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Global Test 2
Mercantilism
• Advocates that countries should simultaneously encourage exports and discourage imports
Adam Smith
• Theory of absolute advantage• Explained why unrestricted free trade is
beneficial to a country• Wealth of Nations• 1776
Free Trade
• Where government doesn’t attempt to influence through quotas or duties what its citizens can buy from another country, or sell to another country
David Ricardo
• Theory of comparative advantage
New Trade Theory
• In some cases countries specialize in the production and export of particular products because certain industries can only support a limited number of firms
0-sum game
• Situation in which an economic gain by one country results in an economic loss by another
• Mercantilism assumed this was the case.• You sell more than you buy, your country gains
and another country gets poorer. Doesn’t work like that in reality
Positive – sum game
• Situation where all countries can benefit
Absolute Advantage
• When one country is more efficient at producing something than any other country
Comparative Advantage
• A can either produce 20 cocoa or 15 rice, while B can produce 5 cocoa or 7 rice.
• B has the comparative advantage for rice• It is a measure of productivity
Samuelson Critique
• 20% cheaper groceries doesn’t necessarily make up for wage losses in America
Heckscher-Ohlin theory
• Comparative advantage arises from differences in national factor endowments, not productivity
• Factor Endowments – extend to which a country is endowed with resources like land, labor, and capital
Leontief Paradox
• Goes against the H-O theory• The U.S. is very high in capital, so according to
the H-O theory their exports should be very capital intensive and imports more labor intensive
• Yet in reality, U.S. imports are more capital intensive than its exports
Product Life Cycle Theory
• United states starts as exporter of new product because initial demand is not based on price
• Later more people produce it, demand based on price, production begins in countries that can do it cheaper
• United states imports it from cheaper countries
Economies of Scale
• Cost advantage associated with large-scale production
• Spreading fixed costs by producing a ton of units
First-Mover Advantages
• Economic and strategic advantages that accrue to early entrants into an industry
Porters Diamond
• Said 4 factors determined comparative advantage• Factor endowments – resources• Demand Conditions – nature of home demand• Relating and Supporting industries – related
industries. Stuff tends to be clustered• Firm strategy, structure, and rivalry – how
companies are managed, organized, etc. Local competition makes for better advantage globally
Tariff
• Tax on imports
Specific tariff
• Tariff levied as a fixed charge for each unit of good imported
Ad Valorem Tariff
• Levied as a proportion of the value of an imported good
Subsidies
• Government payment to a domestic producer
Import Quota
• Direct restriction on the number of a good that may be imported into a country
Tariff Rate Quota
• Applying a lower tariff rate to imports within the quota
Voluntary Export Restraint
• Quota imposed by the exporting country
Local Content Requirements
• A requirement that some specific fraction of a good be produced domestically
Administrative Policies
• Rules designed to make it difficult for imports to enter a country
• Example: japan required searching of packages for pornography, making quick deliveries impossible
Antidumping Policies
• Dumping – selling goods in a foreign market at below their costs of production, or below fair market value
• Antidumping Policies – designed to punish foreign firms that engage in dumping and protect domestic producers from unfair foreign competition
Infant Industry Argument
• New industries should be temporarily protected from foreign competition, until they can hold their own in the global marketplace
Strategic Trade Policy
• Government should use subsidies to support promising firms that are active in newly emerging industries, to help them get first mover advantage
• Second, when they are not the first, is to help them overcome the first-mover advantages of foreign countries
GATT
• Established 1947• Objective – liberalize trade by eliminating
tariffs, subsidies, import quotas, etc
Uruguay Round
• Tariffs reduced• Agricultural subsidies reduced• Protection for intellectual property• WTO created
WTO
• Polices the GATT agreement
Flow of FDI
• Amount of FDI undertaken over a given time period
Stock of FDI
• Total accumulated value of foreign-owned assets at a given time
Outflows of FDI
• Flow of FDI out of a country
Inflows of FDI
• Flows of FDI into a country
United states big part of FDI
• It had a large economy during the post-war period and many large enterprises
Oligopolies
• Firms tend to imitate each other’s FDIs
Product Life Cycle
• At some point, businesses will use FDI for their products when there is demand in other countries
Free Market View of FDI
• FDI benefits both source country and host country
Radical View of FDI
• Source country exploits host country for profits
Pragmatic Nationalism
• FDI benefits host countries, but it comes at a cost
Location-specific advantages
• Advantages that arise from utilizing resources that are tied to a particular foreign location
Benefits of FDI to host country
• Resource transfer – they get stuff they may not normally get (like technology)
• Employment – gives jobs to host country• Balance of payments – gives country more
exports and less imports• Increases global competition, reducing prices
Costs to host country
• Competitors to domestic companies• Balance of accounts – hurts it if they import
most of their parts, rather than buy them in the nation
• Fear of losing economic independence
Home Country Benefits
• Creates demand for home country exports• Profits for companies• Multinationals learn skills from their foreign
companies that can be used at home
Home country costs
• Reduced home country employment
FDI types
• Greenfield Investment – new facility• Acquisition or merger with existing local firm
Gross Fixed Capital Formation
• Summarizes the total amount of capital invested in factories, stores, office buildings, and the like
Internalization Theory
• Argument that firms prefer FDI over licensing to retain control over know-how, manufacturing, marketing and strategy
• They wanna do it themselves
Licensing
• Firm licenses right to produce a product to a foreign firm, and collects a royalty for it
Economic Integration
• Agreements among countries in a geographic region to reduce, and ultimately remove, tariffs and barriers to the free flow of goods and services between eachother
European Union EU
• The countries dropped their trade borders to eachother and adopted a single currency for doing business
NAFTA
• North American Free Trade Agreement• Free trade between Canda, USA, and Mexico
Levels of Economic Integration
Free Trade area
• No barriers to trade between countries in agreement
• Individual countries still free to decide how to deal with non-members
• NAFTA• EFTA (european free trade association)
Customs Union
• Group of countries committed to removing all barriers to flow of goods and services
• Pursuit of a common external trade policy
Common Market
• Everything customs union has, but also factors of production can move freely between members
• Labor and capital are free to move
Economic Union
• Same as those before, but requires common currency, harmonization of tax rates, and common monetary and fiscal policy
• EU is an economic union, though imperfect since not all of its countries have adopted the Euro
Political Union
• Where all of the above are true, and government coordinates
• United States is an example
Trade Creation
• Trade created due to regional economic integration, occurs when high-cost domestic producers are replaced by foreign producers
Trade Diversion
• When low-cost foreign suppliers outside a free trade area are replaced by higher-cost foreign suppliers in a free trade area
EU
• Global Superpower due to high GDP• 27 member states
Single European Act
• Committed members to establishing an economic union
• Remove trade barriers• Mutual product standards between countries• Reduce restrictions on transporting between
countries
Euro Benefits
• Simpler between-country transactions• Easier to compare prices across europe• Long term efficiency of countries
Euro costs
• Nations lose control over monetary policy
Joining the EU
• Have to privatize state assets, deregulate markets, restructure industries, and tame inflation
• Enshrine EU laws into their own systems, establish democratic governments, and respect human rights
Optimal Currency Area
• Similarities in the underlying structure of economic activity make it feasible to adopt a single currency
European Council
• Most important EU authority• Represents interests of member states• Draft legislation from Commission can only
become law if the council agrees
European Commission
• Body responsible for proposing EU legislation, implementing it, and monitoring compliance
European Parliament
• Elected EU body that consults on issues proposed by the european commission
Court of Justice
• Supreme appeals court for EU law