Chapter 2

- Elasticity: a measure of responsiveness that is “unit-free” (the percent change in one

variable resulting from a 1 percent change in another variable)
- Price elasticity of demand: the percent change in quantity demanded resulting from a 1
percent increase in price
- Consumer surplus: the increase in the economic well-being of consumers who are able
to buy the product at a market price lower than the highest price that they are willing and
able to pay for the product (net gain; the difference between the value the consumers
place on the product and the payment that they must make to buy the product)
- Price elasticity of supply: the percent increase in quantity supplied resulting from a 1
percent increase in market price (“unit-free” measure)
- Opportunity cost: the value of other goods and services that are not produced because
resources are instead used to produce this product
- Producer surplus: increase in the economic well-being of producers who are able to sell
the product at a market price higher than the lowest price that would have drawn out their
supply (net gain; the difference between the revenues received and the costs incurred)
- Arbitrage: buying something in one market and reselling the same thing in another
market to profit from a price difference
- International price ( = world price): free-trade equilibrium price (if there are no
transport costs or other frictions)
- Demand for imports: excess demand (quantity demanded – quantity supplied) for a
product within the market; can be determined for each price at which the country might
import
- Supply of exports: the excess supply (quantity supplied – quantity demanded)
- One-dollar, one-vote metric: each dollar of gain or loss is valued equally, regardless of
who experiences it; implies a willing to judge trade issues on the basis of their effects on
aggregate well-being, without regard to their effects on the distribution of well-being
- Net national gains from trade: the difference between what one group gains and what
the other group loses
Chapter 3. Why Everybody Trades: Comparative Advantage
- Labor productivity : the number of units of output that a worker can produce in one
hour
- Absolute advantage: absolute advantage occurs when a country’s labor productivity in
producing a certain product is higher than that of the other country.
- Opportunity cost: the opportunity cost of producing more of a product in a country is
the amount of the other product that is given up.
- Principle of comparative advantage: A country will export the goods and services that
it can produce at a low opportunity cost and import the goods and services that it would
otherwise produce at a high opportunity cost.
- Relative price: the ratio of one product price to another product price
- Arbitrage: buying at the low price in one place and selling at the high price in the other
place
- Production-possibility curve (PPC): production-possibility curve shows all
combinations of amounts of different products that an economy can produce with full
employment of its resources and maximum feasible productivity of these resources.
Chapter 4 Trade: Factor Availability and Factor Proportions Are Key
- increasing marginal costs: As one industry expands at the expense of others, increasing
amounts of the other products must be given up to get each extra unit of the expanding
industry’s product.
- production-possibility curve (ppc): the combinations of amounts of different products
that a country can produce, given the country’s available factor resources and maximum
feasible productivities.
- Indifference curve: the various combinations of consumption quantities that lead to the
same level of well-being or happiness.
- Community indifference curve: how the economic well-being of a whole group
depends on the whole group’s consumption of products.
- Terms of trade: the price the country receives from foreign buyers for its export
product(s), relative to the price that the country pays foreign sellers for its import
product(s).
- Heckscher–Ohlin (H-O) theory: 1) predicts that a country exports the product (or
products) that uses its relatively abundant factor(s) intensively and imports the product
(or products) that uses its relatively scarce factor(s) intensively.
2) predicts that a country exports products that are produced with more intensive use of
the country’s relatively abundant factors in exchange for imports of products that use the
country’s relatively scarce factors more intensively.
- labor-abundant: A country is relatively labor-abundant if it has a higher ratio of labor to
other factors than does the rest of the world.
- labor-intensive: A product is relatively labor-intensive if labor costs are a greater share
of its value than they are of the value of other products.
Chapter 5) Who Gains and Who loses from trade?
Who Gains and Who Loses Within a Country
- Short run: laborers, plots of land, other inputs are tied to their current lines of
production. As a result, all groups tied to the rising sectors gain, and all groups tied to
declining sectors lose.
- Long run: factors can move between sectors in response to differences in returns. As a
result, due to the imbalance in the changes in factor supply and demand, the gainers and
losers in the long run are different from the ones in the short run.

Three Implications of the H-O Theory (Heckscher-Ohlin Theory)

- The Stolper-Samuelson Theorem: given certain conditions and assumptions, including
full adjustment to a new long-run equilibrium, an event that changes relative product
prices in a country unambiguously has two effects; 1) It raises the real return to the factor
used intensively in the rising-price industry / 2) It lowers the real return to the factor used
intensively in the falling-price industry.

- The Specialized-Factor Pattern: 1) the more a factor is specialized (=concentrated), in

the production of a product whose relative price is rising, the more this factor stands to
gain from the change in the product price. / 2) the more a factor is concentrated into the
production of a product whose relative price is falling, the more it stands to lose from the
change in product price.

- The Factor-Price Equalization Theorem: given certain conditions and assumptions,

free trade equalizes not only product prices, but also the prices of individual factors
between the two countries. 1) Laborers (of the same skill level) earn the same wage rate
in both countries. / 2) Units of Land (of comparable quality) earn the same rental return
in both countries.
Chapter 6
- Constant returns to scale: Input use and total cost rise in the same proportion as output
increases. For an industry such as production of basic clothing items, production is
probably very close to constant returns to scale.
- Scale economy: output quantity goes up by a larger proportion than does total cost, as
output increases.
- Internal scale economies: First, scale economies can be internal to the individual firm.
The actions and decisions of the individual firm itself result in internal scale economies.
- Monopolistic competition: a mild form of imperfect competition; a type of market
structure in which a large number of firms compete vigorously with each other in
producing and selling varieties of the basic product
- Oligopoly: Global oligopoly can arise when there are substantial scale economies
internal to each firm.
- External scale economies: The second type of scale economies is external to any
individual firm. External scale economies are based on the size of an entire industry
within a specific geographic area.
- Inter-industry trade: a country exports some products in trade for imports of other,
quite different products.
- Intra-industry trade (IIT): two-way trade in which a country both exports and imports
the same or very similar products (product varieties that are such close substitutes that
they are classified within the same industry).
- Product differentiation: consumers view the varieties of a product offered by different
firms in an industry as close but not perfect substitutes for each other.
- Net trade: The difference between the value of its exports and the value of its imports
over a specific period, usually a year.
Chapter 7: Growth and Trade
Economic growth: expansion of a country’s production capabilities
: changes in productive capabilities
: production-side changes
- Rybczynski theorem: statement that a kind of very biased growth, in which the
endowment of only one factor is growing, results in a decrease in production by the
sector that is not intensive in the growing factor.
: In a two-good world, and assuming that product prices are constant, growth in the
country’s endowment of one factor of production, with the other factor unchanged, has
two results:
o An increase in the output of the good that uses the growing factor intensively.
o A decrease in the output of the other good.2
- Dutch disease: apparent problem in which new production of a natural resource results in
a decline in production of manufactured products (deindustrialization).
: a real-world example. (In the Dutch case the endowment growth was the discovery of
natural gas deposits. Shifting labor and capital to the extraction of this gas led to a decline
in the country’s manufacturing sector.)
- Small country: one whose trade does not affect the international price ratio
- Large country: one whose trade can have an impact on the relative international price
ratio
- Immiserizing growth: growth that expands the country’s willingness to trade can result
in such a large decline in the country’s terms of trade that the country is worse off.
- Research and development (R&D): organized efforts from which most industrially
useful new technology now comes
- Diffusion: international spread or “trade” in technology
- Product cycle hypothesis: an attempt to offer a dynamic theory of technology and trade
by emphasizing that the location of production of a product is likely to shift from the
leading developed countries to developing countries as the product moves from its
introduction to maturity and standardization. (first advanced by Raymond Vernon)
- [ Economic growth ] results from increases in the country’s endowments of factors of
production or from technological improvements
- [ Balanced growth ] shifts the country’s production-possibility curve outward in a
proportionate manner.
- [ Biased growth ] shifts the ppc outward in a manner that is skewed toward one product
Chapter 8
- Tariff : tax on importing a good or service into a country, usually collected by customs
officials at the place of entry
- Specific Tariff : money amount per unit of import
- Ad valorem tariff : percentage of the estimated market value of the goods when they
reach the importing country
- Producer surplus : amount that producers gain from being able to sell products at the
market price
- Consumer surplus : amount that consumers gain from being able to buy products at the
market price
- One-dollar, one-vote metric : every dollar of gain or loss is just as important as every
other dollar gain or loss, regardless of who the gainers or losers are
- Effective rate of protection (of an individual industry) : percentage by which the entire
set of a nation’s trade barriers raises the industry’s value added per unit of output
- Consumption effect (of the tariff) : shows the loss to consumers in the importing nation
(=loss of consumer surplus)
- Production effect (of the tariff) : extra cost of shirting to more expensive home
production
- Monopsony power : a nation having a large enough share of the world market for one of
its import products that the country’s buying an affect the world price unilaterally
- Terms-of-trade effect : Case where a large country can affect the world price of a good
it imports, just by imposing a tariff
- National optimal tariff : yields the largest possible gain. However, it is only optimal
only if foreign governments do not retaliate with tariffs on our exports
- World Trade Organization (WTO) : formed in 1955, successor of General Agreement
on Tariffs and Trade (GATT), oversees the global rules of government policies toward
trade and provides a forum for negotiating global agreements to reduce barriers to trade
Chapter 9 Nontariff Barriers to Imports
-Nontariff barrier (NTB):
Short Ver.: Reduce imports by limiting quantities, increasing costs, or creating uncertainties.
Detail ver: Any policy used by the government to reduce imports, other than a simple tariff
on imports. Nontariff barriers can take many forms, including import quotas, discriminatory
product standards, buy-at-home rules for government purchases, and administrative red tape
to harass importers of foreign products. An NTB reduces imports through one or more of the
following direct effects: • Limiting the quantity of imports. • Increasing the cost of getting
imports into the market. • Creating uncertainty about the conditions under which imports will
be permitted.

- Import Quota:
Short ver.: Sets a maximum quantity of imports. Quantitative limit on imports giving direct
effects on the quantity.
Detail ver.: The best-known nontariff barrier or just quota, a limit on the total quantity of
imports of a product allowed into the country during a period of time (for instance, a year).

- Fixed Favoritism: A way of allocating import licenses adding up to the total quota. The
Government simply assigns the liceses to firms (and/or individuals) without competition,
applications, or negotiation.

- Import license auction: Selling of import licenses on a competitive basis to the highest
bidders.

Resource-using application procedures: Allocating quota licenses on a first-come, first-

served basis; on the basis of demonstrationg need or worthiness or on the basis of
negotiations instead of holding an auction. (If the govt. has a complicated process for
obtaining import liceses, then some of this amount is lost to resource-using application
procedures.

a) With first come, first-served allocation: those seeking the licesenses use resources to get to
and stay at the front of the line.
b) Allocation by worthiness is awarding quota licenses for materials or componetns based on
production capacity of firms= leads to resource wastage because it causes firms to overinvest
in production capacity in the hope of obtaining more quota licenses. E.g.: time and money
spent on lobbying with government officials to press each firm’s case for receiving quota
licenses.
c) Resources-using procedures encourage rent-seeking activites.

- A voluntary export restraint (VER):

Short ver.: Quantitative limit on foreign exports (based on threat of import restriciton)
Detail ver: An odd-looking trade barrier in which the importing country government
compels the foreign exporting country to agree “voluntarily” to restrict its exports to this
country. Through the VER the importing country actually gives foreigners monopoly power,
forces them to take it, and calls their compliance voluntary. E.g.: VERs have been used by
 large countries as a rear-guard action to protect their industries that are having trouble
competing against a rising tide of imports

- Domestic content requirement:

Short ver.: Government procurement favoring domestic products, and a host of quality and
safety standards that have protectionist effects.
Detail ver.: Mandates a product produced and sold in a country must have a specified
minimum amount of domestic production value, in the form of wages paid to local workers
or materials and components produced within the country. This creates import protection at
two levels. 1) barrier to imports of the products that do not meet the content rules. 2) limit the
import of materials and components that otherwise would have been used in domestic
production of the products.

- Mixing requirement:
Short ver.: Require specified use of local labor, materials, or other products.
Detail ver.: A closely related NTB (Nontariff barrier) stipulating importer or import distributor
to buy (must) a certain percentage of the product locally. e.g.: Indonesia adopting regulations
that 80% of sales by modern retails stores must be domestic products.

- Section 301: Part of Trade Act of 1974, which gives the U.S president the power to
negotiate to eliminate “unfair trade practices” of foreign governments after becoming
frustrated with the shortcomings of the GATT dispute resolution process. This was
American’s unilateral pressure trying to resolve its complaints about foreign countries’ trade
practices and policies. (Other countries have resented U.S unilateral approach)