BA 187 International Trade
Problem Set #4:
IRS &
Protectionist Policies
1. Size Matters After All.
Recognizing that economies of scale exist in certain industries makes trade
theory more “realistic” but it has a number of disturbing implications for
the traditional “mutual gains from trade” argument.
A.
What do increasing returns to scale do to the ability of
trade theory to predict patterns of trade between countries?
Increasing returns to scale in an industry generally reduces the
ability of trade theory to predict patterns of trade. The gains to
scale tend to offset any factor considerations in a good’s cost of
production. Thus many IRS trade models have the property that
factor intensity/endowments do not matter for where the good is
produced matters. Often what matters is which country is first to
market which may be influenced by technology or may simply be
a historical accident.
This type of indeterminacy is not always the case. The Product
cycle model and the Linder model have well-defined, but
evolving, patterns of trade associated with them.
You should be able to provide specific examples of indeterminacy
and determinacy in trading patterns for different IRS models.
1. Size Matters After All.
Recognizing that economies of scale exist in certain industries makes trade
theory more “realistic” but it has a number of disturbing implications for
the traditional “mutual gains from trade” argument.
B. Increasing returns to scale is said to introduce potential conflict
between countries, since each country is better off if it can increase
its production in these types of industries. Evaluate this statement for
Krugman’s model of a monopolistically competitive industry.
Look at the slides for the Krugman model used in class. Increasing the
size of the market allows firms to reap IRS, leading to more varieties
in the single international market than when there were two separate
national markets. It also says, however, that there will be fewer firms
in total across both countries after trade.
The model says nothing about where these new, but fewer, firms will be
located. The potential conflict in the Krugman model is not over the
scale of any single firm, but rather over where the new firms are
located after trade is opened up. Nations “win” by having more of the
new firms locating in their country.
Think of the auto industry; as the industry has become international, the
variety of types of cars has increased even as the number of firms
has fallen.
1. Size Matters After All.
Recognizing that economies of scale exist in certain industries makes trade
theory more “realistic” but it has a number of disturbing implications for
the traditional “mutual gains from trade” argument.
C.
What does the specialization necessary to attain economies of scale
say about the Stolper-Samuelson result? (i.e. Does trade equalize
relative factor returns across countries? Do some factors win and
other factors necessarily lose with trade?)
The Stolper-Samuelson effect may fail to hold with IRS. Why?
1. Trade patterns don’t necessarily depend on factor intensity and
endowments under IRS, so no guarantee the export good uses the
abundant factor intensively as the relative return SS result requires.
2. IRS means that it is possible for both factors to gain in absolute terms
with specialization. Remember IRS means double capital and labor
more than doubles output. Hence it is not only possible, but likely that
return to both factors increases under IRS even if country specializes
in a good which uses its scarce factor intensively.
2. Waiting for WTO?
Four men are discussing why the U.S. should provide special support for its
high-technology industries. Which of these statements are valid arguments
for the United States to have a policy targeting these industries?
Vladimir: “They deserve protection because they hold the prospect for
rapid future growth...”
•
Uncertain. It is not enough that an industry have potential for rapid
future growth, trade policy is only justified if the industry will be more
competitive than existing firms and will not develop otherwise
because of pre-existing barriers to entry. We are of course making the
infant industry argument for temporary protection of the industry. So
Vladimir is only partly correct.
Estragon: “No, rather they provide inputs to many other industries, and
…’
•
False in general. A country benefits from cheaper imported inputs
rather than more expensive protected domestic inputs. Protecting
home input industries will raise costs of domestically produced goods
and also reduce the competitiveness of Home exports that use these
inputs.
2. Waiting for WTO?
Four men are discussing why the U.S. should provide special support for its
high-technology industries. Which of these statements are valid arguments
for the United States to have a policy targeting these industries?
Lucky:
•
“Fool! They generate technology that benefits the whole
economy!”
True To the extent that an industry generates external economies of
scale, trade policy benefiting the industry benefits the country as a
whole, and perhaps even the world. We should note that it is very
difficult to identify the scope of these spillovers, so we might take this
argument with a grain of salt.
Pozzo: “There’s no call to be rude. Its most certainly because they
are challenged by government-supported foreign competitors.”
•
False Foreign subsidies reduce the gains to be captured in the industry.
Subsidies to domestic firms simply reduce the profits available in the
industry even further. The only winners of a subsidy competition are
consumers in the 3rd country.
3.A. Import Quota for Small Country
World Market
1. Import quota level set at Qq. Raises
domestic PqH,, ROW price same.
Quota
2. There exists an equivalent tariff, tq ,
for any quota that has same result.
Price, P
3. Market effects of tariff and a quota
are identical but not welfare effects.
4. Consumer surplus, producer surplus
and associated Deadweight loss (= pro’dn
loss + consump loss) are identical.
XS’
PqH
tq
PW
Qq
Q0
XS
5. Quota brings no Government
revenue increase of a tariff. Who
earns this quota profit or rent
MD depends on structure of quota.
Quantity, Q
3.B. Import Tariff for Small Country
1. Import tariff, t, raises domestic
price PT = PW + t for small country.
2. Consumer surplus falls by areas:
a+b+c+d
3. Producer surplus rises by area:
a
4. Government revenue rises by area:
c
Home Market
Price, P
SH
5. Deadweight loss (cost of protection):
b + d (= pro’dn loss + consump loss)
PT
t
a
b
c
d
DH
PW
S0
ST
DT
D0
Quantity, Q
3.C. Domestic Prod’n Subsidy
Price to
Consumer, P
1. Domestic subsidy, s, raises price
received by producers to PW + s. Price
to consumer unchanged at PW .
Home Market
2. Consumer surplus unchanged.
SH
s
PW+
s
a
SHsub
5. Deadweight loss (cost of policy):
b (= pro’dn loss)
b
PW
DH
S0
3. Producer surplus rises by area:
a
4. Government subsidy (cost) is area:
a+b
Ssu
b
D0
6. Domestic prod’n rises, domestic
demand stays unchanged, level of
imports falls.
Quantity, Q