SUGGESTED ANSWERS TO CHAPTER 1 QUESTIONS
1.a. What are the various categories of multinational firms? ANSWER. Raw materials seekers, market seekers, and cost minimizers. b. What is the motivation for international expansion of firms within each category?
ANSWER. The raw materials seekers go abroad to exploit the raw materials that can be found there. It just happens that nature didn't place all natural resources domestically. Market seekers go overseas to produce and sell in foreign markets. The cost minimizers invest in lower-cost production sites overseas in order to remain cost competitive both at home and abroad. In all cases, the firms involved recognize that the world is larger than the home country and provides opportunities to gain additional supplies, sell more products or find lower cost sources of production. 2.a. How does foreign competition limit the prices that domestic companies can charge and the wages and benefits that workers can demand? ANSWER. As domestic producers raise their prices, customers begin substituting less expensive goods and services supplied by foreign producers. The likelihood of losing sales limits the prices that domestic firms can charge. Foreign competition also acts to limit the wages and benefits that workers can demand. If workers demand more money, firms have two choices. Acquiesce in these demands or fight them. Absent foreign competition, the cost of acquiescence is relatively low, particularly if the industry is unionized. Since all firms will face the same higher costs, they can cover these higher costs by all of them simultaneously raising their prices without fear of being undercut or of being placed at a competitive disadvantage relative to their peers. Foreign competition changes the picture since foreign firms' costs will be unaffected by higher domestic wages and benefits. If domestic firms give in on wages and benefits, foreign firms will underprice them in the market and take market share away. In this case, higher domestic costs will put domestic firms at a disadvantage vis-à-vis their foreign competitors. Recognizing this, domestic firms facing foreign competition are more likely to fight worker demands for higher wages and benefits. b. What political solutions can help companies and unions avoid the limitations imposed by foreign competition?
ANSWER. The classic political solution is protectionism. By limiting foreign competition, either through tariffs or quotas, companies and workers limit the ability of foreign goods to restrain domestic price increases. The government can also subsidize domestic firms in competing against foreign firms. These subsidies allow domestic firms and unions to perpetuate uneconomic work rules, wages, and productions processes. c. Who pays for these political solutions? Explain.
ANSWER. Consumers pay for protectionism in the form of higher prices for their goods and service, fewer choices, and lower quality. These consumers include firms that use imports to produce their own goods and services for sale. Taxpayers pay for subsidies in the form of higher taxes or fewer of the other services provided by government. 3.a. What factors appear to underlie the Asian currency crisis? ANSWER. Asian countries had run up huge debts, mostly in dollars, and were depending on the stability of their currencies to repay these loans. Worse, Asian banks, urged on by the often corrupt political leadership, were shoveling loans into money-losing ventures that were controlled by political cronies. The result was financially troubled economies that could not generate the income necessary to repay their dollar loans. b. What lessons can we learn from the Asian currency crisis?
ANSWER. Financial crises can be avoided or mitigated if financial markets are open and transparent, thereby leading to investment decisions that are based on sound economic principles rather than cronyism or...