Economics Test Answers

1. When comparing the composition of world trade in the early 20th century to the early 21st century, we find major compositional changes. These include a relative decline in trade in agricultural and primary-products (including raw materials). How would you explain this in terms of broad historical developments during this period?

The typical composition of world production during this period experienced major changes. Focusing on today’s major industrial countries the industrial-employment composition was focused primarily on agriculture. Most value was in land. The predominant single consumption category was food. Since then, the economies shifted from agriculture to the manufacturing sectors. Income rose, and consumption shifted in favor of (increasingly affordable) manufacturing goods. Both income and price elasticities were in manufactures than in agricultural products. At the same time there was a steady tendency for synthetic (manufactured) inputs to replace agricultural based raw materials and industrial inputs. Hence international trade conformed to patterns of overall change in world consumption and production.

2. In the past-half century, the developing countries have experienced major compositional shifts from exports of primary products (including agricultural and raw materials) to exports of manufactures. How might you explain this in terms of broad historical developments during this period?

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The compositional changes in world trade from the early 20th century to the early 21st century can be attributed to the changes in the composition of world production, brought about mainly due to technological progress. Focusing on today’s Industrialized Countries (primarily members of the OECD), the industrial-employment composition was focused primarily on agriculture. Most value was in land. The predominant single consumption category was food. Since then, technological progress in these economies shifted resources from the agricultural to the manufacturing sectors.

Incomes rose, and consumption shifted in favor of (increasingly affordable) manufactures. At the same time, there was a steady tendency for synthetic (manufactured) inputs (e.g. plastic) to replace agricultural based raw materials (e.g. jute) and industrial inputs. In the developing world, the post World War II period also witnessed a major shift towards industrialization, which consequently led to steady declines in their agricultural sectors. Finally, the advent of the MNC (Multinational Corporation) further boosted the shift in resources towards manufacturing. All these phenomena contributed to the decline in trade in primary products (like agriculture and minerals) and the rise in trade in manufactured goods.

3. The Services sector has been steadily rising in relative importance in GDP of the United States, as well as elsewhere around the world. Since “services” have been identified as “non-tradables” (e.g. it is difficult to export haircuts), it may be argued that this trend will likely slow the rapid growth in international trade. Discuss.

This argument stands on questionable logical foundations. The past half-century has seen a steady growth in the absolute and relative importance of international trade. This trend has been reversed only by global conflicts, i.e. the two World Wars. This trend has remained steady and robust despite major compositional shifts (e.g. from primary to manufacturing), and location shifts (e.g., the sudden rise of NICs as significant group of exporters). The trend will probably continue into the reasonable future, fueled by both super-regional preferential trade regions and a growing impact of the multilateral forces, represented institutionally by the World Trade Organization (WTO)-as illustrated by the recent abolishment of the epitome cartelized trade, the world trade in textiles.

Driven by technology-especially in the areas of communication and transportation-a reversal of the growing trade trend is not likely in the near future. In any case, many ?services are in fact quite tradable. Examples would be financial services, long-distance teaching, ?help-desk? outsourcing, consulting and management services and others. In fact, when a tourist gets a haircut, we see that even haircuts become a “tradable” service.

6. An examination of the Ricardian model of comparative advantage yields the clear result that trade is (potentially) beneficial for each of the two trading partners since it allows for an expanded consumption choice for each. However, for the world as a whole the expansion of production of one product must involve a decrease in the availability of the other, so that it is not clear that trade is better for the world as a whole as compared to an initial situation of non-trade (but efficient production in each country). Are there in fact gains from trade for the world as a whole? Explain.

If we were to combine the production possibility frontiers of the two countries to create a single world production possibility frontier, then it is true that any change in production points (from autarky to specialization with trade) would involve a tradeoff of one good for another from the world's perspective. In other words, the new solution cannot possibly involve the production of more of both goods. However, since we know that each country is better off at the new solution, it must be true that the original points were not on the trade contract curve between the two countries, and it was in fact possible to make some people better off without making others worse off, so that the new solution does indeed represent a welfare improvement from the world's perspective.

7. Many countries in Sub-Saharan Africa have very low labor productivities in many sectors, in manufacturing and agriculture. They often despair of even trying to attempt to build their industries unless it is done in an autarkic context, behind protectionist walls because they do not believe they can compete with more productive industries abroad. Discuss this issue in the context of the Ricardian model of comparative advantage.

The Ricardian model of comparative advantage argues that every country must have a comparative advantage in some product (assuming there are more products than countries.

8. In 1975, wage levels in South Korea were roughly 5% of those in the United States. It is obvious that if the United States had allowed Korean goods to be freely imported into the United States at that time, this would have caused devastation to the standard of living in the United States.,because no producer in this country could possibly compete with such low wages. Discuss this assertion in the context of the Ricardian model of comparative advantage.

Regardless of relative wage levels, the United States would be able to provide its populace with a higher standard of living than would be possible without trade. Also, low wages tend to be associated with low productivities.

9. “No country is abundant in everything.” Discuss.

The concept of relative (country) factor abundance is (like factor intensities) a relative concept. When we identify a country as being capital intensive, we mean that it has more capital per worker than does the other country. If one country has more capital worker than another, it is an arithmetic impossibility that it also has more workers per unit capital.

10.“A good cannot be both land- and labor-intensive.” Discuss.

In a two good, two factor model, such as the original Heckscher-Ohlin framework, the factor intensities are relative intensities. Hence, the relevant statistic is either workers per acre (or acres per worker); or wage per rental unit (or rental per wage). In order to illustrate the logic of the statement above, let us assume that the production of a broom requires 4 workers and 1 acre. Also, let us assume that the production of one bushel of wheat requires 40 workers and 80 acres. In this case the acres per person required to produce a broom is one quarter, whereas to produce a bushel of wheat requires 2 acres per person. The wheat is therefore (relatively) land intensive, and the broom is (relatively) labor intensive.

11. Why is it that an industry is operating under conditions of domestic internal scale economies (applies to firm in the country) - then the resultant equilibrium cannot be consistent with the pure competition model?

Because once one firm became bigger than another, or if one firm began the industry, then no other firm would be able to match its per unit cost, so that they would be driven out of the industry.

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