Midterm Exam Practice Questions by lanyuehua


									                                           University of North Florida
                                               Final Exam
RULES: Read the exam very carefully and answer al l questions. The exam is worth 100 points. The test is due
on May 2nd at 4:50 in my office. Good luck!

1. (20 Points) In the book The World is Flat we analyzed and debated several issues
   related to globalization and how it affects the world we live in. Read the following Wall
   Street Journal article and answer the following questions
a) After reading chapters 8 and 9 of the book the World is Flat, how do the ideas in these chapters compare with
   Blinder’s claims about globalization? Explain and compare them using your own words. What are the proposals
   of both authors to deal with globalization?
b) Based on your readings explain under which conditions Mr. Blinder’s critics can be right. (Note: in answering
   this question you can use any of the theories of trade, or parts of the book the world is flat. You have to make
   the case for these claims as opposed to Mr. Blinder’s claims).

ECO 3703                                            1                                         Spring 2007
                                             University of North Florida

             JOB PROSPECTS
             Pain From Free Trade
             Spurs Second Thoughts
Mr. Blinder's Shift
Spotlights Warnings
Of Deeper Downside
March 28, 2007; Page A1

For decades, Alan S. Blinder -- Princeton University economist, former Federal Reserve Board vice chairman and
perennial adviser to Democratic presidential candidates -- argued, along with most economists, that free trade
enriches the U.S. and its trading partners, despite the harm it does to some workers. "Like 99% of economists since
the days of Adam Smith, I am a free trader down to my toes," he wrote back in 2001.

Politicians heeded this advice and, with occasional dissents, steadily dismantled barriers to trade. Yet today Mr.
Blinder has changed his message -- helping lead a growing band of economists and policy makers who say the
downsides of trade in today's economy are deeper than they once realized.

Mr. Blinder, whose trenchant writing style and phrase-making add to his influence, remains an implacable opponent
of tariffs and trade barriers. But now he is saying loudly that a new industrial revolution -- communication
technology that allows services to be delivered electronically from afar -- will put as many as 40 million American
jobs at risk of being shipped out of the country in the next decade or two. That's more than double the total of
workers employed in manufacturing today. The job insecurity those workers face today is "only the tip of a very big
iceberg," Mr. Blinder says.

The critique comes as public skepticism about allowing an unfettered flow of goods, services, people and money
across borders is intensifying, including some Republicans as well as many Democrats. (See related article.) The
rethinking is helping free-trade foes, underscoring the urgency of helping those battered by globalization and
clouding the outcome of a hot debate: Should government encourage forces of globalization or try to restrain them?

Some trade critics are bothered by the disappointing performance of Latin America since it slashed tariffs in the
1980s and 1990s while more protectionist China and Southeast Asia sped ahead. Others are struck by the widening
gap between economic winners and losers around the globe. The rethinking on trade issues is the most significant
since the early 1990s when many in the U.S. worried that Japan would overtake the U.S., a fear that has since
Some critics are going public with reservations they've long harbored quietly. Nobel laureate Paul Samuelson,
whose textbook taught generations, damns "economists' over-simple complacencies about globalization" and says
rich-country workers aren't always winners from trade. He made that point in a 2004 essay that stunned colleagues.
Lawrence Summers, a cheerleader for trade expansion as Clinton Treasury secretary, says people who argue
globalization is inevitable and retraining is enough to help displaced workers offer "pretty thin gruel" to the anxious
global middle class.

Others are finding the debate moving closer to positions they've had for years. Ralph Gomory, International
Business Machines Corp.'s former chief scientist who now heads the Alfred P. Sloan Foundation, says that changing
technology and the rise of China and India could make the U.S. an also-ran if it loses many of its important
industries. Harvard economist Dani Rodrik says global trade negotiations should focus on erecting new barriers
against globalization, not lowering them, to help poor nations build domestic industries and give rich nations more
time to retrain workers.

Mr. Blinder's job-loss estimates in particular are electrifying Democratic candidates searching for ways to address
angst about trade. "Alan, because of his stature, provided a degree of legitimacy to what many of us had come to feel
anecdotally -- that the anxiety over outsourcing and offshoring was a far larger phenomenon than traditional
economic analysis was showing," says Gene Sperling, an adviser to President Clinton and, now, to Hillary Clinton.
Her rival, Barack Obama, spent an hour with Mr. Blinder earlier in this year.

ECO 3703                                              2                                           Spring 2007
                                             University of North Florida
Alan S. Blinder still considers himself a free trader but now warns loudly that the downsides of trade are deeper and
longer-lived than most free traders say. Read excerpts of his writings and speeches over the past 20 years.

For years, Ralph Gomory and Dani Rodrik were on the outs with the economic establishment because they argued
that free traders greatly underestimated the costs of trade liberalization. Now their views are attracting greater
interest. Take a look9 at their iconoclastic views on trade.
Mr. Blinder's answer is not protectionism, a word he utters with the contempt that Cold Warriors reserved for
communism. Rather, Mr. Blinder still believes the principle British economist David Ricardo introduced 200 years
ago: Nations prosper by focusing on things they do best -- their "comparative advantage" -- and trading with other
nations with different strengths. He accepts the economic logic that U.S. trade with large low-wage countries like
India and China will make all of them richer -- eventually. He acknowledges that trade can create jobs in the U.S.
and bolster productivity growth.

But he says the harm done when some lose jobs and others get them will be far more painful and disruptive than
trade advocates acknowledge. He wants government to do far more for displaced workers than the few months of
retraining it offers today. He thinks the U.S. education system must be revamped so it prepares workers for jobs that
can't easily go overseas, and is contemplating changes to the tax code that would reward companies that produce
jobs that stay in the U.S.
His critique puts Mr. Blinder in a minority among economists, most of whom emphasize the enormous gains from
trade. "He's dead wrong," says Columbia University economist Jagdish Bhagwati, who will debate Mr. Blinder at
Harvard in May over his assertions about the magnitude of job losses from trade. Mr. Bhagwati says that in highly
skilled fields such as medicine, law and accounting, "If we do a real balance sheet, I have no doubt we're creating far
more jobs than we're losing."
Mr. Blinder says that misses his point. The original Industrial Revolution, the move from farm to factory,
unquestionably boosted living standards, but triggered an enormous change in "how and where people lived, how
they educated their children, the organization of businesses, the form and practices of governments." He says today's
trickle of jobs overseas, where they are tethered to the U.S. by fiber-optic cables, is the beginning of a change of
similar dimensions, and American society needs similarly far-reaching changes to cope. "I'm trying to convince a
bunch of economists who are deeply skeptical and hard to convince," he says.

Mr. Blinder, 61 years old, a Princeton college graduate with a Ph.D. from Massachusetts Institute of Technology,
has been on the Princeton faculty since 1971. He is known for his work on macroeconomics and a liberal bent
captured by the title of a 1987 book, "Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society." When
he talked about trade in the past, Mr. Blinder emphasized its great benefits. His undergraduate economics textbook,
first published in 1979, says "the facts are not consistent" with the popular notion that "cheap foreign labor steals
jobs from Americans and puts pressure on U.S. businesses to lower wages."

When Mr. Blinder went to Washington in 1993 to join President Clinton's Council of Economic Advisers, he
became even more convinced of the benefits of free trade. He saw steel, aluminum and farming lobbyists fight for
export subsidies or protection from imports, and then passing the costs to consumers. "I came out a much more
radical free trader than I went in," he says.

As a Clinton aide, he helped sell the North American Free Trade Agreement with Mexico and Canada, although he
says he disagreed with the administration pitch that it would create jobs in U.S. Economic theory teaches that trade
changes the types of jobs in an economy, not the overall number. But he bowed to Mr. Clinton's political savvy. "If
he had left the salesmanship to me, Nafta would have failed," he says.

Mr. Blinder left the White House after 18 months for the Fed in 1994, and immediately was mentioned as a possible
successor to Alan Greenspan. He left in 1996 and returned to Princeton, where he still teaches introductory
economics. Six years ago, he cashed in on his prominence by joining former Clinton banking regulator Eugene
Ludwig in a firm that advises troubled banks and another that deciphers the Fed and other central bankers for a hefty

ECO 3703                                              3                                          Spring 2007
                                             University of North Florida

                                           At Princeton, he began to reassess some of
                                           his views on trade. Visiting the yearly
                                           business gabfest in Davos, Switzerland, in
                                           January 2004, he heard executives talk
                                           excitedly about moving jobs overseas that
                                           not long ago seemed anchored in the U.S.

                                           He was silent when his former Princeton
                                           student, N. Gregory Mankiw, then chairman
                                           of President Bush's Council of Economic
                                           Advisers, unleashed a political firestorm by
                                           reciting standard theory but appearing
                                           indifferent to pain caused to those whose
                                           jobs go overseas. "Does it matter from an
                                           economic standpoint whether items                Alan S. Blinder in
                                           produced abroad come on planes and ships         Philadelphia
                                           or over fiber optic cables?" Mr. Mankiw
                                           said at a February 2004 briefing. "Well, no, the economics is basically the
                                           same....More things are tradable than...in the past, and that's a good thing."

                                          Mr. Blinder says he agreed with Mr. Mankiw's point that the economics of
                                          trade are the same however imports are delivered. But he'd begun to
wonder if the technology that allowed English-speaking workers in India to do the jobs of American workers at
lower wages was "a good thing" for many Americans. At a Princeton dinner, a Wall Street executive told Mr.
Blinder how pleased her company was with the securities analysts it had hired in India. From New York Times'
columnist Thomas Friedman's 2005 book, "The World is Flat," he found anecdotes about competition to U.S.
workers "in walks of life I didn't know about."

Mr. Blinder began to muse about this in public. At a Council on Foreign Relations forum in January 2005 he called
"offshoring," or the exporting of U.S. jobs, "the big issue for the next generation of Americans." Eight months later
on Capitol Hill, he warned that "tens of millions of additional American workers will start to experience an element
of job insecurity that has heretofore been reserved for manufacturing workers."

At the urging of former Clinton Treasury Secretary Robert Rubin, Mr. Blinder wrote an essay, "Offshoring: The
Next Industrial Revolution?" published last year in Foreign Affairs. "The old assumption that if you cannot put it in
a box, you cannot trade it is hopelessly obsolete," he wrote. "The cheap and easy flow of information around the
globe...will require vast and unsettling adjustments in the way Americans and residents of other developed countries
work, live and educate their children." (Read that full article.)
In that paper, he made a "guesstimate" that between 42 million and 56 million jobs were "potentially offshorable."
Since then he has been refining those estimates, by painstakingly ranking 817 occupations, as described by the
Bureau of Labor Statistics, to identify how likely each is to go overseas. From that, he derives his latest estimate that
between 30 million and 40 million jobs are vulnerable.
He says the most important divide is not, as commonly argued, between jobs that require a lot of education and
those that don't. It's not simply that skilled jobs stay in the US and lesser-skilled jobs go to India or China. The
important distinction is between services that must be done in the U.S. and those that can -- or will someday -- be
delivered electronically with little degradation in quality. The more personal work of divorce lawyers isn't likely to
go overseas, for instance, while some of the work of tax lawyers could be. Civil engineers, who have to be on site,
could be in great demand in the U.S.; computer engineers might not be.

Mr. Blinder's warnings, and his numbers, are now firmly planted in the political debate over trade, and sometimes
invoked by those whose views are distinctly more protectionist than Mr. Blinder. Richard Trumka, for instance,
secretary-treasurer of the AFL-CIO, cited them in an indictment of "free market fundamentalism" and a call for
"more balanced trade policies that protect the rights of workers."

Diana Farrell, head of the McKinsey Global Institute, a pro-globalization think-tank arm of the consulting firm that
has done its own analysis of vulnerable jobs, calls Mr. Blinder "an alarmist" and frets about the impact he is having
on politicians, particularly the Democrats who see resistance to free trade as a political winner. She insists many
jobs that could go overseas won't actually go.

ECO 3703                                               4                                           Spring 2007
                                             University of North Florida

Ms. Farrell says Mr. Blinder's work doesn't take into account the realities of business which make exporting of some
jobs impractical or which create offsetting gains elsewhere in the U.S. economy. He counters he is looking further
into the future than McKinsey -- 10 or 20 years instead of five -- and expects more technological change than the
consultants do "even without the Buck Rogers stuff."

Mr. Blinder says there's an urgent need to retool America's education system so it trains young people for jobs likely
to remain in the U.S. Just telling them to go to college to compete in the global economy is insufficient. A college
diploma, he warns, "may lose its exalted 'silver bullet' status." It isn't how many years one spends in school that will
matter, he says, it's choosing to learn the skills for jobs that cannot easily be delivered electronically from afar.

Similarly, he says any changes to the tax code should encourage employers to create jobs that are harder to perform
overseas. While Mr. Gomory, the former IBM chief scientist, suggests tax breaks for companies that create "high
value-added jobs," Mr. Blinder says the focus should be on jobs with person-to-person contact, regardless of pay and
skill levels -- from child day-care providers to physicians.

Mostly he wants to shock politicians, policy makers and other economists into realizing how big a change is coming
and what new sectors it will reach. "This is something factory workers have understood for a generation," he says.
"It's now coming down on the heads of highly educated, politically vocal people, and they're not going to take it."

Corrections & Amplifications
Criticisms of Blinder's trade theories include:
•N.Gregory Mankiw, former chairman of the Bush Council of Economic Advisers, and Phillip L. Swagel, currently
assistant Treasury secretary for economic policy, "The Politics and Economics of Offshore Outsourcing," 12 2005
•McKinsey Global Institute, "U.S. Offshoring: Rethinking the Response," 13 2005
•Jagdish Baghwati et. al, "The Muddles Over Outsourcing,"14 2004

ALAN BLINDER'S ESSAY entitled "Offshoring: The Next Industrial Revolution?" was published last year in
Foreign Affairs. An earlier version of this article incorrectly said it had been published in Foreign Policy. The above
article has been corrected.

ECO 3703                                              5                                           Spring 2007
                                            University of North Florida

2. (40 Points) Answer the following questions describing different market situations with
   different trade policies.
     A. The following table describes the situation before and after a tariff in the market for
        Computers in country B
                                       Free Trade                              With a Tariff
International Price                    300                                     280
Domestic Price                         300                                     350
Domestic consumption                   250                                     225
Domestic Production                    70                                      82.5

a.   Calculate the change in consumer and producer surplus. How much is the total change in welfare? Represent the
     situation in a supply and demand graph.
b.   How much is government revenue from the tariff? How much will be the total change in welfare if the tool used
     is a VER?
c.   How much are imports before and after the tariff? How much is the welfare loss if the government chooses to
     use a subsidy? Which instrument is the best to protect this market?

     B. The following are the demand and supply curves for the market for TVs in country c:
     P=2000-2Q (Demand)
     P=40+2Q (Supply)

     a) Using a graph show the equilibrium for this market when the economy is closed to trade.
     b) Assume the economy opens to free trade, and that the international price for TVs is 800. Show the new
        equilibrium in a graph. How much are imports?
     c) Assume the government decides to implement a tariff, and the domestic prices rises to 1,400. Using a graph
        describe the new situation for this market. Using your own words explain how the situation changed from
        the case of free trade.
     d) Calculate the change in consumer and produce surplus and the total change in welfare.
     e) How much would be the loss in welfare if the government decides to use a subsidy?
     f) Assume that thanks to government protection, technological improvements changed the supply curve in the
        following way:


     Using a graph compare this situation with the previous case. Do you think a subsidy is needed in this case? How
     much are imports/exports? How much is the change in consumer welfare from the situation with a subsidy to
     the new situation without government intervention?
     g) What theory of economic trade you will use to predict the change in the supply curve due to the
          government protection? Give examples

ECO 3703                                             6                                         Spring 2007
                                            University of North Florida
3. (20 Points) In the first part of the course we discussed the theory of comparative
The following graph explains the situation for Country A before and after free trade. Assume that this country
produces two goods, Potatoes and Computers.

    a) In which good Country A has a comparative advantage? How much are exports and imports?
    b) Based on the information in this graph draw the demand and supply for Potatoes, showing the equilibrium
       before and after free trade.
    c) From the demand and supply curves for Potatoes calculate the total change in welfare Country A receives
       for moving to free trade.

ECO 3703                                             7                                         Spring 2007
                                          University of North Florida
4. (20 Points) Read the following Wall Street Journal article and answer the questions
   a.   Using a graph and your own words explain what would be the gains, or losses for the United States if the
        free trade agreement with South Korea implies that trade diversion is larger than trade creation.
   b.   Congress is evaluating to impose tariffs on Chinese goods because of alleged subsidies from the Chinese
        government. Assume that these accusations are unfounded, but these tariffs are passed in Congress anyway.
        In addition assume that, because of the agreement between South Korea and the United States, South Korea
        has become cheaper than China. Using some graphs and your own words explain how this situation is
        going to affect US, South Korea and Chinese consumers and producers.
   c.   When comparing South Korea to China one can make the case that competition between US companies and
        South Korean companies is different than with Chinese companies, given that South Korea is much a more
        developed country than China. Using a graph and your own words explain what would be the effect of this
        free trade agreement in the US and South Korea. (Note: you can use the example of any industry or

ECO 3703                                           8                                        Spring 2007
                                            University of North Florida

                U.S.-Korea Trade Deal Still Faces Hurdles
April 3, 2007; Page A2

SEOUL, South Korea -- The trade pact agreed to by U.S. and South Korean negotiators could generate $20 billion in
trade in coming years and drive similar deals across Asia -- if it can overcome major legislative opposition.

The U.S. Congress and Korean National Assembly are led by politicians who won office in part by campaigning against
free trade. The deal as it stands could face strong opposition from U.S. farm-state lawmakers because of its beef
restrictions and its failure to open any window for U.S. rice exports. U.S. negotiators have told the South Koreans that
the deal won't pass Congress until they lift restrictions on beef imports first put in place during the 2003 scare over
mad-cow disease.

                                                  If it clears legislative obstacles, the deal, reached yesterday afternoon
                                                  minutes before a U.S. legal deadline, will especially benefit U.S.
                                                  farmers and Korean manufacturers. By cutting tariffs, it will lower
                                                  the prices U.S. consumers pay for Korean cars and electronics and
                                                  provide new opportunities for U.S. investors and businesses in South
                                                  Korea. And by cutting tariffs and taxes, it will sharply lower prices
                                                  for U.S. cars and food in South Korea, which has some of the world's
                                                  highest prices for both. However, the agreement doesn't include rice,
                                                  which Korean negotiators insisted on leaving out.

                                                South Korea also gets a head start in Asia on competition for
                                                American business. The trend could spread in the region as bilateral
                                                trade agreements grow in popularity after efforts to strike a global
                         AP/Wide World Photo deal in the Doha Round under the World Trade Organization fell
South Koreans rallied in Seoul to protest the   apart last July. Also Monday, Thailand's prime minister flew to
free-trade agreement struck Monday with the     Japan to sign a free-trade agreement with Japanese leaders. (Thai
U.S.                                            trade talks with the U.S. stalled last year when the former premier
was deposed in a coup.) The U.S. and Malaysia announced they will meet later this month to restart free-trade talks that
stalled a few weeks ago.

The U.S.-South Korea deal is the largest free-trade pact, as measured by the size of the economies involved, since
Canada, Mexico and the U.S. completed the North American Free Trade Agreement, which took effect in 1994. Deputy
U.S. Trade Representative Karan Bhatia, who led the U.S. delegation during the final talks in Seoul, said the U.S.-South
Korea efforts show "that two countries with large, complex and dynamic economies and a tradition of robust public

ECO 3703                                             9                                           Spring 2007
                                             University of North Florida
involvement can work through challenges and create a high-quality free-trade agreement."

Forecasts by private and South Korean government-funded institutes before the agreement showed the countries' two-
way trade, which was $75 billion last year, could increase to between $90 billion and $100 billion within a few years.
South Korea, which had a $14 billion trade surplus with the U.S. last year, would see its surplus continue, though its
advantage would likely shrink as the overall pie grew.

The final pact lowers tariffs in many industrial segments and reduces investment protections in service industries. U.S.
legal and accounting firms, for instance, will find it easier to set up their own offices in South Korea. Producers of U.S.
television shows will be able to sell more of them to Korean broadcasters as quotas on domestic programs fall away.

With more competition, such service businesses could become more efficient and profitable, says Kim Jung Sik, an
international-trade professor at Yonsei University in Seoul. "The agreement will strengthen the service industry just as
the liberalization of the manufacturing industry in the 1980s led to an increase in exports," he says.

In one key part of the agreement, South Korea agreed immediately to drop tariffs and other restrictions on imported
cars. Currently these consist of an 8% tariff, a tax on engine size and restrictions on parts, and have created one of the
most lopsided car markets in the world: Just 3.5% of cars sold last year in South Korea were imported, compared with
37% in the U.S. The U.S. also will drop a much smaller tariff on Korean cars over three years and a larger one on
pickup trucks over 10 years.

Still, the deal is narrower than the countries planned when they began formal talks. South Korea excluded large swaths
of its agricultural production, led by rice, its biggest crop. That means Koreans likely will continue having to pay about
four times as much for rice as Chinese pay. Other food quotas will be reduced slowly: South Korea's 40% tariff on beef
will phase out over 15 years -- though right now South Korea accepts no imports of U.S. beef after a case of mad-cow
disease was found in the U.S. in late 2003.

U.S. Senate Finance Committee Chairman Max Baucus, a Montana Democrat, blasted the agreement over the beef
issue, saying it was "an entirely unacceptable outcome." Sen. Baucus said he wouldn't allow the deal to move in the
Senate "until Korea completely lifts its ban on U.S. beef," a message the administration already has conveyed to the
South Koreans.

Sen. Charles Grassley, an Iowa Republican and the ranking member of the Senate Finance Committee, said he has
"mixed feelings" about the deal, which would open markets for U.S. soybean and wheat farmers while doing little to
reward ranchers or rice farmers.

The agreement is a boost to U.S. President George W. Bush and South Korean President Roh Moo Hyun, who are both
in their final terms and suffering from low support ratings and slowing economies. For Mr. Bush, the deal proves that
the U.S. can forge a major trade pact with another industrial power, not just the smaller economies it has so far reached
deals with, such as Chile, Jordan and Australia.

For Mr. Roh, the deal is a victory for his campaign to shake off the vestiges of the country's protectionist past, when the
country kept out imports and foreign companies to nurture domestically run industries. It sets the stage for South Korea
to forge free-trade deals with Canada, Australia, the European Union and others, and may become the largest economic
accomplishment of Mr. Roh's five-year presidency, which ends early next year.

On the final day of talks, both countries compromised on core areas. South Korea agreed to end its ban on U.S. beef if
an expected safety reclassification of U.S. meat is made by a world health group next month. And the U.S. will consider
adding to the pact items that are made by South Korean companies at an industrial park just across the border in North
Korea. The U.S. has refused to engage in trade with North Korea for years and has expressed worries that the North's
oppressive government benefits from the industrial park.

The two countries reached the deal just before midnight, Eastern Time in the U.S., in time to reach Congress ahead of a
deadline tied to the expiration of Mr. Bush's trade-negotiating powers.

With fewer than 80 minutes remaining to the U.S. deadline, South Korea Trade Minister Kim Hyun Chong left the
Grand Hyatt Hotel in Seoul, where the negotiations were taking place, to meet Mr. Roh and several other cabinet
ministers to discuss final terms. He called Mr. Bhatia on his way back to the hotel -- 22 minutes before the deadline --
to say the countries had a deal. A complete draft of the deal will take a week or two, after which Messrs. Bush and Roh
will have to win approval for the deal from lawmakers.

ECO 3703                                              10                                          Spring 2007

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