Solution Manual for Introduction to International Economics, 3rd Edition

Introduction to International Economics, 3 rd Edition *CHAPTER 2 (Core Chapter) COMPARATIVE ADVANTAGE OUTLINE 2.1 Introduction 2.2 Case Study 2-1 Mercantilism Is Alive and Well in the Twenty-First Century 2.3 Trade Based on Absolute Advantage: Adam Smith 2.4 Trade Based on Comparative Advantage: David Ricardo 2.5 Gains from Trade with Comparative Advantage 2.6 Comparative Advantage with Money Case Study 2-2 The Petition of the Candlemakers 2.7 Comparative Advantage and Opportunity Costs Case Study 2-3 Labor Productivities and Comparative Advantage 2.8 Production Possibility Frontier with Constant Costs 2.9 Opportunity Costs and Relative Commodity Prices 2.10 Basis and Gains from Trade Under Constant Costs Appendix: Comparative Advantage with More than Two Commodities and Nations A2.1 Comparative Advantage with More than Two Commodities A2.2 Comparative Advantage with More than Two Nations KEY TERMS Basis for trade Gains from trade Pattern of trade Mercantilism Absolute advantage Laissez-faire Law of comparative advantage Labor theory of value Opportunity cost theory Production possibility frontier Constant opportunity cost Relative commodity prices Complete specialization Small-country case 2-1 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition LECTURE GUIDE 1. This is a long and crucial core chapter and may require four classes to cover adequately. In the first lecture, I would present Sections 1-4 and assign review questions 1-3. 2. In the second lecture of Chapter 2, I would concentrate on Sections 5-6 and carefully explain the law of comparative advantage using simple numerical examples, as in the text. Both sections are crucial. Section 5 explains the law of comparative advantage and Section 6 establishes the link between trade theory and international finance. I find that the numerical explanations before the graphical analysis really helps the student to truly understand the law. The simple lawyersecretary example should also render the law more immediately relevant to the student. I would also assign Problems 4-7. 3. In the third lecture, I would cover Sections 7-9 and assign Problems 8-10. 4. In the fourth lecture, I would Section 10 and go over problems 4-10. The appendixes could be made optional for the more enterprising students in the class. ANSWERS TO REVIEW QUESTIONS AND PROBLEMS 1. The mercantilists believed that the way for a nation to become rich and powerful was to export more than it imported. The resulting export surplus would then be settled by an inflow of gold and silver and the more gold and silver a nation had, the richer and more powerful it was. Thus, the government had to do all in its power to discourage and restrict imports. However, since all nations could not simultaneously have an export surplus and the amount of gold and silver was fixed at any particular point in time, one nation could gain only at the expense of other nations. The mercantilists thus preached economic nationalism, believing that national interests were basically in conflict. Adam Smith, on the other hand, believed that free trade would make all nations better off. All of this is relevant today because many of the arguments made in favor of restricting international trade to protect domestic jobs are very similar to the mercantilists arguments in the twentythese arguments are basically wrong. 2. According to Adam Smith, the basis for trade was absolute advantage, or one country being more productive or efficient in the production of some commodities and other countries being more productive in the production of other commodities. The gains from trade arise as each country specialized in the production of the commodities in which it had an absolute advantage and importing those commodities in which the nation had an absolute disadvantage. 2-2 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition Adam Smith believed in free trade and laissez-faire, or as little government interference with the economic system as possible. There were to be only a few exceptions to this policy of laissezfaire and free trade. One of these was the protection of industries important for national defense. 3. that it showed that even if a nation is less efficient than or has an absolute disadvantage in the production of all commodities with respect to the other nations, there is still a basis for beneficial trade for all nations. The gains from trade arise from the increased production of all commodities that arises when each country specializes in the production of and exports the commodities of its comparative advantage and imports the other commodities. A nation that is less efficient than others will be able to export the commodities of its comparative advantage by having its wages and other costs sufficiently lower than in other nations so as to make the commodities of its comparative advantage cheaper in terms of the same currency with respect to the other nations. 4. a. In case A, the United States has an absolute and a comparative advantage in wheat and the United Kingdom in cloth. In case B, the United States has an absolute advantage (so that the United Kingdom has an absolute disadvantage) in both commodities. In case C, the United States has an absolute advantage in wheat but has neither an absolute advantage nor disadvantage in cloth. In case D, the United States has an absolute advantage over the United Kingdom in both commodities. b. In case A, the United States has a comparative advantage in wheat and the United Kingdom in cloth. In case B, the United States has a comparative advantage in wheat and the United Kingdom in cloth. In case C, the United States has a comparative advantage in wheat and the United Kingdom in cloth. In case D, the United States and the United Kingdom have a comparative advantage in neither commodities. 5. a. The United States gains 1C. b. The United Kingdom gains 4C. 2-3 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition c. 3C < 4W A for the U.S. and E’ > A’ for the U.K. 2-4 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition Figure 1 Figure 2 2-5 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition MULTIPLE-CHOICE QUETIONS 1. The Mercantilists did not advocate: a. free trade b. stimulating the nation’s exports c. restricting the nations’ imports d. the accumulation of gold by the nation 2. According to Adam Smith, international trade was based on: a. absolute advantage b. comparative advantage c. both absolute and comparative advantage d. neither absolute nor comparative advantage 3. What proportion of international trade is based on absolute advantage? a. all b. most c. some d. none 4. The commodity in which the nation has the smallest absolute disadvantage is the commodity of its: a. absolute disadvantage b. absolute advantage c. comparative disadvantage d. comparative advantage 5. If in a two-nation (A and B), two-commodity (X and Y) world, it is established that nation A has a comparative advantage in commodity X, then nation B must have: a. an absolute advantage in commodity Y b. an absolute disadvantage in commodity Y c. a comparative disadvantage in commodity Y d. a comparative advantage in commodity Y 6. If with one hour of labor time nation A can produce either 3X or 3Y while nation B can produce either 1X or 3Y (and labor is the only input): a. nation A has a comparative disadvantage in commodity X b. nation B has a comparative disadvantage in commodity Y c. nation A has a comparative advantage in commodity X d. nation A has a comparative advantage in neither commodity 2-6 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition 7. With reference to the statement in Question 6: a. Px/Py=1 in nation A b. Px/Py=3 in nation B c. Py/Px=1/3 in nation B d. all of the above 8. With reference to the statement in Question 6, if 3X is exchanged for 3Y: a. nation A gains 2X b. nation B gains 6Y c. nation A gains 3Y d. nation B gains 3Y 9. With reference to the statement of Question 6, the range of mutually beneficial trade between nation A and B is: a. 3Y < 3X < 5Y b. 5Y < 3X < 9Y c. 3Y < 3X < 9Y d. 1Y < 3X < 3Y 10. If domestically 3X=3Y in nation A, while 1X=1Y domestically in nation B: a. there will be no trade between the two nations b. the relative price of X is the same in both nations c. the relative price of Y is the same in both nations d. all of the above 11. Ricardo explained the law of comparative advantage on the basis of: a. the labor theory of value b. the opportunity cost theory c. the law of diminishing returns d. all of the above 12. The Ricardian trade model has been empirically a. verified b. rejected c. not tested d. tested but the results were inconclusive 13. The Ricardian model was tested empirically in terms of differences in a. relative labor productivities costs in various industries among nations b. relative labor costs in various industries among nations 2-7 Copyright © 2012 John Wiley & Sons, Inc. Introduction to International Economics, 3 rd Edition c. relative labor productivities and costs in various industries among nations d. none of the above 14. A difference in relative commodity prices between two nations can be based upon a difference in: a. factor endowments b. technology c. tastes d. all of the above 15. In the trade between a small and a large nation: a. the large nation is likely to receive all of the gains from trade b. the small nation is likely to receive all of the gains from trade c. the gains from trade are likely to be equally shared d. we cannot say 2-8 Copyright © 2012 John Wiley & Sons, Inc.