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Econ13MidtermPracticeQuestionsAnswers - Economics...

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Economics & International Studies 13 Fall 2010 Practice Questions for Midterm 1. Whereas free trade can in principle make everyone better off, in practice trade restrictions abound throughout the world. State and briefly discuss some of the reasons for the existence of so many trade restrictions. Below are several sets of reasons that help explain the prevalence of trade restrictions. A. Strategic trade policy. Under certain circumstances (for example, when a country is large enough and can influence international prices), it may pay one country to impose restrictions on trade so that it can increase its income and welfare. However, other countries might pursue the same policies so that the overall effect, though possibly worse than free trade for all countries, would be adopted by every country. Such an outcome can be "stable" in the sense that no country could do better by unilaterally removing its trade restrictions. B. National security. The national security argument is based on the following two arguments: i. Security externality of trade. When there are disputes between countries that necessitate arming to better each country's negotiating position or even to prepare for the eventuality of war, the gains from trade can increase the adversary's ability to arm. That, in turn, would necessitate greater levels of defense expenditures and thus lead to an arms race. Taking into account, then, the greater expenditures of arming and the increased chance of war may make countries keep high level of trade restriction with potential adversaries. ii. That overseas sources of goods are vulnerable to disruption in times of international conflict; therefore a country should protect domestic suppliers of crucial goods with the aim to be self-sufficient in those goods. C. To shield workers from foreign competition. To protect workers in industries that would be hurt by trade. If the U.S. reduced tariffs for the textile industry, domestic manufacturers could not compete, they would have to close their factories and lay off workers. In an ideal world, the laid-off workers would take new jobs in other sectors of the economy. In practice, this is difficult. Many workers do not have the skills to work in other sectors, and obtaining these skills takes time. Moreover, the textile industry is heavily concentrated in the Southeastern part of the U.S. Politicians from that region will try and keep tariffs in place to prevent changes in unemployment. The result of protection is less efficient production, higher prices, and lower consumption D. To nurture infant industries. During World War II, the U.S. built hundreds of boats, called Liberty Ships, for the Navy. As more and more of these ships were built, each required fewer hours to complete because workers learned from their experiences, acquiring knowledge during the production process. Economists and engineers call this phenomenon “Learning by Doing.” Tariffs and other protectionist policies are often defended on the grounds that they protect new industries, or infant industries, that are in
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the early stages of learning by doing. After the infant industry grows up, the tariff can be
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