Domande e risposte esame prof Ferri

An economy will tend to be relatively effective at producing goods that are intensive in the factors with

which the country is relatively well endowed.

7. Suppose: i) two countries use the same technologies: Home has 100 units of labor (L) and 200 units

of capital (K); Foreign has 500 L and 800 K; ii) there exist only two goods, cars (capital intensive) and

pizzas (labor intensive) with P /P = 1000; iii) the ratio between the wage and the rental price of capital,

c p

w/r = 1. If P /P rises to 1100 what will happen to w/r if the Stolper-Samuelson theorem holds?

c p

The Stolper-Samuelson theorem tells that if the relative price of a good increases, then the real wage

or rental rate of the factor used intensively in the production of that good increases, while the real

wage or rental rate of the other factor decreases.

If Pc/Pp rises to 1100: w/r increases.

8. The Heckscher-Ohlin model of trade has precise implications for the type of goods a country should

export and/or import. Discuss these implications and the empirical evidence in support or against them.

The Heckscher-Ohlin model tells that an economy has a comparative advantage in producing goods

that are relatively intensive in using its relatively abundant factor of production and it will export

these goods and will import goods that are relatively intensive in using its relatively scarce factors

of production.

The model predicts that factor prices will be equalized among countries that trade. Free trade

equalizes relative output prices and factor prices. Trade increases the demand of goods produced

by relatively abundant factors, indirectly increasing the demand of these factors, raising the prices

of the relatively abundant factors. But in reality, factor prices aren't equal across countries.

The model assumes that: - trading countries produce the same goods, but countries may produce

different goods if their factor ratios differ;

- trading countries have the same technologies but different technologies could affect the productivities

of factors and the wages/rates paid to these factors;

- the model ignores trade barriers and transportation costs, which may prevent output prices and

these factor prices from equalizing;

- there are outcomes in the long run, but after an economy liberalizes trade, factors of production may

not quickly move to the industries that intensively use abundant factors;

- owners of relatively abundant factors will gain from trade and owners of relatively scarce factors will

lose from trade.

Empirical evidence: the Leontief Paradox--> US exports were less capital-intensive than US imports,

even if the US is the most capital-abundant country in the world.

9. What are the implications of the existence of economies of scale for international trade? Does it

make a difference whether economies are internal or external to the single enterprise?

There are two types of economies of scale: external: occur when cost per unit of output depends on the

size of the industry; internal: occur when the cost per unit of output depends on the size of a firm.

Both types of economies of scale are important causes of international trade. One consequence of

external economies of scale for world economy is that the larger the industry, the lower the costs of

industry and prices because a geographically concentrated industry is able to support specialized

suppliers, a pooled market for workers with highly specialized skills and knowledge shares. It's

possible that a country is worse off trade in case of external economies, because it looses more

producing itself than pay for imports, if we consider cases where economies of scale depend on the

amount of current output; but if we consider the amount of cumulative output over time, thanks to

the relation between external economies of scale and dynamic increasing returns to scale, countries

may benefit by protectionism. Another implication is that external economies of scale may also be

important for interregional trade within a country: regions that are large producers in certain

industries, remains so.

Instead, internal economies of scale result when large firms have a cost advantage over small firms,

causing the industry to be uncompetitive. Then internal economies of scale imply that a firm's

average cost of production decreases the more output it produces.

Differentiation of goods in sectors and internal economies of scale generate gain from trade because if

the production is concentrated towards better-performing firms, the efficiency of the industry

improves.

10. Referring to the instruments of trade policy – tariffs, export subsidies, import quotas, voluntary

export restraints, local content requirements – which of them is the least distortive (i.e. it has the lowest

impact in terms of reducing the welfare, or total surplus)?

The least distorsive trade policy is the tariff because the increase of producer surplus and fall of

consumer surplus are counterbalanced by increase of government revenue and the possible fall in

national welfare.

International Finance:

11. Describe the interest rate parity condition. Please discuss its validity under fixed and flexible

exchange regimes.

The interest parity condition predicts that the difference between interest rates in two countries is

equal to the difference between the expected exchange rate and the current exchange rate of their

two currencies. In case of flexible exchange rates in order to reach the equilibrium, if the owners of

the currency deposits that have a lower rate of return than the other currency deposits, try to sell

their deposits in order to buy the other currency deposits, the exchange rate falls until the

equilibrium position. In the case of fixed exchange rates, there is the equilibrium when the two

currencies offer the same interest rate: R=R*.

12. What do we mean by the “Open-Economy Trilemma” and how did its relevance change when the

international monetary system moved from the Bretton-Woods era to the following one?

The open economic trilemma talks about the choice that policy makers have to make in order to reach

the internal and external balance goals, among three items:

- exchange rate stability

- monetary policy oriented toward domestic goals

- freedom of international capital movements.

The trilemma is caused by the need to choose only two of these items.

During the Bretton Woods Era, the choice was to restrict financial flows and fix exchange rates using

the US dollar as the reserve currency.

After the collapse of Bretton woods system, was underlined the pros and cons of flexible exchange

rates: they allow monetary policy autonomy, can stabilize the economy and can limit some forms of

speculation; but allow expenditure switching policies and make exchange rate more volatile.

13. Suppose: i) in 2013, a Pizza in the US costs P = 10 US$ and in Canada P = 15 CAN$ while the

USt CANt

exchange rate CAN$/US$ = 1,00; ii) in 2014, P = 11 US$, P = 15 CAN$ and CAN$/US$ = 0,90. Do

t USt CANt t

the ‘absolute’ and/or ‘relative’ versions of the Purchasing Power Parity (PPP) theory hold?

The PPP states that the exchange rate between two countries' currencies equals the ratio of the

countries' price levels. This is called absolute PPP: E $/€= Pus/Peu.

The relative PPP states that changes in exchange rates equal changes in prices between two periods: (E

$/€,t – E $/€, t-1)/E $/€,t-1 = π us,t – π eu,t

In 2013: P us= 10 Pcan= 15 E can/us=1,00--> Absolute ppp= E $/€= Pus/Peu-> 1,00≠1,50

In 2014: Pus= 11 Pcan= 15 E can/us= 0,90--> Absolute ppp= E $/€= Pus/Peu-> 0,90≠1,36

The absolue ppp doesn't hold.

Relative ppp= (E $/€,t – E $/€, t-1)/E $/€,t-1 = π us,t – π eu,t= (E $/€,t – E $/€, t-1)/E $/€, t-1= (P us, t –

P us, t-1)/ P us, t-1 - (P eu, t - P eu, t-1)/ P eu, t-1--> (0,90-1)/1=0 – 0,1

The relative ppp holds.

14. How do Central Banks intervene with “sterilizations” in foreign exchange markets? What is their

impact?

Central banks sometimes do equal foreign and domestic asset transactions in opposite directions to

nullify the impact of their foreign exchange operations on the domestic money supply.

If the Central bank sells bonds in the foreign exchange markets, it can buy domestic government

bonds in bond markets hoping to leave the amount of money in circulation unchanged.

If Central banks aren't sterilizing and home country has a balance of payments surplus any increase

in the home central bank's foreign assets implies an increased home money supply; and viceversa

any decrease in a foreign central bank's claim on the home country implies a decreased foreign

money supply.

15. What is the J-curve effect? Through which channels is it generated?

If the volume of imports and exports is fixed in the short run a depreciation of the domestic currency

will increase the value/price of imports in domestic currency and decrease the current account. The

primary effect of depreciation is to raise the value of the fixed level of imports in terms of domestic

products; the current account falls. Then after the old export and import contracts have been

fulfilled, new shipments will adjust relative price change. There are some delays on the

consumption side, caused by the expansion of foreign consumption of domestic exports; these

delays cause the increase of the current account.

16. In the Asset approach, what is the effect of changing interest rates on the current exchange rate?

An increase in the interest rates paid on the deposits denominated in a particular currency will

increase the rate of return on those deposits; and this causes an appreciation of the currency.

Monetary Union:

17. If two countries join a Monetary Union that is not an Optimal Currency Area, which mechanisms

can help the adjustment process in the case of asymmetric shocks?

If two countries join a monetary union, deal with theory of optimal currency areas, countries lose the

possibility to use a monetary policy instrument and costs arise, especially during asymmetric

shocks, i.e.: asymmetric shock in demand.

In a monetary union there is a common currency and a common central bank setting one interest rate;

adjustment mechanisms are the wage flexibility and labor mobility and if these two didn't exist the

monetary union can be very costly.

In our case, the international exchanges and factor mobility don't exist because we are in a not OCA,

so the just mentioned adjustment mechanism may not exist.

18. Describe the Barro-Gordon approach to the inflation/unemployment choice in a two-country set up.

In that approach, which is the main motive the Eurozone might not be an Optimal Currency Area?

The Barro Gordon approach underlines that unemployment and inflation are inversely correlated, so

authorities have to choose between two strategies: hard-nose, in order to fight inflation and wet-

nose in order to fight unemployment.

In reality, not all countries of Eurozone use the same strategy; for example Italian and