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Chap 9 - Chapter 9 of the question for review and problems

for textbook International
Kinh tế quốc tế (Đại học Kinh tế Quốc dân)

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A - QUESTION FOR REVIEW

1. What is an import quota? How is it mostly used today? What are the partial
equilibrium effects of an import quota? How are they similar to and different
from the effects of an equivalent import tariff?
It is a direct quantitative restriction on the amount of a commodity allowed to be
imported into a country in a given period of time.
It is mostly used by practically all industrial nations to protect their agriculture
and by developing nations to stimulate import substitution of manufactured
products and for balance- of - payments reasons.
An import quota lowers consumer surplus in the import market and raises it in
the export country market. An import quota raises producer surplus in the
import market and lowers it in the export country market.

2. What is meant by voluntary export restraints? How has the United States used them?
A voluntary export restraint occurs when an exporting country or companies in
an exporting country agree to limit how many of a product that they will export
to another country.
The United States has used them to curtail exports of textiles, steel, electronic
products, automobiles and other products from Japan, Korea, China and other
nations.

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3.What are the technical, administrative, and other nontariff barriers to

trade? How do they restrict trade? What is the importance of these nontariff
trade barriers relative to tariff barriers?
These include safety regulations for automobile and electrical equipment, health
regulations for the hygienic production and packing of imported food products,
and labeling requirements showing origin and contents.
They have resulted from laws requiring governments to buy from domestic
suppliers. International commodity agreements and multiple exchange rates also
restrict trade.
The importance of non-tariff barriers is it has been widely used to trade flow
effects of institutions such as customs unions, exchange rate mechanisms, ethics
ties, linguistic identity and international borders.

4. What are international cartels? How do their operations restrict trade?

Which was the most successful international cartel during the 1970s? Why
did its power decline sharply in the 1980s?
An international cartel is an arrangement to avoid some or all forms of
competition, the parties to which are business enterprises domiciled under more
than one government and trading across national frontiers.
Governments three primary means to restrict trade: quota systems; tariffs; and
subsidies. A quota system imposes restrictions on the specific number of goods
imported into a country. Quota systems allow governments to control the
quantity of imports to help protect domestic industries.
When Egypt invaded Israel to start the war, OPEC took the decision to place an
embargo on the United States and its allies that supported Israel. Known as the
1973 Arab Oil Embargo, it is often referred to as “the first oil shock.” Prices
quadrupled from USD 3 per barrel to nearly USD 12 globally from September
1973 until March 1974 when the embargo was finally lifted. OPEC’s rise to
power and prominence in global oil markets as well as international relations
occurred during the 1970s.
The importance of these nontariff trade barriers relative to tariff barriers: It has
been widely used to infer trade flow effects of institutions such as customs
unions, exchange-rate mechanisms, ethnic ties, linguistic identity and
international borders.

5. What is meant by dumping? What are the different types of dumping? Why
is dumping undertaken? What conditions are required to make dumping
possible? Why does dumping usually lead to trade restrictions?
Dumping occurs when a country or company exports a product at a price that is
lower in the foreign importing market than the price in the exporter's domestic
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market. The biggest advantage of dumping is the ability to flood a market with
product prices that are often considered unfair.
Different types of dumping:
● Sporadic dumping: Companies dump excess unsold inventories to avoid
price wars in the home market and preserve their competitive position.
They can either dump by

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destroying excess supplies or export them to a foreign market where the

products are not sold.
● Predatory dumping: Unlike sporadic dumping, which is occasional,
predatory dumping is permanent. It involves the sale of goods in a
foreign market at a price lower than the home market. Predatory
dumping is done to gain access to the foreign market and eliminate
competition. It creates a monopoly in the market.
● Persistent dumping: When a country consistently sells products at a
lower price in the foreign market than the local prices, it is called
persistent dumping. It happens when there is a constant demand for the
product in the foreign market.
● Reverse dumping: Reverse dumping happens when the demand for the
product in the foreign market is less elastic. It means that price changes
do not impact demand. Therefore, the company can charge a higher
price in the foreign market and a lower price in the local market.

The objective of dumping is to increase market share in a foreign market by

driving out competition and thereby creating a monopoly situation where the
exporter will be able to unilaterally dictate price and quality of the product.

Conditions to make dumping possible:

● The product must have a degree of Monopoly at least in the home market.

● There must be a clearly defined separate market.

● It should not be possible for buyers to resell goods from a cheaper

market to a dearer one.

Dumping enables consumers in the importing country to obtain access to goods

at an affordable price. However, it can also destroy the local market of the
importing country, which can result in layoffs and the closure of businesses. The
WTO and EU regulate dumping by putting tariffs and taxes on trading partners.

6. Why do nations subsidize exports? To what prob- lems do these subsidies give rise?
The primary goal of export subsidies is to reduce imports and increase domestic
production. Because the quantity of imports is restricted, the price of imports
increases, which thus encourages domestic consumers to buy more domestic
production.
It would be expensive; the government would have to raise a significant amount
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of tax revenue. There is an argument that when the government subsidizes

firms, it reduces incentives for firms to cut costs.

7. What are the fallacious and questionable arguments for protection? Why
are they fallacious and questionable?
Fallacious is the use of wrong, unreasonable arguments, intentionally violating
the rules of logic in inference. A fallacy may be intended to deceive by making
things appear to be better

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than they really are. Some fallacies are deliberately intended to manipulate and
distract listeners and readers, making them mistakenly believe that what is
wrong is right and what is right is wrong. Intentional mistakes in inference due
to carelessness and ignorance are called fallacies. The infant industry argument
suggests that new industries should be given temporary protection in order to
enable them to build up this experience. This argument applies where the
industry is small and young, and where costs are high but fall as the industry
grows. According to this argument, there are some industries in which a country
would really have comparative advantages if and only if it could get them
started. If faced with foreign competition, such infant (young and growing)
industries would not be able to pass the initial period of experiment and
financial stresses. But given protection for a short period, they can be expected
to develop economies of mass production and they would ultimately be able to
face foreign competition without protection. So, at the infant stage such
industries should be protected for a period till they can face competition
independently.

8. What is the infant-industry argument for protection? How must this

argument be qualified?
It holds that a nation may have a potential comparative advantage in a
commodity, but because of lack of know-how and the initial small level of
output, the industry will not be set up or, if already started, cannot compete
successfully with more established foreign firms. Temporary trade protection is
then justified to establish and protect the domestic industry during its “infancy”
until it can meet foreign competition, achieve economies of scale, and reflect
the nation’s long-run comparative advantage. At that time, protection is to be
removed. However, for this argument to be valid, the return in the grown-up
industry must be sufficiently high also to offset the higher prices paid by
domestic consumers of the commodity during the infancy period.

9. What are the other qualified arguments for protection? In what way must
they be qualified?
The infant-industry argument for protection is correct but requires several
important qualifications which, together, take away most of its significance.
First of all, it is clear that such an argument is more justified for developing
nations (where capital markets may not function properly) than for industrial
nations. Second, it may be difficult to identify which industry or potential
industry qualifies for this treatment, and experience has shown that protection,
once given, is difficult to remove. Third, and most important, what trade
protection (say, in the form of an import tariff) can do, an equivalent production
subsidy to the infant industry can do better. The reason is that a purely domestic
distortion such as this should be overcome with a purely domestic policy (such
as a direct production subsidy to the infant industry) rather than with a trade
policy that also distorts relative prices and domestic consumption. A production
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subsidy is also a more direct form of aid and is easier to remove than an import
tariff. One practical difficulty is that a subsidy requires revenues, rather than
generating them as, for example, an import tariff does. But the principle
remains.

10.What is meant by strategic and industrial trade policy? What is its relevance?
Strategic trade policy is a relatively recent development advanced in favor of an
activist trade policy and protectionism. According to this argument, a nation can
create a comparative advantage (through temporary trade protection, subsidies,
tax benefits, and cooperative

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government–industry programs) in such fields as semi-conductors, computers,

telecommunications, and other industries that are deemed crucial to future
growth in the nation. These high-technology industries are subject to high risks,
require large-scale production to achieve economies of scale, and give rise to
extensive external economies when successful. Strategic trade policy suggests
that by encouraging such industries, the nation can reap the large external
economies that result from them and enhance its future growth prospects. This
is similar to the infant-industry argument in developing nations, except that it is
advanced for industrial nations to acquire a comparative advantage in crucial
high-technology industries. Most nations do some of this. Indeed, some
economists would go so far as to say that a great deal of the postwar industrial
and technological success of Japan was due to its strategic industrial and trade
policies.

11. What is the importance of the Trade Agreements Act of 1934? What are
the ruling principles of GATT?
The importance of the Trade Agreement Act of 1934: It reversed the trend
toward sharply reduced world trade by authorizing the president to negotiate
with other nations mutual tariff reductions of up to 50 percent under the most-
favored-nation principle.
GATT rested on three basic principles:
1. Nondiscrimination. This principle refers to the unconditional acceptance of
the most- favored-nation principle discussed earlier. The only exceptions to this
principle are made in cases of economic integration, such as customs unions,
and in the trade between a nation and its former colonies and dominions.
2. Elimination of nontariff trade barriers (such as quotas), except for agricultural
products and for nations in balance-of-payments difficulties.
3. Consultation among nations in solving trade disputes within the GATT framework.

12.What are the major accomplishments of the Kennedy Round? of the Tokyo
Round? What do the Trade Acts of 1984 and 1988 provide?
Negotiations in the Kennedy Round were completed in 1967 and resulted in an
agreement to cut average tariff rates on industrial products by a total of 35
percent of their 1962 level, to be phased over a five-year period. By the end of
1972, when the agreement was fully implemented, average tariff rates on
industrial products were less than 10 percent in industrial nations.
Negotiated tariff reductions phased over an eight-year period, starting in 1980,
averaged 31 percent for the United States, 27 percent for the European Union,
and 28 percent for Japan. The total static gains from trade liberalization under
the Tokyo Round amounted to an estimated
$1.7 billion annually. With the dynamic gains arising from economies of scale
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and greater all- around efficiency and innovations, the figure might rise to as
high as $8 billion per year.
The Trade Acts of 1984 provides: (1) It authorized the president to negotiate
international agreements for the protection of intellectual property rights and to
lower barriers to trade in services, high-technology products, and direct
investments. (2) It extended the Generalized System of Preferences (GSP),
which granted preferential access to the exports of developing countries to the
United States (see Section 11.6) until July 1993, but with “graduation” or the
removal of preferential access for the exports of the most advanced of the
developing countries,

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such as Korea and Taiwan. (3) It provided authority for negotiations that led to a
free trade agreement with Israel. It was under the provisions of this act that the
United States called for new multilateral trade negotiations (the Uruguay
Round) that started in 1986.
The Trade Acts of 1988: (1) calls on the U.S. Special Trade Representative
(USTR) to designate priority countries that maintain numerous and pervasive
trade barriers, (2) sets a rigorous schedule for negotiations to be held on
eliminating those barriers, and (3) requires retaliation by curbing imports from
those countries if the negotiations are not successful.

13.What did the Uruguay Round accomplish?

The Uruguay Round reduced tariffs by 40 percent for developed countries on
about $787 billion worth of trade in industrial goods. The percent of industrial
goods traded by developed countries with zero tariffs rose from 20 percent to 44
percent.

14.What are the outstanding trade problems facing the world today?

● Economic Warfare: Globalization has a tough challenge against

polarization and conflicting issues. The world is experiencing increased
conflicts, major economic powers are seizing influence, financial
sanctions are being used as a weapon, and the Internet is breaking into
pieces. Therefore, the international flow of money, information, products
and services may slow down.

● Lack of Leadership: Globalization will continue rapidly, but the U.S led
world order is getting diminished. An inconsistent, war-ridden United
States lacks the will and ability to provide global leadership. Moreover,
no other country is interested in taking its place. The West is having its
own problems, and allies are only interested in hedging their bets.
Therefore, there is no clear and definite way for globalization to progress
and it is getting distorted.

● Power Distribution: China, Russia, Turkey, India, and some other

emerging nations are getting powerful enough to dismantle the US led
theory of globalization. But they lack synchronization and influence.
Their values and interests are not compatible. So, a regionalized world is
emerging. Americanization and globalization are neither believed to be
one and the same now nor is it preached by these power-seeking nations.
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15.Why do we need the Doha Round?

Trade tensions between nation states that could lead to conflict are once again
beginning to sharpen. This is particularly the case given the multi-polar world
that has emerged in the 21st century and the rise of emerging countries, such as
China, India and Brazil. Added to this is the selfish attitude of the European
Union and the US which continues to undermine the multilateral system.
The only way to ensure that the world creates a legitimate and secure world
trading system is to rebuild the WTO based on fair trade, balanced rules,
inclusivity and transparency. The next

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opportunity to do this will be when trade ministers meet again at the 11th WTO
Ministerial Conference at the end of 2017. They should gun to revitalize the
Doha round. In the past, It provided the world with a basic framework for the
multilateral trading system. It also succeeded in preventing trade competition
between nations from descending into conflict on the scale of the First and
Second World Wars.

B - PROBLEM

1. Explain why nations impose trade restrictions if free trade is the best policy.
Nations restrict trade either in response to lobbying by the producers of a
commodity in which the nation has a comparative disadvantage or to gain a
strategic advantage in relation to other nations. The first leads to a welfare loss
for the nation as a whole. The second is very difficult to achieve.

*2. Starting with Dx and Sx and Px = $1 with free trade in Figure 9.1,
analyze the partial equilibrium effects of an import quota of 30X if Dx shifts
down to D”x in such a way that D”x is parallel to Dx and crosses Sx at Px =
$2.50.

The partial equilibrium effects of the import quota are:

Px=$1.50; consumption is 45X, of which 15X are produced
domestically. By auctioning off import licenses, the revenue
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effect would be $15.

*3. Starting with Dx and Sx and Px = $1 with free trade in Figure 9.1,
analyze the partial equilibrium effects of an import quota of 30X if Sx shifts
up to S‘x (parallel to Sx ) and crosses Dx at Px = $3.50.

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The partial equilibrium effects of the import quota are: Px=$2.50; consumption
is 40X of which 10X are produced domestically
=> The revenue effect = $45.

4. Starting with Dx and Sx and Px = $1 with free trade in Figure 9.1, analyze
the partial equilibrium effects of an import quota of 30X if Sx shifts down to
S”x (parallel to Sx) and crosses D at P = $2.50.
The partial equilibrium effects of the quota are:
Px=$2; domestic production and consumption are 50X; The revenue is zero.

5. Starting with Dx and Sx and Px = $1 with free trade in Figure 9.1, analyze
the partial equilibrium effects of an import quota of 30X if Sx shifts down to
S*x (parallel to Sx) and crosses Dx at Px = $2.00.
The partial equilibrium effects of the quota are:
Px=$1; consumption is 70X, production is 30X, and revenue is zero.

6.Starting with DX and SX and PX = $4.50 with free trade in Figure 9.1,
analyze the partial equilibrium effects of a negotiated export quota of 30X.
The partial equilibrium effects of a negotiated export quota of
30X are: Px=$4; domestic production is 40X, of which 10X are
consumed at home.

7. Explain how the effects of a negotiated export quota of 30X, found in

Problem 6, are similar to and different from those of an equivalent import
tariff or quota.
An export tariff or quota, as an import tariff or quota, affects the price of the
commodity and domestic consumption and production. But the effects are the
opposite.

8. Draw a straight-line demand curve for a com- modity crossing both axes
and its correspond- ing marginal revenue curve (lying everywhere halfway
between the vertical axis and the demand curve). On the same graph, draw a
hypothet- ical supply curve for the commodity crossing the demand and
marginal revenue curves. If the demand and supply curves refer to the
perfectly competitive market for exports of the commodity, determine the
equilibrium price and quantity of exports of the commodity.
See Figure 1.
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The equilibrium price of the commodity is Px=OC and the equilibrium quantity
is Qx=OB in Figure 1.

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9. For the same statement in Problem 8, determine the equilibrium price and
quantity of exports of the commodity if the supply curve refers to a cartel of
exporters acting as a monopolist.
If the supply curve of the commodity in Figure 1 referred to a cartel of exporters
acting as a monopolist, Px=OF and Qx=OA (see Figure 1).

10.Compare your results of Problems 8 and 9. (Hint: Review the perfectly

competitive and monopoly models in your principles text or notes.)
Px is higher and Qx smaller when exporters behave as a monopolist.

*11. Draw three sets of price-quantity axes side by side. On the first set of
axes (graph), draw a straight-line demand curve (D1) that is steep, starts at a
high price, and refers to the domestic market. On the same set of axes, draw
the corresponding marginal revenue curve (MR1 ) . On the second graph ,
draw a straight-line demand curve (D2) that is low and flat and refers to the
international market. On the same (second) set of axes, draw the
corresponding MR2 curve. On the third graph, sum horizontally the MR1 and
MR2 curves (MR) and draw a marginal cost curve (MC) that intersects the
MR curve from below in the third graph; then draw a horizontal dashed line
and extend it to the second and first graphs. The point where the horizontal
dashed line crosses the MR1 curve indicates how much the domestic
monopolist should sell in the domestic market, and where the horizontal line
crosses the MR2 curve indicates how much he should sell on the
international market.

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(a)What price should the monopolist charge in the domestic market (P1) and
in the foreign market (P2)?

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(b) Why does this represent the best, or optimal, distribution of sales between
the two markets?
a. The monopolist should charge P1=$4 in the domestic market and P2=$3
in Figure 9-5 in Appendix A9.2.
b. This represents the best, or optimal distribution of sales between the two
markets because any other distribution of sales in the two markets gives less
revenue.

12. On a set of axes measuring average costs of pro- duction on the vertical
axis and the level of output on the horizontal axis, illustrate the infant-
industry argument for protection by drawing the long-run average cost curve
of an efficient foreign firm facing constant returns to scale and the long-run
average cost curve of an infant industry in a devel- oping nation that becomes
more efficient than established foreign firms as it grows.
Figure 2. To the left of point A, the domestic firm faces higher long-run average
costs of production (LACD) than the foreign firm (LACF). To the right of point
A the opposite is the case.

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13. Indicate the strategic trade policy required (if any) if the entries in the top
left-hand corner of Table 9.5 were changed to:
(a) 10, +10;
(b) + 10, 0;
(c) + 5, −10.
a) If the entries in the top left-hand corner of Table 9-5 were changed to +10,
+10, then both Boeing and Airbus would produce the aircraft without any
subsidy, and so no strategic trade and industrial policy would be needed in the
U.S. or Europe.
b) If the entries in the top left-hand corner of Table 9-5 were changed to +5, +0,
then both Boeing and Airbus would produce the aircraft without any subsidy,
and so no strategic trade and industrial policy would be needed in the U.S. or
Europe. *Note that even though Airbus only breaks even, in economics we
include a normal return on investment as part of costs. Thus, Airbus would
remain in business because it would earn a normal return on investment.
c) If the entries in the top left-hand corner of Table 9-5 were changed to +5, -10,
then both Boeing produces and Airbus does not produce without any subsidy.
With a subsidy of at least
$10 million per year, however, Airbus would enter the market and lead to a loss
of $100 million for Boeing unless the U.S. government would provide a subsidy
of at least $5 million per year to Boeing.

14.Suppose that from the free trade production point B, the nation of Figure
8.5 wants to produce 65X (point F). Indicate:
(a)How the nation could do this with a tariff or with a subsidy.
(b)Why the subsidy would be better.
a) The nation can achieve that either by imposing a 100% import tariff on
commodity X or giving a 100% subsidy to domestic producers of commodity X.
With a 100% tariff on imports of commodity X, Px/Py=2, thus production takes
place at point F (as required).
With a 100% subsidy to domestic producers of commodity X, The price remains
Px/Py=1 and the nation reaches indifference curve II’’, producing 65X at point
F (as required).
b)Between a tariff and a subsidy that gives the same amount of domestic
production, a subsidy is better because it does not change the prices that
consumers pay, unlike a tariff.
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1dD

120

85

55

40

0 40 65 80 95 100

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