This is called the protectionism under which the government provides protection to 1-3
the domestic producers by giving them subsidies , and imposing barriers. This is done because the domestic producers finds it very difficult to compete with the MNCs due to their scale of operations and low price offerings.Through subsidies, it enables domestic producers’s costs to lower and thus it makes them to offer their products at cheaper rates and compete with the bigger companies. Through barriers, the government enables that imported products are costlier for the domestic people who buy those products, thus demand for imports decreases and demand for local production increases.
1-4
Endowment – 100 units of Labor
With 1 unit, either 1 computer or 10 cameras are produced.
P (Computers) / P (Cameras) = 12
a. Here we need to compute the opportunity cost of producing both the produced
Opportunity cost of producing 1 camera- 1 / 10 , or, it will lose on the production of 1 / 10 computer
Opportunity Cost of producing 1 computer – 10 , or it will lose on the production of 10 cameras.
Since, it is low for cameras, Singapore’s comparative advantage lies in producing cameras.
b. Under free trade, Singapore will use all the 100 units of labor to produce cameras and total 1000 units of cameras will be produced.This can be represented in the graph below-
In the graph above, Computers are depicted on Y Axis and Cameras on X Axis.BC is the PPC of Singapore. It is a straight line because opportunity cost is constant. Without free trade, the country will produce at point A . With free trade, the production point will be B as the country will produce 1000 units of cameras and will move to higher PPF- DB.
c. The point of consumption on DB will depend on the preferences of the consumers. Let the Indifference Curve is given IC-1. The point of consumption is given by point E. Here Singapore will export 1000-X units of cameras to other nation and import OY units of computers from the other nation.
1-5
a. The cost of producing 60 balls in India is 40 hoops, so each ball costs is 4/6=2/3 of a hoop. The cost of a ball in Nepal is likewise calculated to be 1/3 of hoop. The country with the lowest cost of balls in terms of hoops should specialize in balls. This would be Nepal. The cost of hoops in India is 3/2 of a ball, while in Nepal it is 3 balls. Therefore, India should make hoops.
2-1. Explain the difference between the price and the physical definitions of factor abundance. When could they give conflicting answers about which factor is the abundant factor?
Answer – The physical definition of factor abundance is based on the relative physical amounts of the factors present in the country, e.g., the difference in the capital/labor ratios. The country whose K/L ratio is the largest is defined to be the capital-abundant country. The price definition is based on relative prices of the factors rather than on measurements of their presence in the country. It is hypothesized that the relatively-abundant factor in a country should be relatively cheaper compared to a second country. Thus, according to this definition, if the ratio of the price of capital to the price of labor is lower in one country (A) compared to a second country (B), country A is said to be the capital-abundant country.
Under the assumptions of H-O, the two definitions should give the same result. However, if tastes differ between the two countries, then factor prices will not only reflect different supply conditions but also different demand conditions. In this instance the price definition and the physical definition could give conflicting conclusions about relative factor abundance. For example, if consumers in a physically capital-abundant country strongly prefer the capital-intensive product, this would bid up the price of the capital-intensive good and hence would bid up the price of capital. Therefore, other things equal, w/r would fall and could become lower than in the second country. Hence, the physically capital-abundant country could become labor abundant by the price definition.
2. Describe in detail how the concept of demand reversal affects the implications and predictions of the Heckscher-Ohlin model.
3. Briefly describe the Linder theory. What would this theory suggest about the prospects developing countries have for exporting goods to developed countries? Do you think this is a realistic suggestion? Why or why not?
4. Explain how the Krugman model of trade works. Explain the similarities and differences between the Krugman model and Heckscher-Ohlin model.
According to the Krugman model of international trade, the trade between the two countries will depend on the size of the economies and the distance between the two units. Moreover,it also depends on the production capacities of the trading countries. If the countries are facing increasing returns to scale, there will be more exports from that particlaur country. However, in case of Hechsker ohlin model, countries will tend to specialize in goods that are relatively intensive in the inputs (factors of production) that country is relatively abundant in. Thus, the model looks at differences in factor endowments as a cause of international trade. If the U.S. is relatively abundant in capital and Mexico is relatively abundant in labor, it means that the ratio of labor to capital is lower in the U.S. than it is in Mexico. If labor is cheaper in Mexico, Mexican industry is likely to use a greater labor to capital ratio in their production than U.S. industry. Mexico will also tend to produce more of their labor-intensive goods, because labor is relatively inexpensive (to capital). The U.S. will export capital-intensive goods to Mexico, and Mexico labor-intensive goods to the U.S
However, in case of Krugman model, it studies the direct effect of production capacities on the international trade through internal economies of scale. In case, firms are monopolistically competitive, there will be only few firms supplying the entire market whether domestic or international. Hence, even if there are no differences in relative costs, tastes, or technology, there will be gains from trade in the form of lower prices and greater product diversity. Whereas in case of Hecksher ohlin model, the factor abundance and the relative capacity apply over the differences between agents and the economies of scale. It act as an alternative approach to the theories of division of labor and trade.
Krugman modeled a ‘preference for diversity’ by assuming a CES utility function.
The relative importance of intra-industry trade in a given industry between a given country pair is essentially determined by how well this trade is characterized by
the Krugman model relative to the Heckscher-Ohlin model. In particular, the relative importance of intra-industry trade is increasing in (i) the similarity of the countries’ factor endowments, and (ii) the importance of IRS and product differentiation in the industry.
5. Using a general equilibrium approach, point out the real income loss from a tariff to a country. What is the consumer welfare loss? Why might consumers prefer a production subsidy rather than a tariff?
