ECON 433 Problem Set 1- The Ricardian Model

Question I. The Ricardian Model 1. Answer the questions below using the information given by the following table. Home Foreign Absolute country country advantage Number of bicycles produced per hour 4 2 ? Number of snowboards produced per hour 6 8 ? Comparative advantage ? ? a. Complete the above table. b. Which country has an absolute advantage in the production of bicycles? c. Which country has an absolute advantage in the production of snowboards? d. What is the opportunity cost of bicycles in terms of snowboards at Home? What is the opportunity cost of bicycles in terms of snowboards in Foreign? e. Which product will Home export and which product will Foreign export? Briey explain why. 2. Assume that Home and Foreign produce two goods televisions and cars and use the following information to answer the questions. In the no-trade equilibrium Home country Foreign country WageTV = 12 WageC =? Wage TV =? Wage C = 6 MPLTV = 2 MPLC =? MPL TV =? MPL C = 1 PTV =? PC = 4 P TV = 3 P C =? a. What is the marginal product of labor for televisions and cars in the Home country? What is the no-trade relative price of televisions at Home? b. What is the marginal product of labor for televisions and cars in Foreign? What is the no-trade relative price of televisions in Foreign? c. Suppose the world relative price of televisions in the trade equilibrium is PTV =P C = 1. Which good will each country export? Briey explain why. d. In the trade equilibrium what is the real wage at Home in terms of cars and in terms of televisions? How do these values compare with the real wage in terms of either good in the no-trade equilibrium? e. In the trade equilibrium what is the real wage in Foreign in terms of televisions and in terms of cars? How do these values compare with the real wage in terms of either good in the no-trade equilibrium? f. In the trade equilibrium do Foreign workers earn more or less than those at Home measured in terms of their ability to purchase goods? Explain why. 3. Why do some low-wage countries such as China pose a threat to manufacturers in industrial countries such as the United States whereas other low-wage countries such as Haiti do not? II. The Specic-Factors Model 4. In the specic-factors model assume that the price of agricultural goods decreases whereas the price of manufactured goods is unchanged (PA=P A < 0 and PM =PM = 0). Arrange the following terms in ascending order: RT =R T RK =R K PA=P A PM =PM W=W 5. Suppose two countries Canada and Mexico produce two goods timber and televisions. Assume that land is specic to timber capital is specic to televisions and labor is free to move between the two industries. When Canada and Mexico engage in free trade the relative price of televisions falls in Canada and the relative price of timber falls in Mexico. a. Using a graph show how the wage changes in Canada because of a fall in the price of televisions holding constant the price of timber. Can we predict that change in the real wage? b. What is the impact of opening trade on the rentals on capital and land in Canada? Can we predict that change in the real rentals on capital and land? c. What is the impact of opening trade on the rentals on capital and land in Mexico? Can we predict that change in the real rentals on capital and land? d. In each country has the specic factor in the export industry gained or lost and has the specic factor in the import industry gained or lost? III. The Heckscher-Ohlin Model 6. This exercise uses the Heckscher-Ohlin model to predict the direction of trade. Consider the production of hand-made rugs and assembly line robots in Canada and India. a. Which country would you expect to be relatively labor-abundant and which capital-abundant? Why? b. Which industry would you expect to be relatively labor-intensive and which is capital-intensive? Why? c. Given your answers to (a) and (b) draw production possibilities frontiers for each country. Assuming that consumer preferences are the same in both countries add indierence curves and relative price lines (without trade) to your PPF graphs. What do the slopes of the price lines tell you about the direction of trade? d. Allowing for trade between countries redraw the graphs and include a trade triangle for each country. Identify and label the vertical and horizontal sides of the triangles as either imports or exports. 7. Leontief's paradox is an example of testing a trade model using actual data observations. If Leontief had observed that the amount of labor needed per $1 million of U. S. exports was 100 instead of 182 would he have reached the same conclusion? Explain. 2 8. Assume that only two goods are produced and consumed in the world economy shoes and computers. Suppose that there are drastic technological improvements in shoe production at Home such that shoe factories can operate almost completely with computer-aided machines. Consider the following data for the Home country: Computers: Sales revenue = PC QC = 100 Payments to labor = WLC = 50 Payments to capital = RKC = 50 Percentage increase in the price = PC =P C = 0% Shoes: Sales revenue = PS QS = 100 Payments to labor = WLS = 5 Payments to capital = RKS = 95 Percentage increase in the price = PS =P S = 50% a. Which industry is capital-intensive? Is this a realistic scenario (i. e. are some industries capital-intensive in some countries and labor-intensive in others)? b. Given the percentage changes in output prices above calculate the percentage change in the rental on capital. c. How does the magnitude of this change compare with that of labor? d. Which factor gains in real terms and which factor loses? Are these results consistent with the Stolper-Samuelson theorem? 9. In 2008 the Ukraine successfully negotiated terms to become a member of the World Trade Organization. Consequently countries such as those in Western Europe are shifting toward free trade with the Ukraine. What does the Stolper-Samuelson theorem predict about the impact of the shift on the real wage of unskilled labor in Western Europe? In the Ukraine? 10. According to the Heckscher-Ohlin model two countries can equalize wage dierences by either engaging in international trade in goods or allowing skilled and unskilled labor to freely move between the two countries. Discuss whether this is true or false and explain why

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