The Due Date Is Friday, October 16 At Midnight
The Due Date Is Friday October 16 At Midnight
The final problem set is a combination of multiple choice and short answer questions. There are two sections. The first section asks you to answer multiple choice questions and to explain your answers briefly. The second section asks you to provide short-answers to case-study based questions.
Paper For Above instruction
Introduction
Trade theory and policy analysis are fundamental to understanding the economic interactions between nations and their domestic implications. This paper explores various facets of international trade, including the reasons countries engage in trade, the impact of trade policies like tariffs, and the strategic considerations of developing nations such as Ghana transitioning towards industrialization. By analyzing these topics through theoretical models and practical case studies, we aim to provide comprehensive insights into the dynamics shaping global and national economic policies.
Section A: Multiple Choice and Explanation
Question A.1
In free trade, a country will not trade if
A. Autarky prices and free trade prices are the same.
B. Autarky prices are larger than free trade prices.
C. Autarky prices are smaller than free trade prices.
D. The absolute value of autarky prices are negatively correlated with free trade prices.
Answer: A. Autarky prices and free trade prices are the same.
Under autarky (self-sufficiency), a country does not engage in international trade because its domestic prices reflect equilibrium within its own economy. When the autarky and free trade prices are equal, the country has no comparative advantage or disadvantage in trading. If autarky prices differ from free trade prices, there are potential gains from trade—either through exporting or importing—making trade beneficial. Conversely, if the prices are the same under autarky and free trade, there is no incentive for the country to trade since it is already operating at its optimal consumption and production point domestically. Therefore, trade is unlikely or unnecessary when autarky prices match free trade prices.
This explanation aligns with the principle that trade occurs to exploit price differentials driven by comparative advantages.
Diagram illustrating this point would show the autarky equilibrium price aligning with the world price, resulting in no incentive to export or import.
Question A.2
The reason why the most efficient firms in a Melitz industry make greater profits under free trade is due to the fact that they
A. Operate under increasing marginal costs.
B. Operate under FDI.
C. Operate under low transport costs.
D. Operate under increasing returns to scale.
Answer: D. Operate under increasing returns to scale.
In the Melitz model, firms vary in productivity, and those with higher productivity levels benefit more under free trade due to economies of scale, which are characteristic of increasing returns to scale. Efficient firms can expand output once exposed to international markets, reducing average costs through increased production volume. This leads to higher profits as they are able to exploit economies of scale more fully than less efficient firms. Free trade thus amplifies the advantage of highly productive firms, allowing them to capture larger market shares and earn greater profits, whereas less efficient firms may be driven out of the market. The model underscores how increasing returns to scale create a competitive environment where only the most efficient survive and thrive internationally.
Diagram would depict the productivity distribution, showing higher profits for firms operating at the higher end of productivity, with scale economies depicted as falling average cost curves.
Question A.3
In the Pure Specific Factors model with two sectors, Cars (C) and Wheat (W), Capital (K) is specific to C and Land (A) is specific to W. If the government imposes a tariff on the imports of W then
A. Both owners of K and owners of A will benefit.
B. Owners of A will benefit.
C. Owners of K will benefit.
D. Neither owners of K nor owners of A will benefit.
Answer: B. Owners of A will benefit.
In the model described, a tariff on imported wheat (W) raises the domestic price of wheat, increasing the revenue for landowners who own the land (A) specific to wheat. Since land is specific to wheat and benefits from higher prices, landowners gain from the tariff. Conversely, owners of capital (K), which is specific to cars, are unaffected by tariffs on wheat since their sector does not directly benefit from the policy. Additionally, the tariff may lead to resource allocation distortions, but the immediate effect favors landowners of wheat. Therefore, owners of A, the land specific to wheat, benefit from the tariff.
Diagram would show the increase in wheat prices leading to higher income for landowners with no effect on capital owners.
Question A.4
In a Mixed Specific Factors model with two sectors, Cars (C) and Wheat (W), Capital (K) is specific to C and Land (A) is specific to W. If the government imposes a tariff on the imports of W then
A. Both owners of K and owners of A will benefit.
B. Owners of A will benefit.
C. Owners of K will benefit.
D. Neither owners of K nor owners of A will benefit.
Answer: B. Owners of A will benefit.
Similar to the pure factors model, a tariff on imports of wheat raises domestic wheat prices, benefiting landowners (A) specific to wheat. However, unlike the pure factors model, the mixed model allows some degree of mobility or interaction, but since K is specific to cars and not influenced by wheat tariffs, owners of K do not benefit directly. The primary beneficiaries are landowners in the wheat sector, who see increased income from higher wheat prices. Therefore, owners of A benefit from the tariff, while owners of K do not experience gains directly.
Diagram would depict increased wheat prices improving landowner income with unchanged capital costs.
Question A.5
A country imposing a tariff can benefit in terms of social welfare if
A. The terms-of-trade benefit exceeds the sum of production and consumption distortion loss.
B. The tariff revenue exceeds the sum of production and consumption distortion loss.
C. The consumer surplus loss is less than the producer surplus gain.
D. The terms-of-trade benefit exceeds the consumer surplus loss.
Answer: A. The terms-of-trade benefit exceeds the sum of production and consumption distortion loss.
A tariff can enhance social welfare when the benefits from an improved terms-of-trade (the price advantage gained on exports relative to imports) outweigh the distortions caused by production and consumption inefficiencies. These distortions include deadweight losses associated with inefficient resource allocation due to tariffs. If the positive effect on the terms-of-trade—the relative prices of exports and imports—more than compensates for these distortions, the country gains overall welfare. This concept aligns with the optimum tariff theory, which posits that countries can strategically use tariffs to improve welfare if the net gains from better terms of trade surpass the losses from economic distortions.
Diagram would illustrate the terms-of-trade improvement and deadweight losses from tariffs, highlighting the welfare gain threshold.
Section B: Case Study Analysis
Question B.1
Ghana imports and exports food from and to neighboring Cà´te d'Ivoire. The latter nation is very similar to Ghana in most ways. It has a similar environment, a similar level of education, and similar institutional background. Would you argue that trade between the two countries can be explained by comparative advantage? Why or why not? Ghana also exports food to Switzerland. The latter nation is very different to Ghana in most ways. Would you argue that trade between the two countries can be explained by comparative advantage? Why or why not?
Answer:
Trade between Ghana and Cà´te d'Ivoire can be partially explained by comparative advantage, but its explanation is limited due to their similarities. Comparative advantage relies on differences in resource endowments, productivity, or technology that make one country more efficient in producing certain goods. When two countries are very similar — in environment, resources, and institutions — differences in opportunity costs are minimal, reducing the gains from specialization based solely on comparative advantage. Therefore, trade between Ghana and Cà´te d'Ivoire might be driven more by geographic proximity, trade costs, and historical links than by significant comparative advantages.
In contrast, trade between Ghana and Switzerland can be better explained by differences in comparative advantage. Switzerland's advanced technology, capital abundance, and productivity in certain sectors (e.g., electronics or finance) differ substantially from Ghana’s primarily agrarian economy. Ghana’s comparative advantages may lie in raw materials or agricultural products, which Switzerland seeks due to its technological capabilities and consumer preferences. Hence, trade between Ghana and Switzerland is more likely to be driven by their differing resource endowments and productivity levels, aligning with classical trade theory based on comparative advantage.
Question B.2
Explain import substitution industrialization (ISI) and how it can affect Ghana. What role does learning by doing play and when does it make sense for the government to interfere?
Answer:
Import substitution industrialization (ISI) is an economic strategy focusing on reducing dependency on imported goods by promoting domestic manufacturing of these goods. This approach aims to develop local industries, create jobs, and foster self-sufficiency. For Ghana, implementing ISI could stimulate economic growth, build infrastructure, and nurture industrial capacity, potentially leading to increased employment in manufacturing sectors and reduced trade deficits. However, initial stages often involve protectionist policies like tariffs and subsidies that may distort markets and lead to inefficiencies.
Learning by doing plays a crucial role in ISI as domestic firms gain experience, improve productivity, and reduce costs through increased production. Over time, this knowledge accumulation can lead to technological progress and a competitive domestic industry. The government should intervene when the market alone cannot generate sufficient learning or when infant industries face barriers to entry. Such intervention is justified during initial phases of industrialization, especially if there are significant externalities, knowledge spillovers, or positive externalities from developing critical sectors. However, prolonged protection without adequate adjustment can lead to inefficiencies, rent-seeking, and complacency, so interference must be calibrated and time-bound.
Question B.3
Ghana’s president’s ISI strategy is to ask Switzerland to adopt a voluntary export restraint (VER). He believes that this is likely to increase Ghanaian welfare. Using two diagrams (one for each country), explain the Ghanaian welfare consequences of this policy.
Answer:
A voluntary export restraint (VER) imposed by Switzerland limits export quantities to Ghana, effectively reducing Swiss exports to the Ghanaian market. For Ghana, this can lead to an improvement in domestic prices of imported goods, reducing the world price faced by Ghana and potentially improving Ghanaian terms of trade if the restraint favors Ghana’s price position.
In the diagram for Ghana, the reduction in Swiss exports shifts the world supply curve inward, leading to a higher domestic price of the imported good. This benefits Ghanaian consumers who now face higher domestic prices but also benefits domestic producers competing with the imported goods. The welfare effects depend on the relative magnitudes of consumer losses versus producer gains. When the terms of trade improve sufficiently and the increase in producer surplus outweighs consumer surplus losses, Ghanaian welfare increases.
In the Swiss diagram, the VER reduces Swiss export volumes, leading to a loss in Swiss producer surplus and overall welfare. However, the key idea is that the net welfare for Ghana might be positive if the terms-of-trade improvement compensates for higher prices and any deadweight losses. In summary, Ghana’s welfare might increase if the terms of trade benefit exceeds the welfare losses from reduced imports and market distortions.
Question B.4
Explain if the VER is likely to improve the average efficiency of Ghana’s farms?
Answer:
A voluntary export restraint (VER) on imported goods can have mixed effects on the efficiency of Ghana’s farms. Initially, if Ghana relies heavily on imported agricultural inputs or machinery, reduced imports may limit access to better technology and inputs, potentially decreasing farm productivity and efficiency. Conversely, if the VER encourages domestic production of certain agricultural inputs or products by protecting local farmers from foreign competition, it might incentivize investment and learning within the domestic sector.
However, long-term efficiency gains are uncertain, as protectionist measures often diminish incentives for domestic innovation and cost reduction, possibly leading to complacency and allocative inefficiencies. Without complementing policies that promote technological adoption or improve resource allocation, the VER alone is unlikely to appreciably improve the average efficiency of farms. For true productivity enhancement, targeted investments, extension services, and access to technology are necessary alongside any import restrictions.
Question B.5
After a meeting with Ghana’s president, you learn that the government is also interested in repatriating migrants that went to European countries to study engineering a decade ago. Explain how this is likely to change Ghana’s comparative advantage.
Answer:
Repatriating skilled migrants with engineering backgrounds can significantly influence Ghana’s comparative advantage. Human capital is a critical determinant of productivity and technological development. The influx of engineers and technical specialists can lead to technological upgrades, innovation, and improved industrial processes within Ghana. This can shift the country’s comparative advantage from reliance on raw material exports to more knowledge- and technology-intensive sectors such as manufacturing, engineering services, and technology-driven industries.
These skilled individuals may catalyze the development of new industries, improve infrastructure, and foster local innovation ecosystems. Over time, this human capital inflow can elevate productivity, reduce reliance on primary commodity exports, and enable Ghana to compete more effectively in higher-value industries globally. Therefore, the country’s comparative advantage may evolve from traditional sectors to more technologically sophisticated and value-added sectors, enhancing economic development and diversification prospects.
References
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- Development Theory and the Three Worlds: Towards a Post-Developmental Perspective. Zed Books.
- American Economic Review, 68(2), 318–324.
- African Development Review, 26(2), 183–199.
- World Bank Report.
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