The Global Economy
Trade and Trade Policy
1. (30 points) Study the following table, which shows the maximum output of beer and chips
that the Korea and Bangladesh can produce under constant cost conditions (recall from lecture
that constant cost conditions means that the production possibility frontier will be linear; by
contrast increasing costs means the production possibility frontier will have the curved shape).
Product Korea Bangladesh
Smartphones 30,000 12,000
Garments 5,000 3,000
(a) Graph the production possibilities frontiers for Korea and Bangladesh. In the absence
of trade, assume that the Korea produces and consumes 18,000 smartphones and 2,000
garments; Bangladesh produces and consumes 8,000 smartphones and 1,000 garments.
Indicate these points on each country’s production possibilities frontiers.
(b) Determine the domestic relative price ratio for each country (note: this is the same as the
marginal rate of transformation between these two goods). Explain as clearly as you can
how to interpret this domestic relative price ratio using both terms of the marginal rate
of transformation and opportunity costs.
(c) According to comparative advantage, should the two countries specialize and trade with
one another? Explain your answer in reference to relative price ratios. If they do trade,
which country should specialize in the production of which product? Once specialization
has occurred, what is the increase in output?
(d) Suppose that the international price ratio (i.e. the “terms of trade”) is 1 garment for
5 smartphones. Assume that 2,000 garments are traded for 10,000 phones. Are the
consumers in Korea and Bangladesh better off? If so, by exactly how much?
(e) Now suppose that global demand for phones and garments has shifted, which causes a
change in the terms of trade. The new international price becomes 1.2 garments per 5
phones (which is of course equal to 4.17 phones per garment). Assume again that 2,000
garments are traded. How does this shift in the terms of trade affect the gains from trade
for each country?
(f) Suppose that demand shifts again and now the global terms of trade are 2 garments per
5 phones. Will trade occur? Why or why not?
2. (10 points) Traditional trade theory is basically a static theory of international exchange (i.e.
it only focuses on a point in time) leading to certain conclusions about the benefits likely to
accrue to all participants. Explain both the limitations of this static perspective as well as the
dynamic elements that are important (i.e. “dynamic” means refers to trade policy and openness
over time). Please describe specific historical examples (other than the examples given in class
from Korea, the US, and England) to illustrate your points about dynamic trade policy. (Hint:
the Ha-Joon Chang chapters from Bad Samaritans will help you immensely with this problem.)
3. (10 points) Use the Logic of Collective Action to analyze a major Korea or international policy
issue of your choice (it could either be a policy that successfully passed or one that failed to
pass).
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