Econ 420: Final Exam Studyguide
Econ 420: Final Exam Studyguide Econ 420
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This 6 page Study Guide was uploaded by Laura Kunigonis on Sunday May 15, 2016. The Study Guide belongs to Econ 420 at University of Illinois at Urbana-Champaign taught by Werner Baer in Spring 2016. Since its upload, it has received 13 views. For similar materials see International Economics in Economcs at University of Illinois at Urbana-Champaign.
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Date Created: 05/15/16
Econ 420 Final Exam Heckscher Ohlin What is the 'HeckscherOhlin Model' The HeckscherOhlin model is an economic theory that states that countries export what they can most easily and abundantly produce. The HeckscherOhlin model is used to evaluate international trade, specifically trade equilibriums between countries that may have different features. The model emphasizes how countries with comparative advantages should export goods that require factors of production that they have in abundance, while importing goods that it cannot produce as efficiently. Despite sounding reasonable, economists have had difficulty finding evidence that supports the Heckscher Ohlin model. Other models have tried to explain how industrialized countries tend to trade with each other more than they trade with developing countries, as outlined in the Linder hypothesis HeckscherOhlin theorem: An economy has a comparative advantage in producing, and thus will export, goods that are relatively intensive in using its relatively abundant factors of production, and will import goods that are relatively intensive in using its relatively scarce factors of production. FactorPrice Equalization: The factorprice equalization theorem says that when the product prices are equalized between countries as they move to free trade in the HO model, then the prices of the factors (capital and labor) will also be equalized between countries. Factorprice equalization arises largely because of the assumption that the two countries have the same technology in production. Factorprice equalization in the HO model contrasts with the Ricardian model result in which countries could have different factor prices after opening to free trade. StolperSamuelson theorem: If the relative price of a good increases, then the real wage or rental rate of the factor used intensively in the production of that good increases, while the real wage or rental rate of the other factor decreases. Any change in the relative price of goods alters the distribution of income. In the real world, factor prices are not equal across countries. The model assumes that trading countries produce the same goods, but countries may produce different goods if their factor ratios radically differ. The model also assumes that trading countries have the same technology, but different technologies could affect the productivities of factors and therefore the wages/rates paid to these factors. Rybczynski theorem: If you hold output prices constant as the amount of a factor of production increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases. Unlike the Ricardian model, the HeckscherOhlin model predicts that factor prices will be equalized among countries that trade. Free trade equalizes relative output prices. Due to the connection between output prices and factor prices, factor prices are also equalized. Trade increases the demand of goods produced by relatively abundant factors, indirectly increasing the demand of these factors, raising the prices of the relatively abundant factors. The model also ignores trade barriers and transportation costs, which may prevent output prices and thus factor prices from equalizing. The model predicts outcomes for the long run, but after an economy liberalizes trade, factors of production may not quickly move to the industries that intensively use abundant factors. In the short run, the productivity of factors will be determined by their use in their current industry, so that their wage/rental rate may vary across countries. Distribution Implications Changes in income distribution occur with every economic change, not only international trade. Changes in technology, changes in consumer preferences, exhaustion of resources and discovery of new ones all affect income distribution. Economists put most of the blame on technological change and the resulting premium paid on education as the major cause of increasing income inequality in the US. It would be better to compensate the losers from trade (or any economic change) than prohibit trade. The economy as a whole does benefit from trade. There is a political bias in trade politics: potential losers from trade are better politically organized than the winners from trade. Losses are usually concentrated among a few, but gains are usually dispersed among many. Each of you pays about $8/year to restrict imports of sugar, and the total cost of this policy is about $2 billion/year. The benefits of this program total about $1 billion, but this amount goes to relatively few sugar producers. ….. In the HO model, when countries implement free trade, output prices, wages, and rents on capital change. If a country is abundant in capital (labor), then a movement to free trade will increase real rents (wages) and decrease real wages (rents). In other words, income is redistributed from workers (capital owners) to capital owners (workers). Because labor and capital are assumed to be homogeneous factors, workers (capital owners) in both industries realize identical real income effects. The redistribution of income in the HO model is based on which factor an individual owns, not on which industry an individual works in (as it is in the immobile factor model). Over the last 40 years, countries like South Korea, Mexico, and China have exported to the U.S. goods intensive in unskilled labor (ex., clothing, shoes, toys, assembled goods). At the same time, income inequality has increased in the U.S., as wages of unskilled workers have grown slowly compared to those of skilled workers. Did the former trend cause the latter trend? The HeckscherOhlin model predicts that owners of relatively abundant factors will gain from trade and owners of relatively scarce factors will lose from trade. Little evidence supporting this prediction exists. According to the model, a change in the distribution of income occurs through changes in output prices, but there is no evidence of a change in the prices of skillintensive goods relative to prices of unskilledintensive goods. Tariffs Specific tariffs Taxes that are levied as a fixed charge for each unit of goods imported Example: A specific tariff of $10 on each imported bicycle with an international price of $100 means that customs officials collect the fixed sum of $10. Ad valorem tariffs Taxes that are levied as a fraction of the value of the imported goods Example: A 20% ad valorem tariff on bicycles generates a $20 payment on each $100 imported bicycle. A compound duty (tariff) is a combination of an ad valorem and a specific tariff. Modern governments usually prefer to protect domestic industries through a variety of nontariff barriers, such as: Import quotas (Limit the quantity of imports) Export restraints (Limit the quantity of exports) Import Quotas: Theory An import quota is a direct restriction on the quantity of a good that is imported. Example: The United States has a quota on imports of foreign cheese. The restriction is usually enforced by issuing licenses to some group of individuals or firms. Example: The only firms allowed to import cheese are certain trading companies. In some cases (e.g. sugar and apparel), the right to sell in the United States is given directly to the governments of exporting countries. An import quota always raises the domestic price of the imported good. License holders are able to buy imports and resell them at a higher price in the domestic market. The profits received by the holders of import licenses are known as quota rents. Welfare analysis of import quotas versus of that of tariffs The difference between a quota and a tariff is that with a quota the government receives no revenue. In assessing the costs and benefits of an import quota, it is crucial to determine who gets the rents. When the rights to sell in the domestic market are assigned to governments of exporting countries, the transfer of rents abroad makes the costs of a quota substantially higher than the equivalent tariff. Economic Integration Trade Creating Custom Unions Trade creation occurs when domestic production in a member nation is replaced by lowercost imports from another member nation. Leads to increased welfare for members as nations specialize in comparative advantages. Leads to increased welfare for nonmembers as increased real income spills over into increased imports from rest of the world. Trade Diverting Custom Unions Trade diversion occurs when lowercost imports from nonmembers are replaced by higher cost imports from members. By itself, trade diversion lowers welfare as it shifts resources away from comparative advantages. Trade diverting customs union also results in trade creation. Change in welfare depends on relative magnitude of creation and diversion. Developing Trade Comparative advantage and Prebisch Critique Comparative advantage states that countries should specialize in industries where they have the most comparative advantage. This means that a country will export goods where they have comparative advantage and import goods that do not have a comparative advantage. In the past, for developing countries (third world countries) this meant that they specialize in agriculture goods while developed countries specialize in manufacturing goods. Prebisch was one of the first economists to show that this world division of labor would hurt economic prospects of the developing countries. Moreover, Prebisch argued that the world division as CenterPeriphery harmed the periphery as they became dependent on the Center. If the Center faced some recession, the periphery was strongly negatively a affected by the Center recession while the opposite was not true. This meant vulnerability and instability of the Periphery to international trade fluctuations. Raw materials and agriculture supply is difficult to adjust. Hence, changes in demand strongly affect prices. Prebisch noted that economies are dynamic and are able to change their structure over time, thus revealing comparative advantages that could not be explored in the past. This idea was closely associated with the InfantIndustry argument for protection. Hence, one of the major policy implications of the Prebisch (ECLAC) was the ImportSubstituting Industrialization. The main objective was to diversify the economy (increasing the manufacturing sector), as a way to reduce the dependency of the Periphery on the Center, improving its terms of trade. ISI I From World War II until the 1970s many developing countries attempted to accelerate their development bylimiting imports of manufactured goods to foster a manufacturing sector serving the domestic market. Protection through tariffs, exchange controls. State enterprises and development banks. Attraction of multinationals (wanted investors from the center to invest in periphery) It had a growth impact industry as leading sector, change in GDP structure. Many economists are now harshly critical of the results of import substitution, arguing that it has fostered highcost, inefficient production Manufacturing sector was very inefficient in most cases and could not compete abroad. Dual economy is exacerbated. I Import coefficient is sticky downwards and the compositional change in imports can make the Periphery economies even more vulnerable to recessions in the Center. Foreign Direct Investment Before 1930 Investment in infrastructure: Transportation, energy, etc. Direction of FDI From Center to Periphery: in the early stages, investment from Center in their respective Colonies; in later stages, from developed countries to developing countries. Hosting governments gave investors guaranteed rate of return. Also they paid low taxes and charged high rates to exploit developing countries. Foreign investors did not have good reputation because the investment did not improve wellbeing of those countries. Hosting country did not accumulate human capital. The majority of local labor used was unskilled. Foreign Direct Investment After 1930 Nationalization of infrastructure and primary resources be the developing countries changed the nature of FDI from infrastructure and primary resources to manufacturing. ImportSubstitution policies also accelerated this process. The rise of Multinationals corporations after WWII. FDI after 1930 was mainly constituted of investment in companies (purchasing shares) and establishment of subsidiaries by Multinationals. Positive Impact of Multinational Corporations on host country 1. Infow of foreign exchange 2. Access to technology 3. Access to modern organization 4. Human capital development 5. Stimulate local supplying firms 6. Help diversify exports Negative Impact of Multinational Corporation on Host Country 1. Balance of payments profit remittances and import increase (pieces and components). 2. Transfer pricing 3. Little R&D 4. Consumption distortion 5. Denationalization 6. Transfer of decision making centers abroad Foreign Direct Investment Before 1930: Investment in infrastructure: Transportation, energy, etc. Direction of FDI From Center to Periphery: in the early stages, investment from Center in their respective Colonies; in later stages, from developed countries to developing countries. Hosting governments gave investors guaranteed rate of return. Also they paid low taxes and charged high rates to exploit developing countries. Foreign investors did not have good reputation because the investment did not improve wellbeing of those countries. Hosting country did not accumulate human capital. The majority of local labor used was unskilled. After 1930: Nationalization of infrastructure and primary resources be the developing countries changed the nature of FDI from infrastructure and primary resources to manufacturing. ImportSubstitution policies also accelerated this process. The rise of Multinationals corporations after WWII. FDI after 1930 was mainly constituted of investment in companies (purchasing shares) and establishment of subsidiaries by Multinationals. Positive impact: 1. Inflow of foreign exchange 2. Access to technology 3. Access to modern organization 4. Human capital development 5. Stimulate local supplying firms 6. Help diversify exports Negative Impact: 1. Balance of payments profit remittances and import increase (pieces and components). 2. Transfer pricing 3. Little R&D 4. Consumption distortion 5. Denationalization 6. Transfer of decision making centers abroad
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