Questions & explanations
1. Explain how total world output changes when countries specialize according to comparative advantage.
When each country specializes in its comparative advantage good, they produce more of that good per worker. Total world production of both goods can increase. For instance, if A specializes in cloth and B in wine, world cloth output rises because A is more productive in cloth relative to wine? Actually need to check: In A, cloth productivity is 2 per hour, in B 4 per hour, so B is better at both? Wait careful: In the earlier example A:1 wine,2 cloth; B:3 wine,4 cloth. B has absolute advantage in both. But comparative advantage still leads to specialization: B makes wine, A makes cloth. World wine: B uses workers for wine, wine output per worker is 3, A uses none, so total wine from same labor? Actually if both produce both, say half workers each, total wine = (50*1)+(50*3)=200, cloth=(50*2)+(50*4)=300. If specialize: B all wine: 100*3=300 wine, A all cloth: 100*2=200 cloth. So wine increased from 200 to 300, cloth decreased from 300 to 200. But then trade allows both to consume more of both? Actually with trade they can get both goods. The point is that with trade, they can consume b
2. How can trade liberalization threaten national sovereignty?
Trade liberalization can threaten national sovereignty when countries agree to international rules that limit their policy choices. For example, trade agreements often require countries to lower tariffs or remove regulations, which can overrule local laws made by elected governments. Dispute settlement bodies, like the WTO's, can force a country to change its policies if they violate trade rules, even if those policies protect health or the environment. Some critics say this gives too much power to global institutions and corporations at the expense of democracy. Countries may feel they cannot pursue their own economic or social goals if they conflict with trade commitments. Thus, sovereignty becomes shared, and national governments lose some control.
3. How do businesses and industry groups influence trade policy?
Businesses and industry groups influence trade policy mainly through lobbying and consultations. They meet with trade officials, provide data on how tariffs or rules affect their sectors, and suggest desired changes. Many countries have formal advisory committees where industry representatives give input on trade negotiations. For example, exporters may push for lower foreign tariffs, while domestic industries might ask for protection. Businesses can also shape public opinion through media campaigns, which puts pressure on politicians. Governments listen carefully because trade policy directly affects jobs and growth. However, the final decision balances business interests with broader national goals like consumer welfare and international relations.
4. Why do countries have inter-agency committees for trade policy?
Countries set up inter-agency committees because trade policy affects many parts of government, not just the trade ministry. For instance, agriculture policy, health standards, and intellectual property rules all intersect with trade. These committees bring together officials from various ministries—like finance, agriculture, labor, and environment—to discuss and coordinate a unified position. This prevents conflicting policies, such as promoting exports while also restricting them for environmental reasons. The committees help resolve disagreements early and ensure that trade deals benefit the whole country. They also allow experts from different fields to contribute their knowledge, leading to more balanced and effective policies.
5. Given two countries and two goods, how do you determine which country has a comparative advantage in a good?
First, find the opportunity cost of making each good in each country. The opportunity cost is the amount of the other good you must give up. For example, in Country X, 1 ton of wheat costs 3 tons of steel, and 1 ton of steel costs 1/3 ton of wheat. In Country Y, 1 ton of wheat costs 2 tons of steel. Country X has a lower opportunity cost for wheat (3 steel vs 2? Wait: 3 >2 so X has higher cost. Correct: lower opportunity cost means you give up less of the other good. So Y has comparative advantage in wheat because it gives up only 2 steel, not 3. Country X has comparative advantage in steel because it gives up only 1/3 wheat, while Y gives up 1/2 wheat. So each country exports the good with lower opportunity cost.
6. Why do some people fear that trade agreements harm the environment?
Some people fear that trade agreements harm the environment because they can encourage more production and transport of goods, leading to more pollution and carbon emissions. Countries may also lower environmental standards to attract business, creating a 'race to the bottom'. Trade rules often make it hard for governments to ban harmful products or enforce strict environmental laws if they are seen as trade barriers. For instance, a country might be challenged for limiting imports of goods produced with child labor or high emissions. Without strong environmental clauses, trade can increase resource use and waste. Supporters argue that trade can also spread green technologies and raise environmental awareness.
7. Give an example where the intertemporal approach would predict a current account surplus for a country with low current income.
Imagine a country that discovers it will have high oil exports in the future. Today its income is low, but it expects large future wealth. To smooth consumption, it will borrow little today because future income is high. Actually, it might save some of its current low income and even lend abroad if it expects future income to be very high? Wait, better example: A country with temporarily low income due to a natural disaster. It expects recovery soon. To smooth consumption, it borrows from abroad, running a current account deficit. For surplus: A country with temporarily high income saves the extra, running a surplus. Example: A commodity exporter during a price boom saves windfall profits, running a surplus.
8. How does the degree of capital mobility affect the effectiveness of fiscal policy in the Mundell-Fleming model?
Capital mobility refers to how easily money moves across borders. If capital is highly mobile, fiscal policy under fixed exchange rates becomes very effective because interest rate changes attract large capital flows. Under flexible exchange rates, fiscal policy becomes less effective with high capital mobility because higher interest rates cause large capital inflows, which appreciate the currency and reduce net exports, offsetting the fiscal expansion. In the extreme case of perfect capital mobility, fiscal policy has zero effect on output under flexible rates (crowding out through exchange rate). With low capital mobility, the exchange rate effect is smaller, so fiscal policy can still affect output.
9. What does it mean when critics say trade agreements 'corporate sovereignty'?
Critics use the phrase 'corporate sovereignty' to argue that trade agreements give too much power to corporations over governments. They point to investor-state dispute settlement (ISDS) clauses in some deals, which allow companies to sue governments for policies that hurt their profits. For example, if a government passes a law to protect the environment that reduces a company's expected earnings, the firm can demand compensation through secret tribunals. This makes governments think twice before regulating in the public interest. Critics say this undermines democracy and puts corporate profits above people's health and environment. Supporters defend ISDS as protecting investors from unfair treatment.
10. What is the balance of payments (BOP) for a country that shares a currency with others, like in the Eurozone?
The balance of payments records all money flows between a country and the rest of the world. In a currency union like the Eurozone, countries use the same currency, so there are no foreign exchange reserves needed for trade within the union. But the BOP still tracks trade, investment, and transfers with non-union countries. For example, Germany’s BOP with the US is recorded in euros, not a foreign currency. A key difference is that a current account deficit within the union does not directly create currency depreciation. Instead, imbalances show up as changes in bank lending or savings. The BOP also includes intra-union flows, but they are easier because no currency conversion is needed.
11. Using PPFs, explain why a country with absolute disadvantage in both goods can still gain from trade.
Even if a country is worse at producing both goods (PPF lies inside the other's), its PPF still has a slope. The opportunity cost of one good may be lower. For example, Country A makes 1 computer or 2 phones per hour; Country B makes 2 computers or 3 phones per hour. A has absolute disadvantage in both, but opportunity cost of computers is 2 phones vs B's 1.5 phones? Actually A: 1 computer costs 2 phones; B: 1 computer costs 1.5 phones, so B has comparative advantage in computers. A's opportunity cost of phones is 0.5 computers, B's is 0.67 computers, so A has comparative advantage in phones. A specializes in phones, trades for computers, and can consume more than if it made both alone.
12. What is one argument that globalization increases inequality within countries?
Some people argue that globalization widens income inequality because it benefits highly skilled workers and capitalists more than low-skilled workers. When countries open up to trade, industries that use low-skilled labor may shrink in developed countries, leading to job losses and lower wages for those workers. At the same time, high-skilled workers in growing export industries see their incomes rise. This can create a bigger gap between rich and poor. Critics also point out that multinational companies often move production to low-wage countries, which puts downward pressure on wages in higher-wage countries. The overall effect is that the rich get richer while many workers struggle.