Economics Midterm 2
Chapter 8: International Trade
Why did the United States put a tax on the European Union for luxury goods?
- The US didn’t want to hurt US consumers, but they wanted to tax European producers
Imports – goods purchased from other countries
Exports – goods produced domestically and sold to other countries
Globalization – phenomenon of growing economic linkages among countries
Ricardian Model of International Trade – analyzes international trade under the assumption that
opportunity costs are constant
Autarky – a condition when a country is not involved in any trade
Countries will specialize in commodities in which they have the lowest opportunity cost
- Ricardian model shows that trade makes both countries better off than they would be in
ComparativeAdvantage – if the opportunity cost of producing the good or service is lower for
one country than it is for other countries, that country has the comparative advantage. Gains
from trade are dependent on comparative advantage
Trade liberates countries from self-sufficiency and makes more efficient markets.
Relative prices – prices of one good in terms of another in international markets (no country
must pay a price greater than its opportunity cost of obtaining the good in autarky)
Pauper Labor Fallacy – when a country with high wages imports goods produced by workers
who are paid low wages
Sweatshop labor fallacy – trade must be bad for workers in poor exporting countries because
they are paid very low wages by our standards
*It is to the advantage of both countries if the poorer, lower-wage country exports goods in
which it has a comparative advantage 3 sources of comparative advantage:
1. Differences in climate – tropical countries export tropical products, and some trade is
driven by different seasons in countries
2. Differences in Factor Endowments – factors of production due to differences in history
3. Differences in technology – knowledge gained through experience
Hecksher-Ohlin Model – shows relationship between comparative advantage and factor
availability in a country
- Factor Abundance: how large a country’s supply of a factor is relative to its supply of
- Factor intensity: producers use different ratios of factors of production in the production
of different goods (some used more than others)
Acountry that has an abundant supply of a factor of production will have a comparative
advantage in goods whose production is intensive in that factor.
Domestic demand curve –
Chapter 11: Inputs and Costs
Firms produce goods and services for sale.
Production function – the quantity of output depends on the quantity of input
Fixed input – the quantity of this is fixed and cannot be varied (within a specific time period)
Variable input – quantity can be varied any time
In the long run, firms can adjust the quantity of any input, but in the short run, one input must be
Total product curve – a curve that shows how the quantity of output depends on the quantity of
the variable input (slope is not constant)
Marginal product of labor – the additional quantity of output generated from using one more unit
Marginal product – the additional quantity of output produced by using one more unit of an input
Marginal Product = Chane∈Quantityof Input - The slope of the total product curve is equal to the marginal product of labor
There are diminishing returns to an input when an increase in the quantity of input reduces that
input’s marginal product.
Fixed cost – a cost that doesn’t depend on the quantity of output produced (in short run)
Variable cost – depends on the quantity of output
Total cost = Fixed Cost + Variable Cost
Marginal Cost = Change∈Quantityof Output
Marginal cost graphs DON’T start at the origin.
As quantity goes up, marginal cost goes up and marginal benefit goes down.
Objective of a firm: maximize total net benefit
Net Benefit = Total Benefit – Cost
To find the maximum net benefit, find where marginal cost and marginal benefit are equal.
MarginalUtilityof A MarginalUtilityof B
Optimal Consumption Rule: Priceof A = Priceof B
The total product curve is increasing in a decreasing manner, and the slope is not constant
because it flattens over time. (Each worker will generate less than the last worker – “too many
cooks in the same kitchen” will push marginal utility downwards)
You have to pay each worker the same, so even though their productivity is decreasing your cost
The total cost curve is increasing in and increasing manner (gets steeper with more output)
The marginal cost curve is also upward sloping because there are diminishing returns to inputs
Average Cost = Quantityof Output (Gives a U-shaped total cost curve) ¿Cost
Average Fixed Cost = Quantityof Output Average Variable Cost =
Increasing output has two effects:
Spreading Effect: the larger output, the greater the quantity of output over with fixed cost is
Diminishing Returns Effect: larger output, greater amount of variable input required to produce
additional units (higherAVC)
These effects are opposing against each other, and the diminishing returns effect
dominates the spreading effect
The bottom of theAverage Total Cost curve is the level of output at which the marginal cost
curve crosses theATC curve from below.
- This is the minimum cost output
- When MC =ATC, this is the minimum average cost
- At this point, ATC is neither rising nor falling
The marginal cost curve begins increasing due to specialization, but eventually decreases.
- It slopes downwards initially because a firm with few workers can’t reap the benefits of
specialization of labor
- Increasing specialization leads to lower marginal cost initially, but once specialization
benefits are exhausted marginal cost increases
*All inputs are variable in the long run (the firm chooses its fixed cost in the LR based on the
level of output it expects to produce)!!!
- There is a trade-off between higher fixed cost and lower variable cost for any given output level Long RunATC Curve – when fixed cost has been chosen to minimizeATC for each level of
The short runATC curve touches the long runATC curve at whichever quantity you’re producing
Returns to scale – if you increase the scale of production, cost will go down
Chapter 12 – Perfect Competition
Price-Taking Producer – their actions have no effect on the market price of the good they sell
Price-taking consumer – have no effect on market price of the good they buy
In a perfectly competitive market, all market participants are price takers.
- In perfectly competitive industry, producers are price takers
To be a perfectly competitive industry:
1. There must be many producers who don’t have too large of a market share
2. Consumers must regard the products of all producers as equivalent (standardized product)
3. Free entry and exit into the market
Free Entry/Exit – when new producers can easily enter or exit an industry (adjusting to changing