MBA 5326
Sample questions for midterm
1. Consider the trade between a developing country and a developed country. The developing country is an unskilled labor abundant country while the developed country is a skilled labor abundant country. There are two goods, a skilled labor intensive good (SLIG) and an unskilled labor intensive good (ULIG).
- Choose two countries and two goods that satisfy the factor endowments and factor intensities described above
- Using the Stolper-Samuelson theorem, describe who will support and who will oppose free trade in your two countries. Use a flow chart diagram similar to the one I used in my Powerpoint slides to help you in your description and summarize the basic results of the Heckscher-Ohlin model.
2. Assume that South Korea is capital (K) abundant while Vietnam is unskilled labor (UL) abundant . Steel is capital intensive while Rice is unskilled labor intensive. Explain what happens to the returns to capital and unskilled labor after trade begins.
Chapter 4 Chapter 4 Modern Trade Theory 1 Chapters’ objectives Explain other possible sources of comparative advantage and other possible reasons for trade Study the impact of trade on income distribution Inter versus Intra-industry trade Analyzes the impact of factor flows between countries FDI Immigration Explains the relationship between factor movements and trade 2 Heckscher-Ohlin model: Basic characteristics of countries and products Countries differ by their factor endowments Industries differ by their factor intensities 3 An explanation for comparative advantage In the HO model the source of comparative advantage is the difference in factor endowments While in the Ricardian model of chapter 3, the source of comparative advantage was difference in technology 4 Additional assumptions In HO model, the technology sets available to each country are identical Unlike Ricardian model Constant return to scale Perfect competition (like Ricardian model) Two factors of production, Labor (L) and Capital (K) Or skilled Labor (SL) and unskilled labor (UL) 5 Assumption: Factor Abundance (Endowment) Country A is more K abundant Country B is relatively L abundant. Mathematically: Quantity definition: KA/LA > KB/LB Price definition: WA /RA > WB /RB 6 7 Producing aircraft and textiles: factor endowments in the United States and China TABLE 3.1 In US: K/L = 100/200 = 0.5 In China: K/L = 20/1000 = 0.02 Thus US is the relatively capital abundant country and China is the relatively labor abundant country Therefore capital is relatively cheap in the US and labor is relatively cheap in China Since producing aircrafts requires relatively more capital, the US will have a comparative advantage in producing aircrafts Since producing textiles requires relatively more labor, China will have a comparative advantage in producing textiles. 8 Capital stock per worker of selected countries, 1997* TABLE 3.2 The difference in relative resource abundance is the cause of the pretrade differences in the relative product prices between the two countries Assumption: Factor Intensity In both countries, Textiles (T) is labor intensive Steel (S) is capital intensive. This implies that LT/KT > LS/KS 9 More assumptions... The PPCs will exhibit increasing opportunity costs. Why? Identical tastes in the two countries. DDs (Demand Diagonals) are identical Focus on supply conditions 10 The HO Theorem A country will have comparative advantage in, and therefore will export, that good whose production is relatively intensive in the factor which is abundant in that country Graphical proof A’s PPF B’s PPF T T S S Slope=(PS/PT)A Slope=(PS/PT)B Autarky production & consumption Since =(PS/PT)A < (ps/pt)b, country a has a comparative advantage in producing good s while b will produce t. since a is k abundant and s is k intensive, the theorem is proven. dd 11 equilibrium in the ho model production & consumption under autarky consumption under free trade production under free trade tot t s autarky relative price country a dd 12 trade equilibrium in the 2 countries t t s s country a country b a’s imports b’s exports b’s imports a’s exports tot lines (parallel) note that specialization is not complete in the ho model. why? 13 the factor price equalization th. given all the assumptions of the ho model, free international trade will lead to the international equalization of individual factor prices between countries proof? however fpe may not be true in the real world as: three important assumptions may not hold perfectly: perfect competition no barriers to trade access to identical technology 14 the stolper-samuelson theorem free international trade benefits the abundant factor and harms the scarce factor proof follows from the fpe theorem. 15 heckscher-ohlin model & stolper-samuelson theorem country acountry b relatively k abundantendowmentsrelatively l abundant comparative advantage in steelcomparative advantagecomparative advantage in textiles export steel import textilestradeexport textiles import steel increased output of steel decreased output of textilesproductionincreased output of textiles decreased output of steel increased demand for k decreased demand for lfactor demandsincreased demand for l decreased demand for k capital owners gain workers losefactor pricesworkers gain capital owners lose 16 application to north-south trade southnorth relatively abundant in unskilled labor (ul)endowmentsrelatively abundant in skilled labor (sl) comparative advantage in uligscomparative advantagecomparative advantage in sligs export uligs import sligstradeexport sligs import uligs increased output of uligs decreased output of sligsproductionincreased output of sligs decreased output of uligs increased demand for ul decreased demand for slfactor demandsincreased demand for sl decreased demand for ul ul gains sl losesfactor pricessl gains ul loses 17 implications of ss theorem some groups lose from free trade the scarce factors who lose will lobby how to deal with the losers? or should we ignore them? ethics? 18 product life cycle theory raymond vernon has argued that, for many manufactured goods, comparative advantage may shift over time from one country to another the stages of the life cycle: goods are invented, tested in the market place and modified the product becomes standardized the product matures 19 product life cycle (cont’d) in first stage the good is produced and exported by a country that is sl abundant, i.e. u.s. in second stage production moves to a country that has a cost advantage in large scale manufacturing. the good is more k intensive produced in asia in third stage production moves to countries rich in ul examples: automobiles, color television, pocket calculators, other electronics 20 product life cycle (cont’d) can the product life cycle explain also foreign investment (fdi)? could it result in intrafirm trade? in outsourcing? is it consistent with comparative advantage? international flows of factors labor & capital some facts immigration played a large role in the development and growth of the u.s. economy rich western european countries have imported guest workers from spain, portugal, turkey, greece, etc. oil rich middle eastern countries have imported workers from egypt, jordan, pakistan, india, korea, etc. reasons better economic conditions (demand-pull factors) poor countries to rich countries movements of low skilled workers of skilled workers (brain drain) escape from political tyranny or devastation (supply-push factors) reunion with other family members (social networks) international flows of capital physical (fdi) capital greenfield versus brownfield second half of the course will cover financial (portfolio) capital more important than international labor flows the us was an importer of capital throughout the 19th century used to build railroads, factories and communications systems the us was an exporter of capital throughout much of the 20th century after the 1980s, the us became the world’s largest net debtor and thus a net importer of capital another reason for fdi ownership-location-internalization (oli) developed by john dunning firms own an asset (patent, trade secret, trademark, reputation, blueprint, innovation, etc) that confers a potential advantage on the firm firms select the best location (input costs, large customer base, good infrastructure, skilled labor) by investing abroad, i.e. creating its own subsidiary, the firm internalizes the advantages of asset ownership not inconsistent with comparative advantage, but it is not a theory of trade off-shoring and outsourcing off-shoring: the transfer of a firm’s activities to a location outside the home country (to a foreign affiliate (fdi) or a foreign firm) outsourcing: the transfer of activities to another firm either inside or outside the home country the most controversial is the transfer of activities outside the home country to a foreign firm (= off-shoring + outsourcing) maquiladoras are an example of off-shoring off-shoring in some cases leads to job losses in the home country, while in others it is complementary to home production and leads to an expansion of jobs in the home country “source everywhere, manufacture everywhere, sell everywhere” the whole notion of trade (and outsourcing?) is disappearing economic analysis (works for both capital and labor flows) marginal product of labor: mpl it is the additional output produced by one more worker diminishing marginal product as l increases, mpl falls or the additional amount of output produced will become smaller and smaller value marginal product of labor: vmpl = p x mpl it is the additional revenue producers receive from selling the amount produced by the last worker hired profit maximizing rule: w = vmpl distribution of income labor wage (w) labor income payments to capital owners vmpl= demand for labor w* o a the combined area below the vmpl (demand for labor) to the left of ac represents the total income paid to workers and the owners of capital; it is equal to gdp c effects of immigration labor wage (w) vmpl w* o a more goods are produced and gdp increases by the area acdb below the vmpl curve between a and b b w** payments to foreign workers additional payments to capital owners lost earnings to domestic workers (transferred to domestic owners of capital) c d summary international factor inflows tend to lower the incomes of those factors in the host country that most directly substitute for this factor and tend to raise the incomes of other factors. thus some types of labor (i.e. skilled) in the host country could benefit from immigration of unskilled labor while the host country benefits overall (higher gdp), the source country is worse off (see next slide). impact of emigration on the source country labor wage (w) vmpl w* o a the combined area below the vmpl falls and thus gdp falls by area aefg the wage rises (workers have become more scarce) capitalists are worse off; they lose gw*w***f. e w*** f g beyond comparative advantage (chapter 5) intra-industry trade versus inter-industry trade internal versus external economies of scale (firms grouped in clusters) strategic trade policy: the use of industrial policy (trade barriers and subsidies) in order to capture some of the profits of foreign firms intra-industry trade internal economies of scale or increasing returns to scale, whereby a proportionate increase in k and l leads to a greater than proportionate increase in output (i.e. declining lac), can explain iit large firms. imperfect competition irs results in ppfs that are convex to the origin 34 irs and the gains from trade (cont’d) consumption production consumption production luxury cars economy cars luxury cars economy cars germany s. korea intra industry trade similar countries trade not based on differences in factor endowments and comparative advantage gains from economies of scale countries specialize in different varieties of the same good differentiated products more consumer choices less need for workers to shift between industries less opposition to trade perfect competition may not prevail 36 strategic trade policy necessary conditions: economies of scale market power (monopoly/oligopoly) example: aircraft production embraer vs. bombardier boeing vs. airbus game theory: initial payoff matrix brazil embraer (be) canada bombardier (cb)producesdoes not produce producesbe: -10be: 0 cb: -10cb: +25 does not producebe: +25be: 0 cb: 0cb: 0 cb enters the market first. be’s best strategy is not to produce matrix payoff when be receives subsidy = 15 when it produces brazil embraer (be) canada bombardier (cb)producesdoes not produce producesbe: +5be: 0 cb: -10cb: 25 does not producebe: +40be: 0 cb: 0cb: 0 be will now produce, while cb will exit the market payoff matrix when both firms receive a subsidy = +15 brazil embraer (be) canada bombardier (cb)producesdoes not produce producesbe: +5be: 0 cb: +5cb: +40 does not producebe: +40be: 0 cb: 0cb: 0 both firms will now produce while they receive a production subsidy summary inter-industry trade is explained by comparative advantage (differences in technology and factor endowments) (ps/pt)b,="" country="" a="" has="" a="" comparative="" advantage="" in="" producing="" good="" s="" while="" b="" will="" produce="" t.="" since="" a="" is="" k="" abundant="" and="" s="" is="" k="" intensive,="" the="" theorem="" is="" proven.="" dd="" 11="" equilibrium="" in="" the="" ho="" model="" production="" &="" consumption="" under="" autarky="" consumption="" under="" free="" trade="" production="" under="" free="" trade="" tot="" t="" s="" autarky="" relative="" price="" country="" a="" dd="" 12="" trade="" equilibrium="" in="" the="" 2="" countries="" t="" t="" s="" s="" country="" a="" country="" b="" a’s="" imports="" b’s="" exports="" b’s="" imports="" a’s="" exports="" tot="" lines="" (parallel)="" note="" that="" specialization="" is="" not="" complete="" in="" the="" ho="" model.="" why?="" 13="" the="" factor="" price="" equalization="" th.="" given="" all="" the="" assumptions="" of="" the="" ho="" model,="" free="" international="" trade="" will="" lead="" to="" the="" international="" equalization="" of="" individual="" factor="" prices="" between="" countries="" proof?="" however="" fpe="" may="" not="" be="" true="" in="" the="" real="" world="" as:="" three="" important="" assumptions="" may="" not="" hold="" perfectly:="" perfect="" competition="" no="" barriers="" to="" trade="" access="" to="" identical="" technology="" 14="" the="" stolper-samuelson="" theorem="" free="" international="" trade="" benefits="" the="" abundant="" factor="" and="" harms="" the="" scarce="" factor="" proof="" follows="" from="" the="" fpe="" theorem.="" 15="" heckscher-ohlin="" model="" &="" stolper-samuelson="" theorem="" country="" a="" country="" b="" relatively="" k="" abundant="" endowments="" relatively="" l="" abundant="" comparative="" advantage="" in="" steel="" comparative="" advantage="" comparative="" advantage="" in="" textiles="" export="" steel="" import="" textiles="" trade="" export="" textiles="" import="" steel="" increased="" output="" of="" steel="" decreased="" output="" of="" textiles="" production="" increased="" output="" of="" textiles="" decreased="" output="" of="" steel="" increased="" demand="" for="" k="" decreased="" demand="" for="" l="" factor="" demands="" increased="" demand="" for="" l="" decreased="" demand="" for="" k="" capital="" owners="" gain="" workers="" lose="" factor="" prices="" workers="" gain="" capital="" owners="" lose="" 16="" application="" to="" north-south="" trade="" south="" north="" relatively="" abundant="" in="" unskilled="" labor="" (ul)="" endowments="" relatively="" abundant="" in="" skilled="" labor="" (sl)="" comparative="" advantage="" in="" uligs="" comparative="" advantage="" comparative="" advantage="" in="" sligs="" export="" uligs="" import="" sligs="" trade="" export="" sligs="" import="" uligs="" increased="" output="" of="" uligs="" decreased="" output="" of="" sligs="" production="" increased="" output="" of="" sligs="" decreased="" output="" of="" uligs="" increased="" demand="" for="" ul="" decreased="" demand="" for="" sl="" factor="" demands="" increased="" demand="" for="" sl="" decreased="" demand="" for="" ul="" ul="" gains="" sl="" loses="" factor="" prices="" sl="" gains="" ul="" loses="" 17="" implications="" of="" ss="" theorem="" some="" groups="" lose="" from="" free="" trade="" the="" scarce="" factors="" who="" lose="" will="" lobby="" how="" to="" deal="" with="" the="" losers?="" or="" should="" we="" ignore="" them?="" ethics?="" 18="" product="" life="" cycle="" theory="" raymond="" vernon="" has="" argued="" that,="" for="" many="" manufactured="" goods,="" comparative="" advantage="" may="" shift="" over="" time="" from="" one="" country="" to="" another="" the="" stages="" of="" the="" life="" cycle:="" goods="" are="" invented,="" tested="" in="" the="" market="" place="" and="" modified="" the="" product="" becomes="" standardized="" the="" product="" matures="" 19="" product="" life="" cycle="" (cont’d)="" in="" first="" stage="" the="" good="" is="" produced="" and="" exported="" by="" a="" country="" that="" is="" sl="" abundant,="" i.e.="" u.s.="" in="" second="" stage="" production="" moves="" to="" a="" country="" that="" has="" a="" cost="" advantage="" in="" large="" scale="" manufacturing.="" the="" good="" is="" more="" k="" intensive="" produced="" in="" asia="" in="" third="" stage="" production="" moves="" to="" countries="" rich="" in="" ul="" examples:="" automobiles,="" color="" television,="" pocket="" calculators,="" other="" electronics="" 20="" product="" life="" cycle="" (cont’d)="" can="" the="" product="" life="" cycle="" explain="" also="" foreign="" investment="" (fdi)?="" could="" it="" result="" in="" intrafirm="" trade?="" in="" outsourcing?="" is="" it="" consistent="" with="" comparative="" advantage?="" international="" flows="" of="" factors="" labor="" &="" capital="" some="" facts="" immigration="" played="" a="" large="" role="" in="" the="" development="" and="" growth="" of="" the="" u.s.="" economy="" rich="" western="" european="" countries="" have="" imported="" guest="" workers="" from="" spain,="" portugal,="" turkey,="" greece,="" etc.="" oil="" rich="" middle="" eastern="" countries="" have="" imported="" workers="" from="" egypt,="" jordan,="" pakistan,="" india,="" korea,="" etc.="" reasons="" better="" economic="" conditions="" (demand-pull="" factors)="" poor="" countries="" to="" rich="" countries="" movements="" of="" low="" skilled="" workers="" of="" skilled="" workers="" (brain="" drain)="" escape="" from="" political="" tyranny="" or="" devastation="" (supply-push="" factors)="" reunion="" with="" other="" family="" members="" (social="" networks)="" international="" flows="" of="" capital="" physical="" (fdi)="" capital="" greenfield="" versus="" brownfield="" second="" half="" of="" the="" course="" will="" cover="" financial="" (portfolio)="" capital="" more="" important="" than="" international="" labor="" flows="" the="" us="" was="" an="" importer="" of="" capital="" throughout="" the="" 19th="" century="" used="" to="" build="" railroads,="" factories="" and="" communications="" systems="" the="" us="" was="" an="" exporter="" of="" capital="" throughout="" much="" of="" the="" 20th="" century="" after="" the="" 1980s,="" the="" us="" became="" the="" world’s="" largest="" net="" debtor="" and="" thus="" a="" net="" importer="" of="" capital="" another="" reason="" for="" fdi="" ownership-location-internalization="" (oli)="" developed="" by="" john="" dunning="" firms="" own="" an="" asset="" (patent,="" trade="" secret,="" trademark,="" reputation,="" blueprint,="" innovation,="" etc)="" that="" confers="" a="" potential="" advantage="" on="" the="" firm="" firms="" select="" the="" best="" location="" (input="" costs,="" large="" customer="" base,="" good="" infrastructure,="" skilled="" labor)="" by="" investing="" abroad,="" i.e.="" creating="" its="" own="" subsidiary,="" the="" firm="" internalizes="" the="" advantages="" of="" asset="" ownership="" not="" inconsistent="" with="" comparative="" advantage,="" but="" it="" is="" not="" a="" theory="" of="" trade="" off-shoring="" and="" outsourcing="" off-shoring:="" the="" transfer="" of="" a="" firm’s="" activities="" to="" a="" location="" outside="" the="" home="" country="" (to="" a="" foreign="" affiliate="" (fdi)="" or="" a="" foreign="" firm)="" outsourcing:="" the="" transfer="" of="" activities="" to="" another="" firm="" either="" inside="" or="" outside="" the="" home="" country="" the="" most="" controversial="" is="" the="" transfer="" of="" activities="" outside="" the="" home="" country="" to="" a="" foreign="" firm="" (="off-shoring" +="" outsourcing)="" maquiladoras="" are="" an="" example="" of="" off-shoring="" off-shoring="" in="" some="" cases="" leads="" to="" job="" losses="" in="" the="" home="" country,="" while="" in="" others="" it="" is="" complementary="" to="" home="" production="" and="" leads="" to="" an="" expansion="" of="" jobs="" in="" the="" home="" country="" “source="" everywhere,="" manufacture="" everywhere,="" sell="" everywhere”="" the="" whole="" notion="" of="" trade="" (and="" outsourcing?)="" is="" disappearing="" economic="" analysis="" (works="" for="" both="" capital="" and="" labor="" flows)="" marginal="" product="" of="" labor:="" mpl="" it="" is="" the="" additional="" output="" produced="" by="" one="" more="" worker="" diminishing="" marginal="" product="" as="" l="" increases,="" mpl="" falls="" or="" the="" additional="" amount="" of="" output="" produced="" will="" become="" smaller="" and="" smaller="" value="" marginal="" product="" of="" labor:="" vmpl="P" x="" mpl="" it="" is="" the="" additional="" revenue="" producers="" receive="" from="" selling="" the="" amount="" produced="" by="" the="" last="" worker="" hired="" profit="" maximizing="" rule:="" w="VMPL" distribution="" of="" income="" labor="" wage="" (w)="" labor="" income="" payments="" to="" capital="" owners="" vmpl="Demand" for="" labor="" w*="" o="" a="" the="" combined="" area="" below="" the="" vmpl="" (demand="" for="" labor)="" to="" the="" left="" of="" ac="" represents="" the="" total="" income="" paid="" to="" workers="" and="" the="" owners="" of="" capital;="" it="" is="" equal="" to="" gdp="" c="" effects="" of="" immigration="" labor="" wage="" (w)="" vmpl="" w*="" o="" a="" more="" goods="" are="" produced="" and="" gdp="" increases="" by="" the="" area="" acdb="" below="" the="" vmpl="" curve="" between="" a="" and="" b="" b="" w**="" payments="" to="" foreign="" workers="" additional="" payments="" to="" capital="" owners="" lost="" earnings="" to="" domestic="" workers="" (transferred="" to="" domestic="" owners="" of="" capital)="" c="" d="" summary="" international="" factor="" inflows="" tend="" to="" lower="" the="" incomes="" of="" those="" factors="" in="" the="" host="" country="" that="" most="" directly="" substitute="" for="" this="" factor="" and="" tend="" to="" raise="" the="" incomes="" of="" other="" factors.="" thus="" some="" types="" of="" labor="" (i.e.="" skilled)="" in="" the="" host="" country="" could="" benefit="" from="" immigration="" of="" unskilled="" labor="" while="" the="" host="" country="" benefits="" overall="" (higher="" gdp),="" the="" source="" country="" is="" worse="" off="" (see="" next="" slide).="" impact="" of="" emigration="" on="" the="" source="" country="" labor="" wage="" (w)="" vmpl="" w*="" o="" a="" the="" combined="" area="" below="" the="" vmpl="" falls="" and="" thus="" gdp="" falls="" by="" area="" aefg="" the="" wage="" rises="" (workers="" have="" become="" more="" scarce)="" capitalists="" are="" worse="" off;="" they="" lose="" gw*w***f.="" e="" w***="" f="" g="" beyond="" comparative="" advantage="" (chapter="" 5)="" intra-industry="" trade="" versus="" inter-industry="" trade="" internal="" versus="" external="" economies="" of="" scale="" (firms="" grouped="" in="" clusters)="" strategic="" trade="" policy:="" the="" use="" of="" industrial="" policy="" (trade="" barriers="" and="" subsidies)="" in="" order="" to="" capture="" some="" of="" the="" profits="" of="" foreign="" firms="" intra-industry="" trade="" internal="" economies="" of="" scale="" or="" increasing="" returns="" to="" scale,="" whereby="" a="" proportionate="" increase="" in="" k="" and="" l="" leads="" to="" a="" greater="" than="" proportionate="" increase="" in="" output="" (i.e.="" declining="" lac),="" can="" explain="" iit="" large="" firms.="" imperfect="" competition="" irs="" results="" in="" ppfs="" that="" are="" convex="" to="" the="" origin="" 34="" irs="" and="" the="" gains="" from="" trade="" (cont’d)="" consumption="" production="" consumption="" production="" luxury="" cars="" economy="" cars="" luxury="" cars="" economy="" cars="" germany="" s.="" korea="" intra="" industry="" trade="" similar="" countries="" trade="" not="" based="" on="" differences="" in="" factor="" endowments="" and="" comparative="" advantage="" gains="" from="" economies="" of="" scale="" countries="" specialize="" in="" different="" varieties="" of="" the="" same="" good="" differentiated="" products="" more="" consumer="" choices="" less="" need="" for="" workers="" to="" shift="" between="" industries="" less="" opposition="" to="" trade="" perfect="" competition="" may="" not="" prevail="" 36="" strategic="" trade="" policy="" necessary="" conditions:="" economies="" of="" scale="" market="" power="" (monopoly/oligopoly)="" example:="" aircraft="" production="" embraer="" vs.="" bombardier="" boeing="" vs.="" airbus="" game="" theory:="" initial="" payoff="" matrix="" brazil="" embraer="" (be)="" canada="" bombardier="" (cb)="" produces="" does="" not="" produce="" produces="" be:="" -10="" be:="" 0="" cb:="" -10="" cb:="" +25="" does="" not="" produce="" be:="" +25="" be:="" 0="" cb:="" 0="" cb:="" 0="" cb="" enters="" the="" market="" first.="" be’s="" best="" strategy="" is="" not="" to="" produce="" matrix="" payoff="" when="" be="" receives="" subsidy="15" when="" it="" produces="" brazil="" embraer="" (be)="" canada="" bombardier="" (cb)="" produces="" does="" not="" produce="" produces="" be:="" +5="" be:="" 0="" cb:="" -10="" cb:="" 25="" does="" not="" produce="" be:="" +40="" be:="" 0="" cb:="" 0="" cb:="" 0="" be="" will="" now="" produce,="" while="" cb="" will="" exit="" the="" market="" payoff="" matrix="" when="" both="" firms="" receive="" a="" subsidy="+15" brazil="" embraer="" (be)="" canada="" bombardier="" (cb)="" produces="" does="" not="" produce="" produces="" be:="" +5="" be:="" 0="" cb:="" +5="" cb:="" +40="" does="" not="" produce="" be:="" +40="" be:="" 0="" cb:="" 0="" cb:="" 0="" both="" firms="" will="" now="" produce="" while="" they="" receive="" a="" production="" subsidy="" summary="" inter-industry="" trade="" is="" explained="" by="" comparative="" advantage="" (differences="" in="" technology="" and="" factor="">