Reference no: EM1375482

Assume that the country A has only three categories of traded goods and that A's imports and exports of the three goods are as follows:

Good Value of Exports Value of Imports
X $30 $100
Y 60 20
Z 60 80

My responses by section:

a) Calculate Country A's index of intra-industry trade.

{30/150 - 100/200} + {60/150 - 20/200} + {60/150 - 80/200
{30/150 + 100/200} + {60/150 + 20/200} + {60/150 + 80/200}

[.2 - .5] + [.4 - .1] + [.4 - .4]
[.2 + .5] + [ .4 + .1] + [.4 + .4]

-.3 + .3 + 0
.7 + .5 + .8

0/2=0
1 - 0= 1

1 means exports=imports

b) In the real world, intra-industry trade constitutes an important segment of international trade, can traditional trade theory explain this phenomena?

My response:

It is being incorporated as more and more of a component to international trade due to the concept of importing and exporting of same good classification whereas inter-industry is with different classifications of goods. The traditional concept of comparative advantage will do little to predict intra-industry trade. However, the following areas do help to explain intra-industry trade: product differentiation (where the classification is the same but the products themselves are unique or different in the same classification; transportation costs can influence the need for intra trade as importing product in the same classification to a nearby destination can offset any import costs and actually stand as a gain vs. transporting through one's own country; dynamic economies of scale is where improvement is seen as more and more production creates a more streamlined process netting gains for an importing country of the same classification of product; degree of product aggregation is the analysis of trade data and determining how broad or narrow the classifications of products are. Differing income distribution and differing factor endowments and product variety are also factors, which promote intra-industry trade.

Suppose that under free trade a final good F has a price of $1,000 and that the prices of the only two inputs into good F, goods A & B, are Pa=$300 and Pb=$500, and that 1 unit of each A & B are used in the production of one unit of good F. Suppose an ad valorem tariff of 20% is placed on good F while imported goods A & B face ad valorem tariffs of 20 and 30% respectively.

My response:

a) Calculate the ERP (effective rate of protection or effective rate of tariff) for the domestic industry producing good F.

F=100 X .2/Pa= 300 X .2/Pb= 500 X .3
0r 1200 360 650
1200 - 1010=190
200 gain in free trade and 190 with tariff= 190/200= 95% or 5%

b) Interpret the meaning of this calculated ERP.

Factors of production in good F did not benefit from the tariff although consumers have gained (price is less due to tariff).