Chapter 12:
1. Terms of trade (TOT) refers to the relative price of exports in terms of imports and is
defined as the ratio of export prices to import prices. It can be interpreted as the amount
of import goods an economy can purchase per unit of export goods. Changes in the
pattern of relative demand as income or tastes change in various parts of the world, and
changes in supply, such as those brought about by technological progress.
2. In the factor endowment trade theory countries will tend to specialize in the production of
commodities making intensive use of their relatively abundant factors of production; and
import goods that it has relatively less abundant factor.
3. Because countries have different endowments of factors of production, the capital-
abundant developed countries can export manufactured goods and import labor-intensive
goods from developing countries to more efficiently produce and profit in the market.
From the developing country point of view, outward looking trade policies enhance
growth and efficiency. Consumers benefit from a more varied pool of goods to choose
from and workers from higher incomes.
4. Most of developing countries have been benefited by the free trade. Free trade has led to
the free flow of goods, services and capital across the boundaries. Main issue that plagues
the developing countries is lack of demand or small size of market. Free trade opened up
market of developed countries. China, Korea and Vietnam have emerged as supreme
examples free trade derived economies. China achieved over 10 % growth rate due to rise
in its export. Free trade has made the import cheaper and consumers have become better
off due to availability of cheaper goods and services. Further, developing countries
suffers from lack of technology. Thus, trade has facilitated the import sophisticated
technology.
5. Basic factors of the North-South model include location, relatively unskilled labor,
physical resources, and general infrastructure. Advanced factors include education and
firm specific human capital, knowledge resources including universities, research
facilities, and specialized infrastructure. Trade based on a comparative advantage in
primary products may result in limited growth possibilities for a country.
6. Taiwan’s success in the world markets can be attributed to prioritizing education as one
of the important basic need for both the sexes, having a successful democratic political
system with many parties, heavy investment in infrastructure, high saving rate leading to
good availability of loanable funds for investment, and effective land reforms. To become
successful are that investment in human capital is important, followed by investment in
infrastructure and technology which help Taiwan produce goods and services comparable
to world standard, having political stability and strong regulations is also important which
help build trust with foreign partners. Taiwan also show importance to economical
openness and fair international trading policies.
7. The rationale for protective tariffs against an imported commodity is that it allows the
now higher-priced domestic producers enough time to learn the business and achieve the
economies of scale and external economies of learning by doing which is necessary to
lower unit costs and prices. A country might undervalue the exchange rate to promote
exports. This increases local prices that firms receive for exported goods relative to prices
of non-tradable goods that are sold only to domestic buyers, thus motivating a
reorientation of firms to the export market. Both of these policies may be pursued
together to increase a country’s terms of trade.
8. Import substitution may increase urban unemployment because initially, costs of
production in the domestic industry will increase. Employment cannot expand when costs
are too high to maintain. Many IS industries never grow, content to hide behind
protective tariffs that limit competition. This inhibits an economy as industry remains
inefficient. The modern sector enrichment theory can explain this because wages increase
in the modern sector only and people migrate there from the traditional sector. This
increases inequality in favor of capital-intensive industries.
9. (A) When tariffs on final goods exceed those on intermediate and capital good inputs, the
