1. “For a small country like the Philippines, a move to free trade would have huge advantages.
let consumers and producers make their choices based on the real costs of goods, not on artificial
prices determined by government policy; it would allow escape from the confines of a narrow domestic
market; it would open new horizons for entrepreneurship; and, most important, it would help to clean
up domestic politics.”
Separate out and identify the arguments for free trade in this statement.
In the order in which they are presented, the arguments are:
1) Free trade permits households and firms to condition their economic behavior on
marginal costs and benefits, undistorted by government policy.
2) Resource constraints mean that, through trade, consumers will have access to a
broader range of commodities than would be possible under autarky; in addition, if
there are economies of scale, trade permits a more rational division of labor.
3) “New horizons for entrepreneurship” also implies some form of economy of scale, in
this case in terms of the application of entrepreneurial effort.
4) Many forms of trade policy generate rents that may be captured by political effort
(e.g. access to import licenses or foreign exchange).
Eliminating the policies that
generate these rents eliminates the incentive to engage in such rent-seeking behavior.
2. Which of the following are potentially valid arguments for tariffs or export subsidies, and which are
not (explain your answers)?
a. “The more oil in the US imports, the higher the price of oil will go in the next world
This is a potentially valid argument based on a (somewhat peculiar) mix of the optimal tariff and
insurance arguments for protection.
The optimal tariff argument suggests that, since the US is
large in the market for oil, restricting current consumption will hold down the price so that future
price increases occur from a lower base.
The core of this statement, however, seems to be an
insurance argument which is unrelated to market power: protection will raise the price of oil to
domestic producers, increasing production and exploration, and ensuring a domestic supply in
However, in general, one would expect the argument to go the other way: if we are
worried about future disruptions, we should consume as much low priced current oil as possible
to ensure that we don’t use up all the readily available domestic oil.
b. “The growing exports of off-season fruit from Chile, which now accounts for 80 percent of
the U.S. supply of such produce as winter grapes, are contributing to sharply falling prices of
these former luxury goods.”