Licence 2

Faculté de Gestion, Economie et Science

International Economics

Part I : International Trade

Academic year: 2022-2023

Véronique Flambard

12/09/2022

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 International Economics

Licence 2

Faculté de Gestion, Economie et Sciences

Année universitaire 2022-2023

Lecturer : V. Flambard with C. Thiboult and Y. Tchakondo for the tutorials

Office: Euratechnologies Campus, 177 allée des Clémentines, Lille, office B 165

E-mail: veronique.flambard@univ-catholille.fr

Tel : 03 59 31 50 66

Course format: 12h (course) + 18h (application)

Course Description: A study of the basic principles underlying the international economy in both trade
and finance. Emphasis is placed on the determination of trade patterns, comparative advantages, trade
and tariffs and exchange rate changes.

Course Prerequisite: Concepts of Microeconomics, including consumer theory, producer theory,

market equilibrium, monopoly and monopolistic competition as well as concepts of Macroeconomics
(including exchange rates and model of short run open economy). (Concepts will be reviewed in class)

Course Objectives: This course aims at expanding the students’ knowledge and understanding of:
economic tools, international trade theory and policy, exchange rates determination and exchange
rates policy, foreign exchange market, balance of payments and international financial investment.

Upon completion of this course, students are expected to understand economic theory and its
predictions. In addition to learning content, students shall also develop an ability to use these theories.

Required textbook:
• Thomas Pugel, International Economics, McGraw Hill Irwin. The course is mainly based on this
textbook. The last edition is the 17th. Students from last year also used this textbook which
you can buy from them ! You can also buy used version on internet or e_book

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15th edition
Print: 9780071316286 or e-text

16th edition

Previous editions can also be used.

Other reference books (supplemental reading list):

• Paul R. Krugman, Maurice Obstfeld and Marc J. Melitz, International Economics, Theory &
Policy, Pearson
• Robert J. Carbaugh, International Economics, Thomson South-Western.
• Dominick Salvatore, International Economics, Wiley.

The recommended textbooks are at the library.

You can also use a textbook in French if you have too much difficulties studying in English such as:
• Bernard Guillochon, Annie Kawecki, Frédéric Peltrault and Baptiste Venet, Economie
Internationale, Dunod

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Web resources:

• World Trade organisation: http://www.wto.org/

• International Monetary Fund: http://www.imf.org/external/index.htm
• Centre de recherche français en économie internationale: http://www.cepii.fr/

Lecture Schedule:

Chapters 2 to 6 will analyze why countries trade and how trade affects production, consumption, prices
in each country. We will learn how to evaluate the gains or losses from trade. Chapters 8 to 11 will
show how government policies can also affect trade and income distribution. Finally, chapters 16 to
20 will show how real exchange rates are important determinants of trade. The determinants of
exchange rate are analyzed as well as arbitrages made by investors.

Introduction:

The Theory of International Trade:

The Basic Theory Using Demand and Supply Chapter 2

Comparative Advantage Chapter 3

Factor Availability and Factor Proportions Are Key Chapter 4

Who Gains and Who Loses from Trade? Chapter 5

Scale Economies, Imperfect Competition, and Trade Chapter 6

Trade Policy:

Analysis of a Tariff Chapter 8

Non-Tariff Barriers to Imports Chapter 9

Arguments For and Against Protection Chapter 10

Pushing Exports Chapter 11

Understanding Foreign Exchange:

Payments among Nations Chapter 16

The Foreign Exchange Market Chapter 17

Forward Exchange and Financial Investment Chapter 18

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 What Determines Exchange Rates? Chapter 19

Government Policies & Foreign Exchange Market (time permitting) Chapter 20

Tentative lecture and tutorial planning

(It may vary depending on how fast we go, and the pace can differ by groups)

Chapter in the textbook Lecture Tutorial

Introduction- Course Lecture 1-September 13th

presentation

Chapter 2 None- Read by yourself TD 1

Chapter 3 Lecture 1--September 13th TD 2

Chapter 4 Lecture 2- September 27th TD 3

Chapters 4-5 Lecture 2 - September 27th TD 4

Chapter 6-8 Lecture 3 – October 3rd TD 4 and TD 5

Chapter 9 None- Read by yourself TD 6

Chapters 10-11 Lecture 4 – October 17th TD 6

Chapter 16 Lecture 4 – October 17th TD 7

Chapter 17 Lecture 5 – November 7th TD 7

Chapter 18 Lecture 5 – November 7th TD 8

Chapter 19 Lecture 6 – November 21st TD 8

Chapter 20 Lecture 6 – Time permitting TD 9- Time permitting

Tips for effective studies:

International economics addresses important and interesting current events and issues. Hopefully, this
course as well as newspaper and magazine articles will convince you, if you are not already!

The different chapters follow the textbook recommended for this course: International Economics by
Thomas Pugel. The course is delivered in English. When you do not understand a word, make sure to
search in an English-French dictionary. Please, do not wait the end of the semester to do it!

Ask some questions when needed……..Do not hesitate to use the resources available on the publisher
website…Work regularly……

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Best wishes in your studies!

Grade Evaluation:

Type of Evaluation WEIGHTING

On-going assessment CC 60%

Final Exam Final 40%

Format of Exams: The assessments/exams may consist of a combination of in-class-presentation,

multiple choice, true-false questions, definitions and/or written part (short answer questions or essay)
based on material covered in classes and on selected chapters. More information will be given in class.
The midterm exam is worth 30% of the final mark, a press review represents 10% and in-class quizzes
are worth 20% of the final mark. The final examination is a comprehensive exam (and counts for 40%).

Student Responsibilities: Students are expected to be aware of their academic responsibilities (as
outlined in the “Règlement des études Licence”).

Disclaimer: The information in this Course Outline is subject to change; any changes will be
announced in class.

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Chapter 1 Descriptive statistics

International trade has increased quickly since 1980 according to World Bank trade statistics. The
value of world merchandise exports rose from US$ 2.03 trillion in 1980 to US$ 28.5 trillion in 2021
(record high year) (the equivalent of a 7 % growth per year on average in current dollar terms).
Commercial services trade experienced an even faster growth over the same period.
(https://data.worldbank.org/)
The volume of trade has also increased quickly and faster than the GDP.

Figure 1: World trade and the possible effects of the pandemic

https://www.wto.org/english/news_e/pres20_e/pr855_e.htm

Trade in Europe represent 36% of the world trade, followed by Asia with 32% and North America with
less than 20%. See map 2.

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Map 2: World leading traders, 2019

https://www.wto.org/english/res_e/statis_e/wts2020_e/wts2020_e.pdf

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 Practice Exercises (to be prepared before each laboratory/tutorial exercise class)

Travaux dirigés (à préparer avant chaque séance de TD)

--------------------------------------------------------------------------------------------------------

Objectives of the Practice Exercises:

• To review important results of each chapter

• To check your understanding through exercises
• To develop an ability to use the theories seen in class
• To be aware of current events related to international trade and finance

Introduction

Read newspaper(s) and provide one recent example of a newspaper headline relevant for
international trade or finance. Write a short summary of the topic to be able to justify briefly your
choice (why this is an important/interesting issue).

Chapter 2

Question 1:
Study chapter 2 on your own. On the same model as chapter 2, but with a different example,
use a welfare analysis (with consumer surplus, producer surplus and total surplus) to explain
your answers to the following questions. Make sure to use three Figures (one per country, and
one for the international market) following the method used in chapter 2 in Figure 2.3 as
shown below.

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a. Within each country, who are the gainers and the losers from opening trade?
b. Which country gain from trade in this two-country trade? Are gains or losses the same for the
two countries in your example? Justify.

Step-by-step analysis: Replicate Figure 2.3 by choosing a different example than the USA and the
motorbike market. Make sure to change the prices and quantities.
For the country of your choice and the rest of the world, represent graphically the market for your
chosen good, with supply and demand curves. Pick a unit price for the equilibrium (this is the no-
trade or autarky equilibrium). Based on the prices at which the good is exchanged in the two
countries, deduce a possible international price (we call this international price, trade price).
Deduce the new quantity supplied and demanded at this international price for each country and
show them on the three-panel Figure, similar to Figure 2.3. In the Figure summarizing the
International market, the demand for imports Dm should intersects the supply of exports Sx at the
international price you have chosen before. The equilibrium quantity corresponds to the quantity
imported by the importing country (which must be equal by construction to the quantity exported
by the exporting country). The vertical intercept of the demand for imports corresponds to the
maximum price at which the importing country is willing to imports (and is equal to the autarky
price in the importing country). The vertical intercept of the supply of exports corresponds to the
minimum price at which the exporting country is willing to exports (and is equal to the autarky
price in the exporting country).

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 When your three panels Figure is completed, start the welfare analysing following the model of
Figure 2.4 and Table below page 28, using the same letters for respectively the importing and
exporting country. Deduce the welfare effects.

You can calculate net gains/losses by calculating the areas corresponding to the total surpluses as
in page 29. The area of a triangle is calculated with (base*height)/2.

What will you learn? This is a demonstration of trade based on absolute advantage. This shows
that trade has impacts on consumers and producers of the two countries. You develop ability in
using the model of supply and demand and consumer and producer surplus. We will use again this
type of representation in Chapters 8; 9; 10.
(This exercise is interesting only if you choose different numbers than the textbook example! The
price of an ice cream and a car is different; therefore, depending on the good you choose, you
should have different numbers. The reasoning, demonstration and conclusion should be the same)

Question 2:
According to the article “Trade, at what price” (article p. 21 of this document):
a. Who are the losers from trade in the USA?
b. Who gains from trade and why in the USA?
Quote the article for precise answers and concrete examples.

Chapter 3

Question 1:
On the same model as chapter 3, but with a different example, describe trade between two
countries, the terms of trade and the gains from trade. You can duplicate the analysis with the
example below or, better you can design your own example by choosing the time it takes in each
country to produce each good.

China and India produce tea and cloth according to the Table below. To simplify assume the only
input is labour.

Number of hours to produce Number of hours to produce 1

1kg of tea meter of cloth

China 1 1

India 4 2

a. Assume both countries have 120 hours of labour available for a given period. Assume it is a
two-country world (China and India only trade with each other).
b. Which country has an absolute advantage in producing tea? In cloth? Show it using the Table
above and graphically with production possibility frontier PPF (the PPF is also called
production possibility curve PPC and shows the combination of goods a country can produce
when all resources are used). For all graphical representation, represent cloth on the
horizontal axis and tea on the vertical axis. Recall that a country has an absolute advantage if
it can producer a good faster than the other country.

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 c. Using community indifference curves show the no-trade equilibrium for each country.
Assuming China wants to consume 10 meters of cloth and India 8 kgs of tea. (Hint: you first
have to deduce how many kilograms of tea China can produce with 120 hours of labour once
they have produced 10 meters of cloth. Similarly, based on the PPC if India consumes 8 kgs of
tea calculate the quantity of cloth it can produce and consume. Then, at the no-trade
equilibrium, if the country maximizes its utility how do you draw the indifference curve?
Tangent at the equilibrium?).
d. What is the opportunity cost of producing 1m of cloth in China? Explain what it means. What
is the opportunity cost of producing 1m of cloth in India? (Recall that the opportunity cost of
producing 1 unit of cloth in China is the quantity of tea China cannot produce during the same
time). Be careful in the example developed in class, we had the productivity. Here we know
the time it takes to produce one good. Recall the definition of opportunity cost and formula.
In class, to calculate the opportunity cost of 1 unit of cloth in the USA (in terms of unit of
wheat sacrificed) we used Opportunity cost= Productivity of wheat/productivity of
cloth=0.5/0.25=2. If we had had the time needed for production, we would have calculated
like this: Time to make 1 unit of cloth/time to make 1 unit of wheat=4/2=2. Now it is your turn
to calculate the opportunity cost of 1m of cloth in China.
e. Which country has a comparative advantage in producing cloth? In tea? Based on the theory
of comparative advantage, who will export cloth? At what price?
f. When trade is opened, if the international price of tea is equal to 1.5 meter of cloth, what
happens to production in each country according to David Ricardo?
g. Draw the trade line for each country. (Recall that the trade line shows the combination of
goods a country can consume with trade)
h. Trade: In this free-trade equilibrium, 10 kgs of tea are exported. How many meters of cloth
are imported?
i. What is the consumption point in each country with free trade? Show this graphically with
community indifference curves.
j. Does each country gain from trade? Explain, referring to your graphs.

With this exercise, you demonstrate the impact of trade based on comparative advantage and
learn how to use the PPC, trade line and indifference curve. You also practice the calculation of
opportunity cost. In the textbook, the table provided is a productivity table: you have the production
per hour. By doing this exercise, you learn how to calculate the opportunity cost with the time
needed to produce one good. (The productivity is the inverse of the time it takes to make one unit.)

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Question 2 :

Stern (1962) analyses the extent to which differences in the relative labor productivity (measured
here on the vertical axis by the output per worker ratios) in selected manufacturing industries are
reflected in differences in the relative export performance of the two countries. In 1950, average
American wages were approximately 3.4 times average British wages. It might be expected,
therefore, that the ratio of American to British exports would be greater than unity when the ratio
of United States to United Kingdom output per worker exceeded 3.4, and lower than unity when
the relative output per worker was below 3.4. The U.S. output per worker is more than 3.4 times
the British for: tin cans, wireless receiving sets and valves, electric lamps, paper, motor cars, pig
irons and matches. For nearly all these goods, U.S. exports exceeded U.K. exports (except for pig
iron and matches, for which U.S. output per worker is more than 3.4 times the British, but U.K.
exports exceeded U.S. exports). For all the other industries, the U.S. output per worker was less
than 3.4 times the British and U.S exports were lower than U.K. exports (except glass containers
and hosiery, for which U.S. output per worker was less than 3.4 times the British, but U.S. exports
exceeded U.K. exports). This study extends and confirms an ealier study by MacDougall (1951).
The relationship demonstrated in the plot below was replicated many times by MacDougall itself
(1952) and by Balassa (1963)

References :
Balassa, B. (1963). An Empirical Demonstration of Classical Comparative Cost Theory, Review of
Economics and Statistics, 45 (1), 231-238.
MacDougall, G. D. A. (1951). British and American Exports: A Study Suggested by the Theory of
Comparative Costs. Part I, Economic Journal, 61 (Dec.), 697-724.
MacDougall, G. D. A. (1952). British and American Exports: A Study Suggested by the Theory of
Comparative Costs. Part II, Economic Journal, 61 (Sep.), 487-521.
Stern, R.M., (1962). British and American Productivity and Comparative Costs in International
Trade, Oxford Economic Papers, 14 (3), 275-296.

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a. What type of relationship between exports ratios and productivity ratios can you infer from
the scatter diagram above ? (Positive? Negative? Uncorrelated? Linear? Quadratic?)
b. According to this Figure which country had an absolute advantage in tin cans ? cement ?
(Recall that a country has an absolute advantage if it can produce faster than the other one.
Based on the ratio of the productivities on the vertical axis, which country has the highest
productivity for tin cans? Cement? Other goods?)
c. According to this Figure which country had a comparative advantage in paper? tins cans ?
cement ? (For this question, take the time to read carefully the information provided before
the Figure and the information on wages: average American wages were approximately 3.4
times higher than British wages. To develop the intuition, take the example of paper for which
the ratio of the US productivity divided by the UK productivity is 3.4. Does one country has a
comparative advantage for this good taking into consideration the comparative productivity
ratio and wage ratio? How would your answer differ for tin cans with a productivity ratio above
5?)...
d. Is this relationship consistent with the theory of comparative advantage of Ricardo for tins
cans? cement ? all goods ? In other words, does a country with a comparative advantage in tin
cans for example tend to export tin cans? Check out the exports ratio in the horizontal axis,
does it exceed 1? Is below 1?)

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Hint: If US productivity/UK productivity>1 for one good then the US is more productive for that good
(you can read this information on the vertical axis)

If US exports/UK exports>1 for one good then the US is a net exporter for that good (you can read this
information on the horizontal axis)

Chapter 4

Question 1:
We will use the statistics presented in an empirical study titled “The case of international trade
between Croatia and the rest of the European Union member states” by Vlatka Bilas, Mile Bošnjak. Zb.
rad. Ekon. fak. Rij. • 2015 • vol. 33 • sv. 1 • 103-124 published in 2015 • vol. 33 • sv. 1 • 103-124

a. Is Norway relatively more or less capital abundant than France according to the Table below?
b. According to Hecksher Ohlin in a bilateral trade between Norway and France which of the two
country should export leather to the other? Explain why using the two tables and the theory.
c. According to Hecksher Ohlin in a bilateral trade between Norway and France which of the two
country should import metal to the other? Explain why using the two tables and the theory.
You can also choose 2 other countries, than France and Norway for this exercice (for example,
Denmark and Sweeden).

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Question 2:
We will use statistics from CEPII.
a. Summarize France’s revealed comparative advantages and compare them with Germany’s
revealed comparative advantages.
b. Are French products more or less sensitive to price variation relative to Germany? Is France
more specialized in differentiated products relative to Germany (less sensitive to price)? See
background information below trade statistics.
c. Is there any difference in terms of trade balance between France and Germany? See
background information below trade statistics and below Figure on price positioning.

https://unctadstat.unctad.org/en/RcaRadar.html

“Revealed comparative advantage (RCA) is based on Ricardian trade theory, which posits that patterns
of trade among countries are governed by their relative differences in productivity. Country A is said
to have a revealed comparative advantage in a given product i when its ratio of exports of product i to
its total exports of all goods (products) exceeds the same ratio for the world as a whole.

The plots presented below are designed to present a full picture of any country's revealed comparative
advantage in producing and exporting a full range of products in a given year. […] The revealed
comparative advantage of exported products are indicated in the plot for all product groups which
have an RCA greater than 1.

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And trade…
https://oec.world/en/profile/country/fra
France

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Germany
https://app-goat.oec.world/en/profile/country/deu#yearly-trade

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“It seems hard to explain the divergent export dynamics of advanced economies solely on the basis
of global demand and price competitiveness. "Non-price" determinants such as quality, innovation,
design, brand image and distribution networks also help to explain export performance.

In Germany, a country with a relatively low sensitivity to price competitiveness, the steady
improvement in export performance seems mainly due to a non-price competitiveness advantage.

In France, a country more sensitive to price competitiveness, the same mild decline in price
competitiveness observed before the crisis appears to have had a more adverse impact on export
performance.

The breakdown of France's non-energy trade balance by contribution of "quality" dominant

products, "price" dominant products and "intermediate" products shows that the deterioration since
the early 2000s is mostly due to the worsening balances for "price" products and, to a lesser extent,
"mid-range" products. The doubling of the trade surplus for "quality" products does not suffice to
offset the decline of the other components. These patterns confirm that, while France has a
reasonably good positioning on non-price criteria and high-technology products, its position is not
strong enough to withstand an erosion in price competitiveness.

”
Sources: CEPII’s world economic overview or European specialization
(http://www.cepii.fr/PDF_PUB/pano/monde_en.pdf)

The TRÉSOR-ÉCO – n° 68 – December 2009 –8 pages on comparative advantage in France versus

Germany : http://www.tresor.economie.gouv.fr/file/327027
The TRÉSOR-ÉCO – n° 122 – January 2014 – 12 pages What is the "non-price" positioning of France
among advanced economies?: http://www.tresor.economie.gouv.fr/file/327027

https://www.cairn-int.info/article-E_REI_144_0059--france-and-germany-a-comparison.htm

“'While external balance is a priority for Germany, for France it is more of an adjustment variable'
Economists André and Thomas Grjebine lay out how the French trade deficit can be explained by the
divergence of economic strategies and doctrines within the eurozone – including exports in Germany
and supporting demand in France.

By Béatrice Madeline (Research director at the Centre d’Etudes et de Recherches Internationales

(CERI) de Sciences Po) and Jim Phillipoff

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Published on June 7, 2022 at 03h47, updated at 16h59 on June 29, 2022

A crisis is inevitable for a monetary union like the eurozone if the economic priorities of its member
countries are fundamentally different. Since 1945, Germany has pursued a neo-mercantilist policy in
contrast to the French policy of supporting demand, with intermittently more restrictive policies
when external constraints become too strong.
These opposing strategies, at the root of our persistent external deficits and German surpluses, have
divergent theoretical foundations. From the sixteenth to the first half of the eighteenth century,
mercantilism accompanied the early development of French industry. It was evident in both an
industrial policy geared towards the production of goods for export, and in the discouragement of
importing finished goods, via protectionist measures. Germany has been inspired by this doctrine for
decades, at least since Bismarck (1815-1898). Its mercantilism is expressed not so much by
protectionist measures as by a supply-side policy based on reducing demand, which aims both to
ensure the competitiveness of companies (with, in particular, long phases of wage moderation) and
limit imports. Social consensus enables implementation of this strategy with the agreement from the
trade unions, which are anxious to preserve the competitiveness of German industry.

'Live beyond one's means'

While external balance is a priority for Germany, for France it is more of an adjustment variable. This
is a reflection of the influence of classical international trade theories, which have always had a
strong impact on French economists. The theories of "absolute advantage" by Adam Smith (1723-
1790) and, even more so, "comparative advantage" by David Ricardo (1772-1823) were developed in
reaction to the mercantilist theories in vogue at the time: The idea was to move from a world where
everyone tried to maximize their trade surpluses to a world where everyone had an interest in
exchange. No matter what was produced, the division of labor should allow each country to become
richer, with each country specializing in those productions in which it had a comparative advantage.
In a world where everyone has an interest in exchange, trade deficits are no longer a problem.”

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Chapters 5-6:

Question 1:
Differences in wages are still very important around the world. We often hear that foreign
competition is unfair and hurts other countries such as France when it is based on low wages. This
argument is sometimes referred to as the « pauper labor argument ». Does it imply that French
workers should accept lower wages otherwise our trade balance will continue to deteriorate ? How
can you answer using the Ricardo or the Hecksher-Ohlin theories or even the elements provided in
question 3 of chapter 4?

Question 2:
In countries that are abundant in capital and highly-skilled workers, such as France, do wages of
unskilled workers tend to increase/decrease with trade? Why according to the economic theory?

Comment the conclusion of the study “Labour market polarisation: are there more low-skilled jobs in
France?” (can be accessed here:
https://www.strategie.gouv.fr/sites/strategie.gouv.fr/files/atoms/files/note_danalyse_ndeg98_-
_en_0.pdf)

“The labour market polarisation observed in France is marked by a shift in employment towards the
highest qualifications, going hand in hand with an erosion of jobs located in the middle of the
distribution of qualifications which the 2008 crisis has amplified. On the other hand, there is no
evidence of polarisation or employment concentration at both extremities of the skills distribution,
unlike in the United States. The lowest-paid occupations in personal services (childcare assistants,
home care providers) or retail services (hairdressers, hotel and restaurant workers, cashiers) have
only increased significantly in the 1990s. In this sense, the trend observed in recent years is a decline
in sales workers and personal services employees, which could forecast a shrinking of their share
within the working population, while the current health and economic crisis is particularly a-ecting
these occupations.”

To go further read article 2 in the appendix of this document

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Question 3:

Croatia will soon adopt the euro.

"I would like to congratulate my counterpart, Zdravko Maric, and the whole of Croatia for becoming
the 20th country to join the euro area," said Zbynek Stanjura, the finance minister of the Czech
Republic, which holds the EU's rotating presidency.
Croatia's switch from the kuna to the euro in 2023 will come less than a decade after the former
Yugoslav republic joined the European Union and will set a new milestone in the bloc's further
integration.
"This is a time for celebration... and an act of conviction," said Christine Lagarde, the head of the
European Central Bank at a signing ceremony in Brussels.
"The whole of Croatia decided and was convinced of the value of joining the euro and the euro area,"
she added.”

https://www.france24.com/en/europe/20220712-eu-gives-croatia-final-green-light-to-adopt-euro-
in-2023

1. What is the expected effect of that adoption of the euro on income for workers? Capital
owners? through an expected increase in trade? Explain using economic theory.

2. What can be said about intra industry trade between Croatia and the European Union? Why
does it matter to predict the impact on workers and capital owners income?

“This paper investigates trends and determinants in intra-industry trade in Croatia. Intra-
industry trade refers to a two-way trade of differentiated products. […] it can be concluded
that Croatia’s trade with its most important trade partners is mostly of inter-industry
character, but there appears to be a shift towards intra-industry trade. […] The point is that all
values, with a few exceptions, are lower than 0.5, which indicates a larger inter-industry than
intra-industry trade. […] (Intra industry trade indices) are highest for the world, then for trade
with EU-28, and lowest for trade with CEE countries. A steady and gradual increase can be
noticed in the value of all indicators in the observed period from 2001 to 2017. […] From the
presented analysis, it can be concluded that the character of trade in Croatia is largely of inter-
industry type. However, there is a trend showing a gradual but steady rise of intra-industry
trade. The main determinants of intraindustry trade in Croatia are GDP of trade partner

24
 country, common border, and membership in the European Union. On the other hand,
distance has a negative effect on the level of intra-industry trade, which is a highly expected
result from the aspect of economic theory. “ (Source: https://hrcak.srce.hr/file/346872)

Chapter 8

Question 1:
a. What is the effect of a tariff on producers? On consumers? On the nation well-being? Explain in
words without any diagram for a small country.
b. How would your answer differ for a large country?

Question 2:
Assume a small country produces 60 million tonnes of wheat per year, sold at 100 euros per tonne.
Also assume this country imports 10 million tonnes of wheat. Assume there is initially no tariff and no
quota of production for this market. A tariff of 20 euros per tonne is considered.
What is the minimum net national loss that this tariff could cause to this small country?

The maximum net national loss?

Step-by step analysis: Draw a model of supply and demand and show the effect of a tariff of 20 euros
on the quantity demanded, supplied, on the imports. Use a welfare analysis to show the change in
total surplus (with consumer surplus, producer surplus, government revenue). The change in total
surplus is equal to 2 areas b and d, which are respectively called the production effect and consumption
effect. The size of the production effect depends on the responsiveness of the quantity supplied to the
change in price caused by the tariff. The size of the consumption effect depends on the responsiveness
of the quantity demanded to the change in price caused by the tariff. Discuss the possible size of each
effect.
(Hint: what is the concept in economics, which is used to measure how responsive the quantity
demanded is to a change in price? For which type of goods is demand relatively unresponsive to a
change in price?)

Chapters 9, 10 and 11:

Question 1:
How can a country protect its domestic industry from foreign competition? List at least 3 foreign
policies. Compare them in terms of social benefits and costs using economic theory.
Read the text below for some hints.

“IT’S a big day for trade, a big day for our country,” boasted President Donald Trump on August 27th
(2018). The cause of this jubilation was progress in renegotiating the North American Free Trade
Agreement (NAFTA), a deal between America, Mexico and Canada. […] The Mexicans have agreed to
a higher threshold for regional content in cars (up from 62.5% to 75%) and to the removal of loopholes
that meant some auto parts were, in effect, exempt. A minimum share of steel and aluminum must be
sourced from the region. Most unusually, a minimum share of production must be done by workers
earning above $16 an hour. All this is supposed to sharpen carmakers’ incentives to locate production
in America. Juan Pablo Castañón, head of the Mexican Business Co-ordinating Council, says that 70%

25
of Mexican car plants comply with the new rules for parts and metal. So the renegotiation could shift
employment towards the United States, if carmakers rejig their supply chains in response or ramp up
the supply of compliant vehicles there while selling non-compliant ones elsewhere. But they might
simply choose instead to import more parts from outside the NAFTA region, and swallow the resulting
2.5% tariff. In any case, consumers will probably have to pay more.”

The Economist, Aug 30th 2018

Question 2:
Explain why lowering non-tariff barrier to trade would help lower inflation. Read the following article:
https://www.allianz.com/en/economic_research/publications/specials_fmo/trade-inflation.html
which is article 3 in appendix.

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 Appendix: reference Articles

ARTICLE 1 FOR CHAPTER 2: TRADE AT WHAT PRICE

Trade, at what price?- America’s economy benefits hugely from trade. But its costs have been
amplified by policy failures- The Economist- Apr 2nd 2016 | WASHINGTON, DC | From the print
edition

SO COMMON is anti-trade rhetoric in the election campaign that you might think America is about to
erect a wall on every side. […]

In any case, cheap imports were a windfall for American consumers. Excluding food and energy, prices
of goods have fallen almost every year since NAFTA. Clothes now cost the same as they did in 1986;
furnishing a house is as cheap as it was 35 years ago. More trade brought more choice, too. Robert
Lawrence and Lawrence Edwards, two economists, estimate that trade with China alone put $250 a
year into the pocket of every American by 2008. The gains from cheap stuff flowed disproportionately
to the less well-off, because the poor spend more of their incomes on goods than the rich.

At the same time, trade created new markets for American firms. In 1993 America sold nearly $10
billion-worth of cars and parts to Mexico, at today’s prices. By 2013 that had risen to $70 billion. Many
American firms have become tightly integrated across the southern border, with low-skilled work done
in Mexico and more complex tasks done at home. Exports to China grew by almost 200% between
2005 and 2014, with agriculture and the aerospace and car industries leading the charge. Some
workers have benefited from rising exports, because firms that export pay more; one estimate puts
the export wage-premium at 18%. Outsourcing low-wage assembly has also increased the productivity
of America’s high-skilled workers. For example, Apple’s ability to assemble its iPhones cheaply in China
has made the work of its American designers much more lucrative.

The gain and the pain

Trade, though, has an acute image problem. Its benefits are hard to perceive directly, spread as they
are across large constituencies: consumers, exporters, and workers who may not realise just how much
of what they make is shipped overseas. In contrast, its costs are highly concentrated. Cheap imports
have been lethal for many American manufacturers, particularly in the midwestern rustbelt and in the
South.

Economic theory predicts that trade, though often good for average incomes, will squeeze the pay of
those workers whose skills are relatively abundant overseas. A sharp rise in the college premium—the
additional wages earned by skilled workers—from around 30% in 1979 to almost 50% by 2000 seemed
to corroborate that theory, as it coincided with the first wave of cheap imports (see chart). […]

The sharp decline in American manufacturing employment began in 2000, just as Chinese imports took
off (see chart). Yet on the extreme assumption that every dollar spent on imports replaced a dollar
spent employing an American, Mr Lawrence calculates that between 2000 and 2007 Chinese imports

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caused, at most, 188,000 of 484,000 annual manufacturing-job losses. A recent, more detailed,
estimate by Daron Acemoglu, David Autor and others chalks up about 1m of 5.5m manufacturing jobs
lost between 1999 and 2011 to Chinese competition (with similar-sized job losses in other industries).

This implies that many other factors are in play. Technological change is probably the prime culprit for
shrinking manufacturing employment

But another recent achievement of trade economists has been to show that trade-induced job losses,
while relatively small, are particularly painful: more so than those caused by technology. Until recently,
most economists assumed that displaced workers could find new work relatively easily. […] But many
workers displaced by Chinese imports did not simply find another job. Mr Autor and his colleagues
have shown that, at local level, employment falls at least one-for-one with jobs lost to trade, and that
displaced workers are unlikely to move to seek new work.

Obstructing their progress

[…] living standards today are far higher. Trade barriers, which prevent such advances, are a futile, self-
defeating way to help the unskilled. […]

To the extent that some Americans are harmed, which is inevitable, the projected gains of future free-
trade agreements should be more than enough to compensate losers, if only the government can get
itself organised. Peter Petri and Michael Plummer, two economists, estimate that the TPP will boost
American incomes by $131 billion, or 0.5% of GDP. That is over 100 times what America spent on trade-
adjustment assistance in 2009: there is plenty of scope to do more for the losers from trade. […]

ARTICLE 2: An inconvenient iota of truth. The Stolper-Samuelson theorem. Sep 4th 2016. BY S.J.C.
ON CHAPTER 5

DOES trade hurt wages? Or, more precisely, do imports from low-wage economies hurt workers in
high-wage ones? Many people assume so. Economists take a bit more convincing. Back in the 1930s,
one trade economist, Gottfried Haberler, argued that “the working class as a whole has nothing to fear
from international trade”—at least in the long run. This confidence rested on three observations.
Labour, unlike other many other productive resources, is required in all sectors. It will thus remain in
demand however much globalisation shakes up a country’s industrial mix. Over time, labour is also
versatile. Workers can move and retrain; new entrants can gravitate towards sunrise sectors rather
than industries in decline. Finally, workers are also consumers, who often buy the foreign goods in
local shops. Even if competition from cheap imports drives down their (nominal) wages, they will come
out ahead if prices fall by even more. Haberler’s confidence was not universally shared, however.
Wolfgang Stolper, a Harvard economist, suspected that competition from labour-abundant countries
might hurt workers elsewhere. In 1941, he teamed up with Paul Samuelson, his Harvard colleague, to
prove it.

Their Stolper-Samuelson theorem concluded that removing a tariff on labour-intensive goods would
depress wages by more than prices, hurting workers as a class, even if the economy as a whole gained.
The theorem’s logic rests on the interaction between industries with different degrees of labour-

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 intensity. It is perhaps best explained with an example. Suppose a high-wage economy were divided
into two industries: wheat-growing (which is land-intensive) and watchmaking, which makes heavy use
of labour and shelters behind a 10% tariff. If this protection were removed, watch prices would fall by
10%. That would force the industry to contract, laying off labour and vacating land. That in turn would
put downward pressure on wages and rents. In response, wheat growers would expand, taking
advantage of the newly available land and labour. This dance would continue until watchmaking’s costs
had fallen by 10%, allowing the industry to compete with tariff-free imports.

Stolper and Samuelson paid close attention to the combination of rents and wages that would achieve
this cost reduction. One might assume that both would fall by 10%. But that would be wrong. Since
watchmaking is labour-intensive, its contraction releases more labour than land, putting greater
downward pressure on wages than on rents. Conversely, the expansion of wheat growers would put
more upward pressure on rents than on wages. The end result is that wages would have to fall by more
than 10% because rents would fall by less. Rents would paradoxically rise. The combination of much
cheaper labour and slightly pricier land would restore the modus vivendi between the two sectors. It
would halt the contraction of the watchmakers (because cheaper labour helps them more than pricier
land hurts them). It would also check the expansion of the wheat growers (because pricier land hurts
them more than cheap labour helps them).

Trade liberalisation, in this example, depresses wages by more than prices, hurting labour in real terms.
This gloomy conclusion has proved remarkably influential. It appears even 75 years later in debates
about the Trans-Pacific Partnership between America and 11 other countries, many of them low-wage
economies. Some economists regret this influence, arguing that the theorem’s crisp conclusion does
not hold outside of the stylised settings in which it was first conceived. Even the theorem’s co-author,
Paul Samuelson, was ambivalent about the result. “Although admitting this as a slight theoretical
possibility,” he later wrote, “most economists are still inclined to think that its grain of truth is
outweighed by other, more realistic considerations.”

ARTICLE “: ON TRADE POLICIES (CHAPTERS 8, 9, 10): HOW TO EASE INFLATION? NON-TARIFF

BARRIERS TO TRADE IN THE SPOTLIGHT FROM ALLIANZ SE MUNICH JULY 28, 2022
They could knock -4.5% off inflation in the EU and -2.0% in the US

• A stronger US dollar will not be enough to rein in inflation in the US. Even as the appreciation of
the USD will reduce inflation by -1.4pp in the next three months, and the US is less exposed to
surging energy prices, we still expect inflation to remain well above 2% next year. In this context,
the Biden Administration is considering lifting some of the tariffs imposed on China during the
Trump era, and stepping up efforts to strengthen supply chains.

• However, we find that even a full tariff-based trade liberalization in the US and the EU would not
be a game-changer for the inflation outlook. If tariff rates on the main import partners (including
China) were shaved to zero, inflation would be reduced by just -0.4pp in the US and -0.1pp in the
EU, given the high share of duty-free imports (72% in the US on non-agricultural goods, 56% in the
EU) already in place.

• In contrast, lowering non-tariff barriers to trade would have a material impact. In the US, close to
80% of trade is affected by non-tariff measures, while in the EU it is close to 95%. We find that
reducing non-tariff measures to trade to below 50% would lower corporate markups and in turn
knock at least -2pp off inflation in the US and -4.5pp in the EU. Lowering protection for local

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 producers could thus yield sizeable benefits for consumers, especially in the EU, where the -9%
depreciation of the EUR will push up inflation by more than +1.0pp after one year.

• Easing supply-chain disruptions could also lower inflation by up to -1.5pp in both the US and the
EU, according to our estimates. This would require normalizing industrial output and trade flows
among key import partners in a context where China is likely to maintain its zero -Covid policy
through Q2 2023. Separately, domestic policies could help, such as an infrastructure plan focused
on ports and/or increasing competition in the shipping industry, accompanied by appropriate labor
market policies.

Impact of trade-related policy measures on inflation

Source: Allianz Research

Trade liberalization is back on the agenda.

Even as the appreciation of the USD will reduce inflation by -1.4pp in the next three months via
reduced import prices (see Figure 1), and the US is less exposed to surging energy prices, we still
expect inflation to remain above its pre-pandemic level through at least the first half of 2023. This
persistently high inflation has heightened policymakers’ concerns about its increasingly visible costs
on the economy and growing public discontent. In this context, the US Administration is considering
lifting some of the Trump-era tariffs imposed on Chinese goods. This follows a mandatory four-year
review of the tariffs, which could result in their expiry in July and August. Rolling back some of the
tariffs imposed on Chinese imported goods is seen as a way to ease the cost of living crisis on
households by softening consumer prices of goods.

US import prices and broad dollar index

Sources: US BLS, BIS, Allianz Research

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