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1. Chapter 16 THE UNITED STATES AND THE GLOBAL ECONOMY

1. The U.S. economy has become increasingly integrated into the world economy in recent decades. Such integration involves a number of dimensions, including the trade of goods and services, financial markets, the labor force, ownership of production facilities, and dependence on imported materials. 2. Specialization and trade pertain to individuals, but also to groups of individuals and nations. By increasing productivity, specialization can result in a more efficient use of resources and an increase in output. However, the very nature of specialization can limit its benefits because repetitive jobs can result in bored and unproductive workers. 3. Proponents of free trade contend that if each country produces what it does best and allows trade, over the long run all will enjoy lower costs and prices and also higher levels of output, income, and consumption than could be achieved in isolation. A free market compels firms and their workers to adjust to forces such as shifts in technologies, input productivities, and tastes and preferences. 4. The principle of comparative advantage underlies patterns of world trade. This principle states that countries should specialize in producing those goods in which they are relatively, not absolutely, more efficient. In other words, comparative advantage is the ability of a country to produce a good at a lower opportunity cost than some other country. Among the sources of comparative advantage are natural endowments of resources, a skilled labor force, and superior knowledge. 5. Although economies can benefit from specialization and free trade, some people object to free trade. This is because some groups in the economy lose from free trade, while others gain. Consumers and those firms and their workers who produce goods in which the home country has a comparative advantage gain from free trade. However, firms and their workers in import-competing industries suffer. Government officials must thus consider the opposing interests of these groups when setting the course for international trade policy. 6. To protect firms and their workers from foreign competition, governments can impose tariffs and quotas. These devices, however, tend to foster the growth of inefficient industries that do not have a comparative advantage and promote the decline of efficient industries which do have a comparative advantage, thus reducing the standard of living for the nation. 7. Among the arguments for trade restrictions are job protection, protection against cheap foreign labor, fairness in trade, infant industry, national security, and preservation of culture. 8. Since the 1940s, advanced nations have significantly lowered their trade barriers. Such trade liberalization has stemmed from the World Trade Organization and regional trading arrangements such as the North American Free Trade Agreement. Chapter Objectives After reading this chapter, you should be able to: 1. Describe the United States as an open economy. 2. Discuss the advantages of specialization and trade. 3. Explain why free trade is controversial. 4. Discuss the effects of tariffs and quotas. 1 2 Chapter 16: The United States and the Global Economy

5. Evaluate the arguments for trade restrictions. 6. Assess the advantages and disadvantages of the North American Free Trade Agreement.

Key Concept Quiz 1. absolute advantage _____ a. the ability of a country to produce a good at a lower opportunity cost 2. comparative advantage _____ b. physical restriction on the quantity of goods 3. tariff traded 4. quota _____ c. a tax imposed on imports 5. unit labor cost _____ d. the possession of superior production skills 6. level playing field _____ e. the contention that free trade can jeopardize 7. infant industry argument national security 8. national security _____ f. an argument that does not deny the validity of the argument case for free trade 9. World Trade _____ g. an argument favored by domestic producers who Organization want to compete on equal terms 10. North American Free _____ h. consists of members who acknowledge the need Trade Agreement for tariff reductions _____ i. a regional trading arrangement _____ j. reflects not only the wage rate but also the productivity of labor Chapter 16: The United States and the Global Economy 3

Multiple Choice Questions

2. Specialization creates opportunities for 3. division of labor 4. erecting tariff barriers 5. imposing restrictive quotas 6. increasing self-sufficiency

7. All of the following are advantages of specialization except a. it allows the trading partners to consume more b. it enables the trading partners to produce more c. it enables a better resource allocation d. it improves the efficiency of protective tariffs

8. If a country enjoys comparative advantage, it implies that the country can produce a. one or a few goods at a lower opportunity cost b. all goods at a lower opportunity cost c. nothing at all, at a lower opportunity cost d. and sell goods at lower cost and prices

9. If Germany enjoys an absolute advantage over Italy in production of goods and services, a. everything should be produced in Germany b. Germany will inevitably change higher prices for its, and hence Italy will produce a few goods c. no reason for trade exists d. Germany should only produce goods in which it has comparative advantage

10. All of the following may be sources of comparative advantage except a. superior knowledge b. better endowment of natural resources c. a non-unionized labor force d. saving and capital accumulation

11. Tariffs a. benefit workers in specific industries at the expense of consumers b. hurt foreign exporters c. raise revenues for the government d. all of the above

12. U.S. exporters a. can be indirectly impeded by a tariff b. always benefit from a tariff c. is protected from the effects of a tariff d. tend to ignore its effects since tariffs are imposed on foreign markets 4 Chapter 16: The United States and the Global Economy

13. Quotas a. are used to restrict trade b. increases domestic prices c. does not raise revenue for he government d. all of the above

14. All of the following are arguments for trade restrictions except a. job protection argument b. mature industry argument c. national security argument d. preservation of culture argument

15. The fairness in trade argument is usually presented by a. organized lobbies that are losing sales to foreign competitors b. does not recognize how retaliatory trade barriers reduce domestic welfare c. fails to recognize the impact on global trade d. all of the above

16. An example of a regional trading arrangement is the a. World Trade Organization b. Organization for Economic Cooperation and Development c. North American Free Trade Agreement d. General Agreement on Tariffs and Trade

17. Typically, regional trading arrangements provide for a. reductions in trade restrictions among two countries b. reductions in trade restrictions among a group of countries c. increases in trade restrictions among two countries d. increases in trade restrictions among a group of countries

18. Import quotas tend to result in all of the following except a. companies in the import-competing industry are harmed b. consumers of the imported good are harmed c. prices increase in the import-competing industry d. workers in the import-competing industry are helped

19. With free trade based on the principle of comparative advantage, a nation can usually consume at a point a. outside of its production possibilities schedule b. along its production possibilities schedule c. inside of its production possibilities schedule d. where the production possibilities schedule intersects the axes

20. The formation of the North American Free Trade Agreement makes it more difficult for a. Germans to compete in the Canadian economy b. Canadians to compete in the Mexican economy c. Mexicans to compete in the German economy d. Canadians to compete in the United States economy Chapter 16: The United States and the Global Economy 5

21. Major determinants of comparative advantage include all of the following except a. education and training of workers b. technological breakthroughs c. climate d. all of the above are determinants

22. International trade in goods and services tends to a. increase jobs and profits in import-competing industries b. increase the amount of competition facing home manufacturers c. increase all domestic costs and prices d. reduce the level of national income

23. Increased international trade is promoted by a. higher tariffs and quotas b. reduced transportation costs c. government subsidies to import-competing producers d. productivity decreases in exporting industries

24. Which institution promotes trade liberalization for more than 140 countries throughout the globe? a. World Trade Organization b. European Community c. North American Free Trade Area d. Central American Common Market

25. Trade between two nations would not be gainful if they had a. identical demand conditions b. identical supply conditions c. identical demand conditions and identical supply conditions d. neither identical demand conditions nor identical supply conditions

26. If the U.S. government imposed a lower tariff on Japanese steel, it would most directly benefit a. the United Steel Workers of American b. U.S. Steel Corporation c. Ford Motor Company d. The Japanese government

True-False Questions 1. T F Advanced nations began lowering trade barriers in the early 1930s. 2. T F The North American Free Trade Agreement is an example of a regional trading arrangement. 3. T F Today, economists generally believe that the principle of absolute advantage underlies patterns of world trade. 6 Chapter 16: The United States and the Global Economy

4. T F Absolute advantage allows for specialization. 5. T F Specialization can enhance productivity and thus improve resource allocation. 6. T F The U.S. economy has become increasingly dependent on imported goods. 7. T F If the U.S. economy based its trade on the principle of comparative advantage it would not be dependent on imported goods. 8. T F Lower opportunity cost of production is the basis of comparative advantage. 9. T F A skilled labor force may constitute the source of comparative advantage. 10. T F There are always some groups in an economy who may not benefit from free trade. 11. T F Proponents of free trade argue that over the long run all will enjoy lower costs and prices. 12. T F Tariffs decrease government revenues. 13. T F Quotas always raise revenues for the government. 14. T F Quotas tend to increase domestic prices. 15. T F Tariffs help all domestic producers, and especially companies exporting to foreign countries. 16. T F Tariffs and quotas promote industries that have comparative advantage. 17. T F Tariffs and quotas inhibit efficient resource allocation. 18. T F Consumers are generally hurt by tariffs and quotas. 19. T F Since production always shifts to regions where labor is cheap, U.S. industries need to be protected. 20. T F The infant industry argument for tariffs is especially valid for nations such as Japan, U.S. and Germany. 21. T F Although import tariffs provide welfare gains for domestic consumers, they result in losses for producers of importcompeting goods. 22. T F Most of the tax revenue of the U.S. government comes from revenue collected from duties on imported goods. 23. T F If wages are lower for textile workers in Malaysia than the United States, then the United States necessarily will have a comparative disadvantage in textiles. 24. T F The infant industry argument contends that developing countries are justified in using tariffs to temporarily shield their newly developing industries from foreign competition. Chapter 16: The United States and the Global Economy 7

25. T F The most vocal political pressure for import tariffs is usually made by domestic consumers. 26. T F An import tariff on steel tends to improve the competitiveness of domestic producers of tractors and earthmoving equipment. 27. T F When the North American Free Trade Area went into effect in 1995, the ability of Mexican farmers to export to the United States improved relative to European farmers. 28. T F The WTO is essentially a regional trading agreement among nations in North America and South America. 29. T F Critics of NAFTA maintain that relatively low labor standards and environmental regulations in Mexico have encouraged U.S. firms to move assembly plants to Mexico. 30. T F Non-economic arguments for tariffs include the national security argument and the preservation of domestic culture against outside influences.

Application Questions

1. Suppose that in one hour Japanese workers can produce 180 microchips or 220 bushels of rice and that in one hour South Korean workers can produce 160 microchips or 120 bushels of rice.

a. What is the opportunity cost of a microchip in Japan? In South Korea? Which country would specialize in microchip production?

b. Which groups win and which groups lose in each country as a result of specialization and trade?

c. Which principle of trade are you using to arrive at your answers for the questions above? 8 Chapter 16: The United States and the Global Economy

27. The following data describes the demand and supply schedules for the mango market in the Unites States:

Quantit Quantit Price y y ($/lb.) Deman Supplie ded d (lbs.) (lbs.)

0 1 0 . 0 0 0 0

0 8 2 . 0 0 2 0

0 6 4 . 0 0 4 0

0 4 6 . 0 0 6 0

0 2 8 . 0 0 8 0

1 0 1 . 0 0 0 0

a. Graph the demand and supply curves of mangoes.

b. Concerning mangoes, what are the equilibrum and the quantity produced and consumed in the U.S. when the U.S. operates as a closed economy without trade?

28. Let’s suppose that the U.S. decides to open its mango market to Mexican exporters who are willing to supply any quantity of mangoes at $0.20 per pound.

a. Draw the Mexican supply curve in the U.S. market for mangoes. Chapter 16: The United States and the Global Economy 9

b. At the free-trade price, how many mangoes will U.S. producers supply?

c. At the free-trade price, how many mangoes will Mexican producers supply?

d. At the free-trade price, how many mangoes will U.S. consumers purchase?

29. Now suppose the United States imposes a 100 percent tariff on Mexican mangoes. Mexico, however, is still willing to supply any quantity of mangoes to the U.S. market at this new price.

a. Draw the new supply curve for Mexican mangoes on the U.S. mango market.

b. What is the new price of mangoes in the U.S.?

c. How many mangoes will U.S. producers supply?

d. How many mangoes will U.S. consumers purchase?

e. How much revenue will the tariff generate?

f. Who loses and who gains from this protective measure? 10 Chapter 16: The United States and the Global Economy

Key Concept Answers 1. d 6. g 2. a 7. f 3. c 8. e 4. b 9. h 5. j 10. i

Multiple Choice Answers 1. a 6. d 11. c 16. d 21. c 2. d 7. a 12. b 17. b 3. a 8. d 13. a 18. b 4. d 9. b 14. a 19. a 5. c 10. d 15. a 20. c

True-False Answers 1. F 6. T 11. T 16. F 21. F 26. F 2. T 7. F 12. F 17. T 22. F 27. T 3. F 8. T 13. F 18. T 23. F 28. F 4. F 9. T 14. F 19. F 24. T 29. T 5. T 10. T 15. F 20. F 25. F 30. T

Application Question Answers 1. a. The opportunity cost of a microchip in Japan is 11/9 bushels of rice. The opportunity cost of a microchip in South Korea is ¾ bushel of rice. Japan should specialize in rice production, and South Korea should specialize in microchip production. b. In Japan, rice farmers gain an immediate advantage as a result of trade, while microchip producers are hurt. In South Korea, rice farmers lose; microchip producers gain. c. The principle of comparative advantage should be used to arrive at this answer.

2. a. The diagram below shows the demand and supply curves of mangoes.

b. Equilibrium price is $0.50 per pound. Fifty pounds are bought and sold.

3. a. The diagram below shows the Mexican supply curve in the U.S. market for mangoes.

b. U.S. producers supply 20 pounds of mangoes. c. Mexican exporters supply 60 pounds of mangoes. Chapter 16: The United States and the Global Economy 11

d. U.S. consumers purchase 80 pounds of mangoes.

4. a. The diagram below shows the new supply curve for Mexican mangoes in the U.S. mango market.

b. The new price is $0.40 per pound. c. U.S. producers supply 40 pounds of mangoes. d. U.S. consumers purchase 60 pounds of mangoes. e. Tariff revenues are calculated as follows: Tariff Revenues = Tax x Imported Quantity = $0.20 x 20 = $4.00 f. U.S. mango producers and workers in this industry gain; so does the U.S. government. Mango producers and workers lose, as do U.S. consumers.