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Global Economy Test 2
Global Econ gTest 2
Undergraduate 3

Additional Economics Flashcards





·         a country’s wealth is measured by its holdings of “treasure,” which usually means its gold.

o   Countries should export more than they import

o   Interventionist theory

o   Governmental intervention

§  Governments imposed restrictions on most imports


·         a country that practices neomercantilism attempts to run an export surplus to achieve a social or political objective

o   the approach of countries that try to run favorable balances of trade in an attempt to achieve some social or political objective

Absolute Advantage

·         different countries produce some goods more efficiently than other countries; thus global efficiency can increase through free trade

o   Started by Adam Smith

§  Questioned why the citizens of any country should have to buy domestically produced goods when they could buy those goods more cheaply from abroad

o   Started the specialization with countries

o   Ability of a party to produce a particular good at a lower absolute cost than another

o   Can either be natural or acquired

§  Natural: considers climate, natural resources, and labor force availability

§  Acquired: consists of either product or process technology

·         Enables a country to produce a unique product or one that is easily distinguished from those of competitors

o   Each country should specialize in the production and export of that good which it produces most efficiently, that is with the fewest labor-hours

Comparative Advantage

·         global efficiency gains may still result from trade if a country specializes in those products it can produce more efficiently than other products—regardless of whether other countries can produce those same products even more efficiently

o   Stated by David Ricardo

o   Answers the question: “What happens when one country can produce all products at an absolute advantage?”

o   Can produce a particular good or service at a lower marginal cost and opportunity cost than another party

o   Even if one country was most efficient in the production of two products, it must be relatively more efficient in the production of one good

§  it should then specialize in the production and export of that good in exchange for the importation of the other good

Theory of Factor Proportions

·         factors in relative abundance are cheaper than factors in relative scarcity

o   Started by Eli Heckscher and Beril Ohlin

o   Based on countries’ production factors—land, labor, and capital

o   A country that is relatively labor abundant (capital abundant) should specialize in the production and export of that product which is relatively labor intensive (capital intensive)

o   Said that differences in countries’ endowments of labor compared to their endowments of land or capital explain differences in the cost of production factors

o   If labor were scarce, labor costs would be high in relation to land and capital costs and vice versa

o   Relative factor costs would lead countries to excel in the production and export of products that used their abundant and cheaper production factors

o   Each country exports that good which it produces relatively better than the other country and imports what it does not

The Leontief Paradox

·         the country with the world’s highest capital-labor ratio has a lower capital- labor ratio in exports than in imports

o   Founded by Wassily Leontief

§  Devised this contradiction of the Theory of Factor Proportions

§  Discovered that despite the US being endowed with an abundance of capital, its exports were labor intensive and imports capital intensive

o   Trade is determined by the relative abundance of factors of production in each economy

Overlapping Product Range

·         the type, complexity, and diversity of product demands of a country increase as the country’s income increases

o   Founded by Staffan Burenstam Linder

o   International trade patterns would follow this principle

§  So that countries of similar income per capita will trade most intensively having overlapping product demands

o   Produce at home, then export them to similar income level countries

o   Similarity of demands influence global trade in manufactured goods

Product Cycle Theory

·         the production location for many products moves from one country to another depending on the stage in the product’s life cycle

o   Founded by Raymond Vernon

o   The location of production of certain kinds of product shifts as they go through their life cycles

§  Introduction, growth, maturity, and decline

o   The country that possesses comparative advantage in the production and export of an individual product changes over time as the technology of the product’s manufacture matures

o   Focus on product not nation

o   Requires large amount of capital and highly skilled labor

o   Located primarily in highly industrialized nations

Imperfect Markets and Trade Theory

·         theories that explain changing trade patterns, including intra-industry trade, based on the imperfection of both factor markets and product markets

o   Founded by Paul Krugman

o   uses market structure and economies of scale (oligopoly, monopoly)

o   internal and external scale of economies

§  internal: larger firms, can monopolize industry, set the market prices, sell more products

§  external: a lot of small firms

Competitive Advantage of Nations

·          a nation’s competitiveness depends on the capacity of its industry to innovate and upgrade

o   Founded by Michael Porter

o   Companies gain competitive advantage because of pressure and challenge

o   Companies benefit from having strong domestic rivals, aggressive home-based suppliers, and demanding local customers

o   The dimensions of competitiveness were categorized into four determinants or “the diamond of national advantage”

§  Firm strategy, structure and rivalry

§  Demand conditions

§  Related and supporting industries

§  Factor conditions

 Identify the tools of protection/trade policy instruments


export subsidy

import quota

voluntary export restraint


·         a tax levied when a good is imported

o   Specific tariffs: levied as a fixed charge for each unit of goods imported

o   Ad valorem tariffs: taxes that are levied as a fraction of the value of the imported goods

o   The effect of the tariff is to raise the cost of shipping goods to a country

o   The oldest form of trade policy and have traditionally been used as a source of government income

o   Because a tariff raises the price they receive; the domestic consumers lose, for the same reason

Export Subsidy

·         payments made by the government to encourage the export of specified products

o   a payment to a firm or individual that ships a good abroad

o   can be levied on a specific or ad valorem basis

o   most commonly found in agricultural and dairy products

o   when the government offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy

Import Quota

·         limitations on the quantity of goods that can be imported into the country during a specified period of time.

o   Binding quota: typically set below the free trade level of imports

o   Non-binding quota: a quota at or above the free trade level of imports

o   The restriction is usually enforced by issuing licenses to some group of individuals or firms

o   An import quota always raises the domestic price of the imported good

o   An import quota will raise domestic prices by the same amount as a tariff that limits imports to the same level

Voluntary Export Restraint

·         a restriction set by a government on the quantity of goods that can be exported out of a country during a specified period of time.

o   A VER is a quota on trade imposed from the exporting country’s side instead of the importer’s

o   Are generally imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions

o   Always more costly to the importing country than a tariff that limits imports by the same amount

o   VERs are much more costly than tariffs

What is the case for free trade? 
Increases efficiency, increases economies of scale (protects weak firms), increases opportunities for learning and innovation, specialization, higher global output
What is the political argument for free trade?
Nation will not be better off, the producers will be better off
Describe the national welfare arguments against free trade
Large nations benefit more than small ones
What is the "theory of second best"?
 If you can’t solve a problem at the root then go for the second; trade barriers

What is meant by levers, ratchets and binding agreements relative to trade?


·         One way to think about the GATT-WTO approach to trade is to use a mechanical analogy:

o   A device designed to push a heavy object, the world economy, gradually up a slope—the path to free trade

o   Levers- what pushes the object in the right direction

o   Ratchets- to prevent backsliding

o   Binding- the principle ratchet in the system

§  When a tariff rate is “bound,” the country imposing the tariff agrees not to raise the rate in the future

§  At present, almost all tariff rates in developed countries are bound, as are about three-quarters of the rates in developing countries

What is the WTO and its structure and purpose and its impact upon global businesses?  What are some of the new issues facing the WTO?

·         Started in 1995 and replaced the GATT

·         Has been accused of acting as a sort of world government, undermining national sovereignty

·         A full-fledged international organization

·         Main purpose is to serve as the basis for negotiating future trade rounds

·         With trade appeals, it isn’t suppose to take more than 15 months

Explain the theory of country size and the country similarity theory

Country size: large countries usually depend less on trade than small countries

·         Countries with large land areas are apt to have varied climates and an assortment of natural resources, making them more self-sufficient than smaller countries


Country similarity theory: once a company has developed a new product in response to observed market conditions in its home market, it turns to markets it sees as most similar to those at home


How does trade affect the distribution of income and factor prices?


·         Because of the tariffs.

o   The country who is exporting gains revenue and the country who is importing is loosing.

·         Because of import quotas

o   Raises the domestic price of an imported good

What are the major issues involving government trade policy? Why might they fail?

·         With mercantilism, the country would lack some goods that they might need to be an efficient country

o   Could have a surplus

·         With the unfavorable balance of trade, it could cause a trade deficit


What is the "specificity rule" and how does this apply to answering the question: Is trade policy the best option for achieving macroeconomic goals?


·         The principle that the optimal policy for correcting a distortion is one that deals most directly, or specifically, with that distortions

·         States that it is more efficient to use those policy tools that are closest to the sources of the distortions separating private and social benefits or costs

·         It would answer by going to the specific macroeconomic goals and how they influence the trade policy

·         To answer with tariffs is indirect and not the best policy

Treaty of Rome


·         Two treaties were signed in Rome to give birth to the European Economic Community (EEC) and the European Atomic Energy Community (Euratom)

o   EEC: goal was the rebuild their destroyed economies and to prevent the destruction from happening again

o   Euratom: goal was to create a single, integrated market for goods, services, labor, and capital

§  The latter sought jointly to develop nuclear energy for peaceful purposes


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