Module Contact: Dr Jibonayan Raychaudhuri, ECO Copyright of the University of East Anglia Version 1

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1 UNIVERSITY OF EAST ANGLIA School of Economics Main Series UG Examination ECONOMICS OF INTERNATIONAL TRADE AND INTEGRATION ECO-5005A Time allowed: 2 hours Answer THREE questions. All questions carry equal weight. Notes are not permitted in this examination. Do not turn over until you are told to do so by the Invigilator. ECO-5005A Module Contact: Dr Jibonayan Raychaudhuri, ECO Copyright of the University of East Anglia Version 1

2 Page 2 1 Consider the information given below for two countries HOME and FOREIGN and two goods BUTTER (B) and CLOTH (C). The entries in the table show the unit labour requirements (number of hours required to produce one unit of the good) for the two countries for the two goods: COUNTRY BUTTER (B) CLOTH (C) HOME 1/5 HOURS 1 HOUR FOREIGN 1 HOUR 1/3 HOUR Answer the following questions: a) In which commodity does HOME have an absolute advantage? In which commodity does FOREIGN have an absolute advantage? [10 marks] b) In which commodity does HOME have a comparative advantage? In which commodity does FOREIGN have a comparative advantage? [13 marks] c) In the absence of trade, what would be the autarky price of CLOTH in terms of BUTTER? Why? [5 marks] d) How much will HOME gain if it trades 5 units of BUTTER for 3 units of CLOTH (compared to autarky)? [5 marks] 2 Singapore in 1965 was a low-skill labour abundant country compared to the rest of the world and exported low skill labour intensive goods like garments. Singapore s leader Lee Kuan Yew placed great emphasis on education. Then 25 years later, in 1990 Singapore started exporting high skill labour-intensive computer parts and importing garments. How would the Heckscher Ohlin model explain such a phenomenon? ECO-5005A Version 1

3 Page 3 3 Consider the case of a small country in the context of the Specific Factors model. There are only two sectors in this economy agriculture and manufacturing. Assume that land is specific to agriculture, capital is specific to manufacturing, and that labour is used in both sectors and is free to move between the two sectors. In the context of this model, consider a decrease in the stock of land. For example, suppose that a natural disaster decreases the quantity of arable land for planting crops. a) Redraw the equilibrium labour allocation diagram starting from the initial equilibrium point (call the initial point - A). [10 marks] b) What is the effect of this change (i.e. decrease in the stock of land) on the quantity of labour in each industry and on the equilibrium wage? [10 marks] c) Now suppose that the international community wants to help the country struck by the natural disaster and decides to do so by increasing its level of FDI in this country. That is, the rest of the world increases its investment in physical capital in the stricken country. What is the effect of this policy on the equilibrium wage? What is the final effect on the equilibrium wage of the disaster and the subsequent FDI investment (does the wage increase, decrease or is the change in wage ambiguous)? Does the agriculture industry benefit or lose from the FDI? [13 marks] 4 The fact that we observe Germany at the same time both importing and exporting cars proves that international trade is a waste of resources and only serves the interests of large multinational corporations. Discuss. 5 The US government under President Obama in 2009 imposed a specific tariff on tire imports coming from China. Assume that the United States is a small open economy. Show, using a diagram if necessary, what the effect will be in the United States on: (i) tire prices, (ii) imports of tires coming from China, (iii) US demand for tires (from US consumers), (iv) domestic (US) tire production and (v) overall welfare in the US from this policy. Use diagrams if necessary. 6 Using the theory of external economies of scale state and explain (in detail) three main reasons why a cluster of firms (an industry such as Silicon Valley in California, United States) may be more efficient than an individual firm in isolation. TURN OVER ECO-5005A Version 1

4 Page 4 7 A large country gives a generous export subsidy to beef exporters. Explain, using diagrams if necessary, the effect on the quantity of beef exported, the price of beef and the total welfare for this large country. 8 The new strategic trade policy argument demonstrates the wisdom of policies like that of South Korea, which subsidizes its exports across the board. The subsidy gives each industry the strategic advantage it needs to establish itself in world competition. Discuss. END OF PAPER ECO-5005A Version 1

5 Examination Feedback Module: ECO-5005A Economics of International Trade and Integration, Structure of the exam: Students were required to answer 3 out of 8 questions. This is a change from earlier years where they were required to answer 3 out of 7 questions. Marks distribution: The following information is based on provisional marks. Mean: Median: Standard deviation: There were some excellent scripts and the highest mark awarded was in the nineties. The distribution of marks is as follows: Range of marks Number of students < 40% % % % 2 70% + 46 n 50 It is disappointing to see three students fail the exam but it is gratifying to note that most students have achieved high marks as evinced by the high number of students achieving a first-class mark and/or a 2:1. In the personal opinion of the module convenor, this cohort of students happens to be one of the very best that he has encountered in his career. Feedback by question Question One Parts (a) to (d) were very straightforward and similar to the seminar exercises. You had to work out comparative and absolute advantage using the formulas used in the lecture notes and mentioned in the seminar problems. In part (d) you had to show the gains from trade. You will find a detailed solution to a similar problem from the seminar solutions. 1

6 Question Two This question was quite well answered. You had to state and explain the main results of the H-O framework and link to the case of Singapore. You will find a detailed solution to a similar problem from the seminar solutions Question Three This question was not well answered. This is surprising since we had done something very similar in the seminars. The first part is the crucial part. Here the size of the half-box labour allocation diagram changes and the P A.MPL A curve shifts down. This leads to a lower equilibrium wage in BOTH sectors. After investment the wages in both sectors rise. You will find a detailed solution to a similar problem from the seminar solutions Question Four See lectures slides from EIB_ECO-2A _Topic_5_Internal_Economies_of_Scale_and_the_New_Trade_Theory_WITH_EXTRA _SLIDES. You should have highlighted/definitely mentioned the following in your answer: a. Firms can differentiate their products or cars and consumers love variety (cars). b. A move from autarky to free trade between two countries increases the market size for cars. c. The number of varieties or cars available to each consumer increases, output of each product supplied under free trade is higher than that supplied under autarky and each product is available at a lower price. d. Welfare in both countries increases. e. The number of varieties with free trade is smaller than the total number of varieties available in both countries taken together. Diagrams (such as the ones used in lecture) are a necessary ingredient of a good answer. Question Five For a small importing country, like the US in this example, a tariff has the following price and welfare effects: 1. A tariff raises the price of a good in the importing country and reduces the quantity demanded and increases the quantity supplied (by domestic producers) in the importing country. 2. A tariff has no effect on the price in any other country. 3. For welfare effects you need to draw a diagram and calculate CS, PS and the quota rents. A diagram such as the one given in lecture is an essential 2

7 Question Six ingredient of a good answer. You needed to draw a general diagram where you clearly mention the initial world price, the price after the tariff on tires is imposed. External economies of scale: when the average cost of production of firms in the same industry decreases with the total output of that industry. Sources of external economies of scale: Existence of a network of specialised suppliers. An individual firm might not provide a large market for these services but a cluster of firms might. This matters especially if the specialised inputs cannot be transported easily. Labour pooling effects The argument is only valid for industry-requiring skills that cannot be used anywhere else. Workers with transferable skills would prefer to work in a region with a variety of industries to diversify the risk of a sector-specific downturn. Knowledge spillovers Knowledge (research and development, informal exchange of information and ideas, etc) is one of the important input factors in highly innovative industries. You must relate the above points to the context of Silicon Valley Question Seven You will find a detailed solution to a similar problem from the seminar solutions Question 8 In short, we need to understand that strategic trade policies need more information than what is available and the subsidy might be very costly. A subsidy to Airbus might fail to deter Boeing to produce, both produce and the subsidy might be larger than Airbus profits. Also, strategic policies are beggar-thy-neighbour policies so they carry the risk of retaliation and trade wars. You will find a detailed solution to a similar problem from the seminar solutions 3