International Trade

Chapter 5:The Standard Trade Model

Question 1:

• Assume that France and Germany trade with each other, with France exporting fish to Germany and Germany exporting Volksawagens (automobiles) to France. Illustrate the gains from trade between the the countries assuming first that tastes for goods are the same in both countries, but the production possibilities frontier differ: France has a long coast, making it relatively more productive in fishing. Germany has a greater stock of capital, making it relatively more productive in automobiles.

Countries trade for two reason :

• economic of scale• they are different

International economic

• The trade between Germany and France can achieve economic of scale.

• Economic of scale is described as the reduction of the cost per unit of goods as more units of goods are being produced.

• As they specialize in producing in fishes or automobiles, each country only produces a limited range of goods, it can produce each of these goods at a larger scale and hence more efficiently than it tried to produce everything.

International economic

• Germany and France are different from the aspect of resource they owns.

• Germany have greater stock of capital so it will be more productive in automobiles.

• France have a long coast so it will be more productive in fishing.

QUESTION 2

• In the trade scenario in Problem 1, due to overfishing, France becomes unable to catch the quantity of fish it could in previous years. This change causes both a reduction in the potential quantity of fish that can be produced in France and an increase in the relative world price for fish, Pf/Pa.

BEFORE :

AFTER:

Before: = USD 8

After: = USD 15

a) Show how the overfishing problem can result in a decline in welfare for France.

potential quantities of fish

Overfishing supply less

world price

welfare of France

• Fish = exports of France. production of fish will caused exports . France income .

Welfare• the decline in welfare also caused by the

substitution effect in economy.

• Indifference curve• When Pf increase, consumer will reduce

consumption of fish. • Consumer will prefer spend on other goods such

as automobile from Germany• D1 D2, demand of fish Q1 Q2.

substitution effect: consume less fish will leads to consume more automobile.

• Rises in price if fish in France also causes Germany can’t afford to import fish from France. export and welfare decline.

• Less production of fishes will increase the unemployment rate in France.

b) Also show how it is possible that the overfishing problem could result in an increase in welfare for France.

• Terms of Trade= price of export goods (Pf) price of import goods (Pa)

• The rise in price will cause increase in terms of trade.

• The rise in the terms of trade will increases a country’s welfare.

• When Pf/Pa increase, economy want to produces more fish and less automobile.

• The more economy want to produces fish, the more valuable fish goes.

• France will try to get more ways to produce fish such as fish rearing farm.

• Therefore, production shift from Q1 to Q2.• Isovalue line shifts from VV1 to VV2. (steeper

when price increase)• Consumer choice shifts from D1 to D2.

• The move from D1 to D2 shows higher indifference curve.

• When the indifference curve move to the right, means the more fish and the less automobile an individual prefer, the more valuable a unit of fish is at the margin compared with a unit of automobile.

• Higher indifference curve also shows that consumption of both goods increase.

• This helps to increase the welfare of both nations including France.

• The higher is the price of fish which is the export of France represents an advantage to France.

• This is because when the price of fish increase, the economy of France can exports more and earn more profit.

• lead to more action will be taken by government to take care of the coast from pollution.

• This will provides a better surroundings and environment to the citizens of France.

• In this case, the increases in price of fish indirectly increase the welfare of France.

Question 8:

• It is just as likely that economic growth will worsen a country’s terms of trade as that it will improve them. Why, then, do most economists regard immiserizing growth, where growth actually hurts the growing country, as unlikely in practice?

Answer:

• Two types of biased:• Export-biased • Import-biased

What are those biased?

• Export-biased: tends to worsen a growing country’s terms of trade, to the benefit of the rest of the world

• Import-biased: tends to improve a growing country’s terms of trade at the rest of the world’s expense.

What is Immiserizing growth?

• Refers to a situation which is increase in economic growth associated with a fall in real living standard.

Malaysia

• If Malaysia experiencing export-biased, its terms of trade will be worsening.

• If Malaysia experiencing import-biased, the terms of trade will increase.

• Because this country will increase its ability to produce import-competing goods.

•Why Immiserizing growth is more to a theoritical point than a real-world issue?

Reason 1

• Worse terms of trade do not necessarily imply immiserizing growth.• If trade accounts for 20 percent of

national income, the terms of trade have to be worsen by over 5 percent for each 1 percent growth of output to be immiserizing.

Reason 2:

• If a country which experiencing strong export biased have very steep RS and RD curves, then the change in terms of trade is large enough to offset the initial favorable effects of an increase in a country’s productivity capacity.

Question 11:• Suppose that one country subsidizes its

export and the other country impose a “countervailing” import tariff that offsets its effects, so that in the end relative prices in the second country are unchanged. What happens to the term of trade? What about welfare in the two countries? Suppose, on the other hand, that the second country retaliates with an export subsidy of it own. Contrast the result.

Answer:

• Suppose that there are two goods are trade among first and the second country, there are cloth and food. We also assume that the first country export cloth to second country and import food from second country and vice versa to the second country.

• When the 1st country imposes a subsidy on cloth exports, the price of cloth relative to the price of food that producers and consumers face rises.

• Producers: Relative supply of cloth rises, relative supply curve shifts from RS1 to RS2.

• Consumers: switch to food consumption, relative demand of cloth decrease (RD1 to RD2).

• Causes: Relative price of cloth decrease (PC/PF1 to PC/PF2), term of trade and welfare decrease in 1st country, 2nd country gain from the lower relative price of cloth

• When 2nd country imposes “countervailing” import tariff, the term of trade will moving further against the first country.

• Assume that the price of cloth is higher relative to the price of food in 2nd country after import tariff.

• Producers switch to cloth production and less produce food (shifts the relative supply curve of cloth to left); consumers demand more food (upward shifts relative demand curve).

• 2nd country term of trade and welfare increase as the relative price of food increase.

• 1st country worse off as it import food with higher relative price PF/PC2

• But, the “retaliatory” export subsidy will hurts the 2nd country.

• It is because when 1st country may subsidize the export of a good that the 2nd country also exports, the relative price of the exported goods in the 2nd country will be reduced in world market.

• The term of trade and welfare in the 2nd country decrease.

• Thank You For Your Attention!