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10 Cards in this Set
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Abraham Lincoln once said: “I don't know much about the tariff, but I know this. If I buy a coat in England, I get the coat and England gets the money. If I buy a coat in America, I get the coat and America gets the money.” From an economics perspective, what is wrong about this idea of restricting international trade in order to rely more on national production? |
Resources are scarce. If the U.S. allocates resources to the production of coats, it must give up other productive activities. That is, the U.S. “gets the money” and gives up resources. To the extent that coat production is not the good of comparative advantage for the U.S., then by producing coats the US is misallocating resources.
The U.S. would be better off if it produced the good with the lowest opportunity cost, trade it on the international market and in return for the gained income from exports, buy foreign goods.
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Kept within sustainable bounds, trade deficits are not considered harmful by economists. Define the trade balance equation of a country, and explain the economic justification of a country’s trade deficit. (Hint: use the current account accounting to justify your answer). |
Current Account (CA) = Net Exports + Net current transfers
In general, for a country like the U.S., net transfers are so small that we can almost ignore them. So then, the current account is (approximately) equal to net exports. Net exports are the difference between the value of exports and the value of imports, or simply the trade balance:
Exports(X) – Imports(M) So, it follows that: CA= X–M.
Furthermore, we know that:
It means that a country that is a net exporter of goods on the world market, it is also a net exporter of capital on international markets (i.e., a lender). Vice-versa, a country that carries a trade deficit must also be a borrower on international capital market (i.e., a target of foreign investments). This implies that this country has an attractive set of assets (e.g., firm stocks, government bonds) that carry a high rate of return.
So, if a country’s trade deficit is maintained within reasonable bounds relative to GDP, this means it attracts more investments relative to the domestic sources of savings available. This is a good thing to the extent that these current investments lead to higher output and overall economic growth in the future. |
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Describe two ways in which economists measure the degree of financial market integration (provide a brief explanation for their use). |
____current account (CA) as a fraction of GDP: high CA means either a country borrows a lot, or it lends a lot relative to its economic size (GDP)
____ correlation of domestic savings and investments: a low correlation coefficient (i.e., close to zero) suggests that a country does not invests all its savings domestically, but rather in the location that provides the highest returnàevidence that the country is tapped into the international financial system |
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Define the two waves of globalization. List at least three factors that played a key role in determining the first wave of globalization. |
Economic historians identify 2 waves of globalization: – 1870 – 1914 (wave 1) – 1960 – present (wave 2)
Main factors contributing to the first wave of globalization: Transportation revolution: steam ships Communication revolution: first cable under Atlantic Ocean Industrial revolution à development of machine tools |
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Define the concept of comparative advantage. In a globalized world, do you agree that countries are better off if they specialize according to comparative advantage rather than absolute advantage? Explain. |
Comparative advantage = Ability to produce a good/service at the lowest opportunity cost.
The most efficient use of scarce resources is to allocate them towards the activities that incur the lowest opportunity cost. This implies countries should specialize in sectors and industries where they have comparative advantage. In this way, through international trade, countries can have access to a larger variety and quantity of goods (i.e., higher gains) than producing these goods on their own. |
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Does international trade lead to unemployment in the long run? Justify your answer. |
A: Trade does not lead to unemployment in the long run, but it does lead to a change in the mix of output because of labor reallocation |
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Economists often argue in support of free trade agreements. However, agreements such as NAFTA could bring not only benefits but also costs to member countries. Explain three negative consequences of NAFTA that we discussed in class. |
1). Drop in real wages (w/P) for some workers ▶ BUT: supporters of NAFTA argue that cause of fall in real wages could be due to price inflation and the exchange rate appreciation (US $ very strong against Mexican peso) 2). Rising rural poverty in Mexico ▶ Imports of agricultural products by Mexico raises the supply of goods in domestic market, lowering prices and hurting rural farmers 3). Rising wage inequality ▶ No environmental standards enforced in Mexico ▶ Free trade and investment liberalization allows firms to move out of regulated countries (US) into unregulated ones (Mex) 5). Worker displacement effects (unemployment) ▶ Import competing industries affected by free trade |
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What is Horizontal FDI? |
investments made in another country in order to overcome trade barriers and gain access to foreign markets |
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What is Veritcal FDI ? |
investments made in another country in order to take advantage of low costs of produc'on |
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Why become multinational? Describe the OLI Framework |
• Ownership (O) • Location (L) • Internalization (I) Should transac'ons be internal to the firm or arms-length? |
