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Econ S-1536

International Trade and Globalization

Peter Zamborsky
Summer 2007

Assignment 3 (Maximum 20 points)

Due Thursday, July 26, 6pm (electronically or in my mailbox in front of Adams A-17)
1. Outsourcing Revisited (3 points)
a) The Internet has allowed for increased trade in services such as programming and technical
support, a development that has lowered the prices of such services relative to manufactured
goods. India in particular has been recently viewed as an exporter of technology-based
services, an area in which the US had been a major exporter. Using manufacturing and
services as tradable goods, create a standard trade model for the US and Indian economies
that shows how relative price declines in exportable services that lead to the outsourcing of
services can reduce welfare in the US and increase welfare in India.
b) Please read The Economist article Does Economics Need a New Theory of Outsourcing?
(uploaded on the course website under Links to Readings). Do the new models of
outsourcing change the conclusion of the standard trade model from a) (that outsourcing can
reduce US welfare and increase Indian welfare)? Explain.
2. US and EU Automobile Market (4 points)
Suppose that fixed costs for a firm in the automobile industry (start-up costs of factories,
capital equipment etc.) are $5 billion and that variable costs are equal to $17,000 per finished
automobile. Because more firms increase competition in the market, the market price falls as
more firms enter an automobile market, or specifically P = 17,000 + (150/n), where n
represents the number of firms in a market. Assume that the initial size of the US and
European automobile markets are 300 million and 533 million people, respectively.
a) Calculate the equilibrium number of firms in the US and European automobile markets
without trade.
b) What is the equilibrium price of automobiles in the US and Europe if the automobile
industry is closed to foreign trade?
c) Now suppose the US decides on free trade in automobiles with Europe. The trade
agreement with the Europeans adds 533 million consumers to the automobile market in
addition to the 300 million in the US. How many automobile firms will there be in the
US and in Europe combined? What will be the new equilibrium price of automobiles?
d) Why are prices in the US different in (c) than in (b)? Are consumers better off with free
trade? In what ways?
3. US Multinationals (3 points)
a) Please briefly review the slides related to my paper on Profitability and Ownership
Structure of US Foreign Ventures. Ask three critical questions about the paper.
b) Please review Table 1. It is related to the paper and gives estimates for the US foreign
sales compared to local sales and foreign sales in the US compared to local sales of US
corporations (see the table note). How would you determine the sectors in which the US
multinationals are most competitive (have comparative advantage) relative to their
foreign rivals? Which three sectors are the most competitive from the US point of view?

Table 1
US Foreign Sales Intensity and Foreign Sales Intensity in the US
US Foreign
Instruments and related products
Radio, TV & Phone Equipment
Office and computing machines
Electronic components
Stone, clay and glass products
Fabricated metal products
Textile products and apparel
Paper and allied products
Motor vehicles and equipment
Average for these sectors

US Fsales/
Sales US

Intensity in
Fsales US/
Sales US

Note: US Fsales are sales of US MNEs abroad. Sales US are sales of US

corporations at home. FSales US are sales of foreign affiliates in the US.

4. Temporary Migration (3 points)

Philippe Legrain, the author of Immigrants, and the United Nations Commission on
International Migration have both called for more temporary migration from poor to rich
countries. However, The Economist magazine seems to be somewhat skeptic about these
proposals. Please refer to the articles Waves of Fear and Be my Guest (uploaded on the
course website under Links to Readings and briefly expose two arguments for and two
against temporary migration. With which arguments do you agree more? Why? Please make
two concrete suggestions for an effective policy towards migration into the US.
5. Effects of a Tariff (7 points)
a) Homes demand curve for wheat is D = 100 20P. Its supply curve is S = 20 + 20P.
Derive and graph Homes import demand schedule. What would the price of wheat be in
the absence of trade?
b) Now add Foreign, which has a demand curve D* = 80 20P, and a supply curve S*= 40
+ 20P. Derive and graph Foreigns export supply curve and find the price of wheat that
would prevail in Foreign in the absence of trade.
c) Now allow Foreign and Home to trade with each other, at zero transportation cost. Find
and graph the equilibrium under free trade. What is the world price? What is the volume
of trade?
d) Home imposes a specific tariff of 0.5 on wheat imports. Determine and graph the effects
of the tariff on the following: (1) the price of wheat in each country; (2) the quantity of
wheat supplied and demanded in each country; (3) the volume of trade.
e) Determine the effect of the tariff on the welfare of each of the following groups: (1)
Home import-competing producers; (2) Home consumers; (3) the Home government.
f) Calculate the total effect on Homes welfare of the tariff.