economies may result in China continuing to hold the world s market (and thus be the primary exporter) of cigarette lighters. $ Q Cigarette lighters Trade and Growth 7. Define the Rybczynbski theorem. Briefly explain why the following statement is false. An increase in the county s labor force will result in an increase in the quantity produced of the labor intensive good, with no change in the quantity produced of the other good. 8. Define immiserizing growth. Briefly explain why this following statement is false. A country whose trade has almost no impact on world prices is at great risk of immiserizing growth. 2 Krugman, Paul (November 2009), Increasing Returns in A Comparative Advantage World. 6

7 con Econ 342 International Trade 9. Assume the world includes only the US and Mexico and that both behave according to the Heckscher-Ohlin model of international trade. Both countries have access to the same technology to produce 2 goods: corn (relatively land intensive) and textiles (relatively labor intensive). Both countries have endowments of labor and land, but Mexico is relatively labor abundant and the US is relatively land abundant. Assume that both countries have similar preferences for corn and textiles. a. The PPF below reflects assumptions about Mexico s endowment of labor and land. Assume there exists some international terms of trade (which reflects the appropriate pattern of trade for Mexico); add the terms of trade line to diagram and show a plausible points of production and consumption. Mexico textiles b. Suppose a baby boom in Mexico 20 years ago generated a growth in the supply of labor in Mexico today. Show the impact of this growth in labor with a new PPF on the diagram above. c. Assuming prices are held constant, what does the Rybczynski Theorem suggest will happen to trade? That is analyze and explain this impact on the Mexican economy using Mexico s production possibility frontier. 7

8 soybeans Econ 342 International Trade 10. Suppose a free trade equilibrium exists between the EU and Brazil in a two good world: soybeans and machinery. Brazil is land abundant (soybeans are land intensive) and the EU is capital abundant (machinery is capital intensive). The trade patterns are predicted by the HO theory of trade. Consider for now just the EU. Suppose the EU s endowment of capital increased. a. Show and explain the impact of a growth in capital endowment on the shape and position of the EU s PPF on the graph below. EU C1 P1 b. Use your labels to explain describe the effect of the new PPF on the actual production quantities in the EU if the product price ratio is unchanged? Explain using the Rybczynbski theorem. tt 1 machinery c. As a result of the change in production, what will be the impact the EU s willingness to trade? d. Now assume that the EU s growth does change the international equilibrium price ratio, what is the direction of change in this price ratio? That is what happens to the slope of the new terms of trade line? e. When the international terms of trade line changes, as described in (d), is this an improvement or deterioration in their terms of trade? That is are the relative price of exports higher or lower? f. Under what condition can a decline in the terms of trade result in immiserating growth? 8

9 soybeans Econ 342 International Trade 11. (optional) Suppose a free trade equilibrium exists between the EU and Brazil in a two good world: soybeans and machinery. Brazil is land abundant (soybeans are land intensive) and the EU is capital abundant (machinery is capital intensive). The trade patterns are predicted by the HO theory of trade. Consider for now just the EU. Suppose the EU now invents a new agricultural technique that makes production of soybeans more efficient. (Assume this new technology is only available in the EU). a. Explain the effect on the shape and position of the EU s PPF on the graph below. EU C1 P1 machinery b. What will be the effect on the actual production quantities in the EU if the product price ratio is unchanged? Explain using the Rybczynbski theorem. tt 1 c. What will be the impact the EU s willingness to trade? d. Now assume that the EU s growth does impact the international equilibrium price ratio, what is the direction of change in this price ratio? Is this an improvement in the terms of trade? 9

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