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Mid Answer - < Answer Keys for Mid-term Exam > E 101:...

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< Answer Keys for Mid-term Exam > E 101: International Trade (Professor: Young-Han Kim) Exam Date: August 19, 2008 1. What is the relationship between the recent information technology (IT) revolution and the volume of world trade? (Explain the relationship using Gravity model.) (10 points) O The relationship between the recent information technology revolution and the volume of world trade can be explained through Gravity model as follows. o The recent trends of international trade can be characterized by the fact that the majority of trade is between larger economies located closely. And this trends can be characterized by Gravity model, ij j i ij D Y AY T = , which shows that the trade volume increases when the economic size of trading countries is bigger, and the distance (transaction costs) between trading countries are lower . o Globalization is the second feature characterizing recent trends of international trade. Globalization is characterized by i) sharp reduction of physical transaction costs by information and communication technology revolution , and ii) rapid reduction of legal and institutional transaction cost (as tariff and non-tariff trade barriers.). As a result of globalization, the physical and legal distance between trading country is sharply decreased, and this results in more rapid increase of the trade volume. IT revolution sharply decreases the physical distance ( D ij ), which is the denominator in the Gravity model, and as a result, the trading volume is increased dramatically due to the reduction in transaction costs. 1
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2 2. Consider a Ricardian world where there are only two countries, Home and Foreign country, and two commodities, Color HD TV and Automobile, and one mobile factor, labor. In addition, units of labor requirement for the production of each unit of commodity are given as in the following table. Unit of labor requirement Color TV Automobile Foreign Country a LC * = 3 a LA * = 9 Home Country a LC = 2 a LA = 2 i) Which country has the comparative advantage in the production of Color TV and Automobile? (Explain why.) (7points) o A country which has a lower opportunity cost to produce C-TV has the comparative advantage in the production of C-TV. Foreign country’s opportunity cost of producing C-TV is lower than the Home country opportunity cost to produce C-TV: ( a LC */ a LA * =3/9) < ( a LC / a LA =2/2 =1.) - Therefore, the Foreign country has the comparative advantage in producing commodity C-TV, and Home country has comparative advantage in the production of Automobile: ( a LA / a LC = 2/2=1) < ( a LA */ a LC * =9/3=3). ii) Assume that the initial endowment of economic resources (labor endowments) of Home country 12 units of labor, while Foreign country is endowed with 36 units of labor. In case both countries specialize in the sector of comparative advantage, and participate in free trade according to an international price, (P A /P C ) I =2, i.e., one unit of automobile is exchanged with 2 units of C-TVs in world markets, what is the level of gains from trade to Foreign country
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Mid Answer - &lt; Answer Keys for Mid-term Exam &gt; E 101:...

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