Questions about course content for Econ 340, Fall 2019 Dec 12: In the Fall 2018 practice Final exam, question 16 about Tariff Jumping, is the correct answer supposed to be (a)? The answer key says (b), so I was confused. Ans: Yes, it should have been a. Dec 12: I was wondering if you could aid me in what the purchasing power parity formula is in respects to the Winter and fall terms practice exams?  I figured out the inverse exchange rates and the percentages of price changes from within a certain amount of years. I just can't seem to figure out the last portion.  Ans: Once you've figured out the percentage price changes, then just use these to calculate the percentage depreciation of a currency as its own price change minus the price change of the other country.  That's the formula I presented in class.  If its price change is smaller than the other country's, then the difference is its percent appreciation. Dec 10: As the Acronym Handout only shows PIGS (Portugal, Italy, Greece, Spain) rather than the full BAFFLING PIGS + SCLELMS (accounts for 2002 Euro countries like Belgium and Austria, as well as countries such as Slovakia and Estonia that adopted the Euro post-2002), I was wondering: are we only expected to know PIGS (and PIGS + Ireland) for the exam? If so, in the context of Lecture 17 and the Eurozone, what makes PIGS + Ireland more important than the other countries in the longer acronym above? Ans: The second mention of PIGS (and the first of PIIGS) in that lecture was to identify the countries that broke the limits set in the SGP.  It was that, not BAFFLING PIGS, that got this into the list of acronyms.  It was only the mention with regard to breaking the SGP limits that got into the news, where it has also been used to identify the countries that tended to get into trouble within the eurozone.   The BAFFLING PIGS is just a mnemonic for remembering the Eurozone members that my friend Jay Levin told me and I include in the lecture, but it is not, as far as a know, used by others.  And there certainly is no need to remember SCLELMS. Nov 17: I had a doubt in this study question: 5. Suppose the following facts (not all of which are relevant to the answer): • Yesterday the exchange rate between the British pound and the US dollarwas 2.00 £/$. • The interest rate in the U.S. is 6% per year. • The rate of inflation in the U.K. is 1% per year. • The public expects the exchange rate tomorrow to be 1.92 £/$. • The rate of inflation in the U.S. is 3% per year. • The interest rate in the U.K. is 5% per year. • The U.S. bilateral trade deficit with the U.K. is 2% of U.S. GDP.  Then according to the asset theory of exchange rate determination, the exchange ratetoday should be approximatelya. 1.92 £/$b. 1.96 £/$c. 1.98 £/$d. 2.00 £/$e. 2.02 £/$  Ans: a I thought the answer would be c because the rate of depreciation is the difference in the two countries' rate of inflation, which is 2%. So the new exchange rate would be 2 - 0.02 = 1.98. Can you explain how the correct answer is a? Ans: You are using the purchasing power parity theory of the exchange rate, which is valid, if ever, only over a long time period.  this is about the exchange rate the next day.  And in any case, the question asks you to use the asset theory, not the PPP theory.  The asset theory say the exchange rate will be what people expect it to be, which is stated as 1.92. Nov 15: I have one more question on the Pegging Powerpoint. On the slide with the graph titled "Effects of US Expansion on China if Renminbi is floating", it says that "Rising renminbi reduces US imports and increases US exports". I am confused on the wording. Does this mean the same thing as Chinese import from the US are increasing and US imports from China are decreasing? Ans: Yes.  It would have been clearer if I had worded it differently:  "Rising renminbi makes China's exports more expensive and therefore reduces US imports from China, and it makes China's imports from the US cheaper and so increases US exports to China." Nov 12: When I am reviewing previous lecture content, I'm confused by two slides in Lecture 12 (attached). On one slide, you said that the borrowing from abroad and selling assets are both negative in Financial account. However, on the other slide, you said borrowing from foreigners and selling assets to foreigners is surplus. I'm very confused. Isn't that a negative balance in the financial account should be in deficit, instead of surplus. Borrowing from abroad and selling assets are inflows of currency, so wouldn't that be positive instead of negative?  Ans: You are right to be confused.  I made an error.  The slide that said "Both negative in Financial Account" should have said "Both positive in Financial Account."  I've made that change now in the slides that I posted after class.  Thank you for catching that. Nov 3: So is it the case that increase in demand for US exports would cause dollar to appreciate according to the supply and demand model for exchange rates but having a stronger dollar would further make US exports less attractive? What would then happen to the exchange rates and the value of the dollar? Also, I am a little confused why higher demands of US exports would cause the dollar to appreciate. Does it shift the supply curve for euros right? Is so, why would that be the case?    Ans: Yes, an increase in demand for US exports (if not caused by a change in the exchange rate itself) causes a shift to the right in the supply curve for foreign exchange.  The reason is that in order to buy US exports, foreigners need to buy US dollars, which means they are supplying more of their own currency.  (If our exporters accept payment in euros, then it is they who will need to sell them; either way the supply curve shifts.)  And yes, that shift in the supply curve causes the dollar price of the euro to fall and thus the dollar to appreciate.  That makes US exports more expensive, reducing them.  But that effect is just a movement along the shifted supply curve -- one of the reasons why it slopes the way it does.  So the end result is that exports do increase, but by less than the original shift. Oct 22: For this question [short-answer 4 on Study Questions for Lecgture 11], is it correct to put FDI in a third country and then export to that foreign country? Would it be a different answer from the third one?  Ans: Yes, that would be a fourth way.  The three listed are those that I mentioned in class, but yours is also valid. Oct 20: Does a country have an absolute advantage if they produce more of the good than another country or less of a good than the other? I have seen both of the situations that a country has an Absolute advantage. For example, if Belgium produces 300 brooms and Spain produces 200, which one has the absolute advantage? Ans: Absolute advantage is not determined by how much or how little a country produces.  It is determined by how costly it is for them to produce the good.   Thus, if a country requires more labor to produce a unit of a good than a second country, then the first country has an absolute disadvantage in producing that good and the second country an absolute advantage.  The theory of comparative advantage tells us that absolute advantage is often not helpful for finding out which country will export or import a good; for that one needs comparative advantage. Oct 20 1. What does it mean that it is crucial to assume all labor in a country is paid the same wage under the H-O model? Isn't the wage for abundant factors going to go up due to increased demand and the wage for scarce factors going to go down due to decreased demand?  Ans: If there is more than one kind of labor, e.g., skilled and unskilled, then it is not the case that all labor is paid the same wage.  That statement refers to when there is only one kind of labor, and it refers to labor in different sectors being paid the same wage.  Q: 2. Why does a tariff on imports increase the domestic price by exactly the amount of the tariff and the same thing applies to a tariff on exports? Is this trying to reach some sort of equilibrium?  A: Where did you see that?  I don't recall ever mentioning a tariff on exports.  A tax on exports does not raise the domestic price of the exported good; it lowers it, since exporters now get the world price minus the tariff, and the domestic price must be the same if it's a homogeneous good.   What you may have seen (in the textbook?) is that a tariff on imports and a tax on exports have the same effect on relative prices in the domestic market, since a rise in price of the import is the same (in a two-good world) as a fall in price of the export.  Q: 3. Why is the effect of government procurement regulations like a tariff, rather than a quota?  Ans: I guess that depends on the exact nature of the regulation.  One that I mentioned in class was that the government says it will buy domestic unless imports are, say, 10% cheaper.  That's a lot like a 10% tariff.  But if the regulation specifies a quantity, then yes, it would be like a quota.  And if it specified imports of zero, then it's like either a prohibitive tariff or a quota of zero, for that portion of demand that is due to government. Q: 4. For this question, why would the real wage of labor in the machine industry rise and the real return to capital in the textile industry fall?  A: Because both factors are perfectly mobile within the country between industries.  If the real wage of labor in machines did not rise, all labor would move from there to textiles, and the machine industry couldn't produce at all. Similarly, if the real return to capital in textiles did not fall, all capital would leave machines for textiles.  In equilibrium with both industries producing, factor prices must move in the same direction in both industries. Oct 17 I have noticed that the change of deadweight loss is the square of tariff, but I cannot understand what does the coordinate(0,20) to (10,10) mean in this example. Ans: Since the deadweight loss is the square of the tariff, and since the squares of 10 and 20 are 100 and 400 respectively, then the total deadweight loss from (0,20) (weighted equally) is 0+400=400, but the deadweight loss from (10,10) is 100+100=200. Oct 14 I am confused about the point that National Security is the reason given for Trump's threated tariffs on cars and I am wondering how does it affect, for example. in what way? Ans: I'm not sure what you are asking.  But if it is just how imports of cars can threaten national security, I don't have a good answer.  Most observers find the connection between car imports and national security weak, in spite of the fact that Trump's Commerce Department gave it approval.  Sep 19: You said that because the US is already hurting by the trade war therefore the effects of additional subsidies on agriculture are ambiguous. So, assume that we are participating in free trade which mainly focuses on imports on agriculture and exports on other sectors of the economy. Imports on agriculture will most likely hurt domestic farmers but we will result in a net gain from free trade activities. Does the benefit from trade overall greatly satisfy the compensation needs for the farmers? In other words, in this hypothetical case are the subsidies to farmers actually going to help the economy function as a whole? Ans: It wasn't because the US is already hurting that the effects of subsidies are ambiguous. In general, as long as markets are working properly so that market prices give correct signals of benefits and costs to suppliers and demanders, then subsidies to production can only hurt, since they distort those prices. But once we have tariffs, those also distort prices and it is possible that a subsidy might either correct those distortions or make them worse. I didn't follow your hypothetical case. If there were free trade, then the US would export, not import, the products that have been subject to the subsidies (soybeans, for example). In fact we have actually subsidized agriculture for years, so we have been over-producing these products even though it's pretty clear that we would export even without subsidies. Once the trade war led to China putting tariffs on these exports (in retaliation to our tariffs on many other products of theirs), the markets were even more distorted, and I suspect that this more than offset our original subsidies. So a subsidy to our soybean farmers might be welfare improving. But with so many tariffs on so many things, it's such a mess that I would hesitate to say with certainty whether Trump's subsidies to farmers are good or bad for economic efficiency. And in any case, he doesn't care about that. He just wants to keep farmers voting for him after his own tariffs and China's retaliation have hurt them. Q: Furthermore, there seem to exist better alternatives than providing subsidies to result in a more efficient outcome. Are there any cases in the past where the government implemented better policies in the fight of trade wars or against a period of recessions? Ans: The only fairly clear case of a major trade war in the past was the Great Depression, in which countries tried to pull themselves out by raising tariffs. Eventually, the US turned to using macroeconomic expansionary policies (government spending) to fight the Depression, and that sort of worked. And Roosevelt accompanied that with negotiated cuts in US and foreign tariffs. What really pulled us out, though, was spending on World War II. Sep 16: I have a question on the topic of subsidies. Chapter 3 from the book says that "It is possible to make individual firms highly profitable through subsidies or protection from international competition, while at the same time and through the same policies cause the nation’s overall standard of living to be lower than it would be otherwise." It points out that profit gains for individual firms can go against national interest and subsidies for one corporation could hurt the national economy as a whole. It takes me back to the comments that you made in class regarding the subsidies that Trump is paying for farmers in compensation for their losses from trade wars. Is it inherently bad and inefficient to allocate a nation's resources on subsidies? Will this decision hurt other industries, such as the high-techs or other business sectors? Or is it the case that the gains on farmers' profits will actually compensate for the losses from other industries and the nation's economy overall would not be subject to change? Ans: Good questions. Subsidies are not inherently harmful for an economy, but they are only beneficial if they are designed to offset some other market failure. For example, in some sectors one can argue that there are positive externalities from activities that benefit society in some fashion the the firms themselves cannot charge for. A subsidy to encourage that production can therefore, if well designed, be beneficial. However, it is very tricky to do this well, as the best information about the externality may have to come from the industry, which will benefit from the subsidy whether or not they are truthful in the information they provide. Because getting a subsidy right is so hard, and the incentives to get it wrong are so strong, the presumption for most subsidies is that they are harmful to the economy, in the sense that the larger economy loses more than the beneficiaries of the subsidy gain. In the case of Trump's subsidy to farmers, we are in a situation where the tariffs by the US and others have already created so much distortion that it is hard to know for sure whether the subsidies might be beneficial. The intent seems to be just to compensate farmers for their losses, and not to encourage inefficient production as subsidies in other contexts might do. If that can be managed, the effect of the subsidies would be primarily redistributive, to farmers from everybody else in the country. Had the others gained from the farmers' loss, that would sound llke an appropriate policy. However, the trade war hurts most people it least somewhat, so the subsidies are just shifting some of the loss from those who felt it most -- the farmers -- to the general public. Sep 10: I unfortunately have class during both of your office hour times, but I wanted to run this question by you that I had during lecture today. When saying that trade has been growing faster than GDP is that just an indication that we are globalizing faster than we are developing? is that then the only thing I'm supposed to understand from that statement? I feel like that is an important trend and that I'm not fully grasping the gravity of it (say that bad things happen when the two are not proportional or something like that).Or is it some type of link to social rejection and backlash of globalization as introduced in the Swanson piece? But maybe I am just overreacting to something more or less irrelevant to the class. Not sure, but thought I'd ask! Ans: Good question. Yes, the main message is that the world is globalizing faster than it is developing, but I'd also like you to be aware of some of the reasons for that: falling tariffs, cheaper international transportation, and cheaper/faster international communication, all of which have helped to expand supply chains across borders. By saying that "we are globalizing faster than we are developing," this may sound like a bad thing, but in fact (though it's not something I've mentioned yet), globalizing makes the economy more efficient so that on average, people are better off from a given level of income. So that's a good thing. But as you say, globalization hurts some while it helps others, and that is a source of the backlash that you mention.