Assignment 1

This problem set is designed to help you master the concepts and tools covered in class so far. Question 2 requires you to manipulate real data and apply it to the concepts used in class. Question 1 looks at the theory.

Question 1 Quantitative/Graphing Problem on the Ricardo Model (50 points)

Apply the Ricardian model to the following scenario: Two countries, Home (H) and Foreign (F) produce two goods, clothing (C) and wheat (W) using labor as the only factor of production. Marginal productivity of labor is constant in each country and is defined by the following schedule: 1 worker can produce 1 yard of cloth or 1/4 a bushel of wheat at home, while 1 worker produce 1 yard of clothing or 1/2 bushels of wheat. Finally, each country has 1000 workers.

1. what are the production functions for cloth and wheat in each country and the marginal product of labor in each?
2. Which country has absolute advantage in the production of clothing? How about wheat? Explain.
3. Which country has comparative advantage in clothing? How about wheat? Why?
4. What is the price of cloth in terms of wheat in the home country?
5. According to the principle of comparative advantage, which country should specialize and
6. export what good?
7. In order for Home to gain from trade the world price of Clothing in terms of Wheat should be
8. lower than ____________.
9. At what price of clothing, in terms of wheat, will the benefits to Foreign from trade be largest?
10. What will the benefit for home be at this price?
11. Draw the Production possibilities frontier (PPF) for home in Autarky by putting clothing on the X-axis and wheat on the y-axis. Make sure that you label each axis and that you mark down the appropriate numbers for the maximum amounts of wheat and clothing that can be produced.

• -What is the slope of the PPF?
• -What is the equation for the PPF curve?
• -Include the utility function in your drawing and show where the economy would operate in autarky (mark A). Can you explain why this is the autarkic equilibrium?
• i. Now assume that home and foreign start trading (at zero cost) at a relative price of wheat in terms of clothing that is feasible. Use graphical analysis, to show that Home can gain from trade. Denote the new trade equilibrium T.
• Now let's put some numbers and equations to the autarkic and with-trade equilibriums
• h. Assume that preferences in home and foreign are identical and described by a Cobb Douglas utility function: = /. /

- In autarky, how much C and W will be produced and consumed in the home country?

j. Given what we know about the utility functions of Home and Foreign, what is the world price of cloth relative to wheat with trade.

- How much wheat and cloth are produced by Home and Foreign under trade (Remember in the Ricardo model both countries would specialize)? Why?

- Using the utility functions work out the world price where total demand equals total supply for each commodity.

- What would be the quantities of cloth and wheat consumed by home and foreign? - Do both countries gain from trade at this price? Explain.

Question 2 Analyzing Real Data (50 points)

This question is designed to get you looking at real data and to relate it to the concepts and theories discussed in class. Accompanying this assignment is an excel sheet containing trade and value-added data for a number of countries.

a) You must first select the two countries you would like to discuss. Note that because we examined China and the USA in class, you must select at least one country that is not China or the USA. Instead pick select the USA and the Philippines; or China and India or you can choose to discuss the USA, China and a third country or two entirely different countries. What are your countries?

Using the data from the excel file answer the following questions:

1. b)In topic 2 we spoke about the revealed comparative advantage index (or Balassa index) used to look at which products a country export's most intensely. Using the data provided, calculate the Balassa indexes for US and China exports by commodity using the following formula:
3. Where

• are the exports of commodity j by country i (e.g., for USA and China, i includes the USA and China)
• are total exports of country i
• are the world imports/exports of commodity j
• are world imports/exports

1. c)Which commodities do each of your countries export most intensely (i.e., more than the average country - list top 10)? Based on these lists, do you see any opportunities for these countries to trade?

Country 1

Balassa

Country 2

Balassa

1. d)Do the countries you are looking at have any trade-related agreements or belong to a common agreement? Do both your countries belong to the WTO? What does this mean for their trading relations (what agreement governs trade between them)?
2. e)Ricardo's theory of comparative advantage relates trade to relative productivity. The excel file provides information on value added which can be used to look at productivity.

i. Calculate the relative productivity per worker by sector (j):

= , , , ,

Where:

• is value-added in production of commodity j by country i (where i is country or 2)
• is the number of workers employed in the production of commodity j by country i (where i is country 1 or 2)

1. Calculate relative exports by commodity for country 1 and 2:
2. = , ,
3. Calculate the correlation coefficient between the two vectors. Are productivity and trade related?

f) What conclusions can you draw from the data about the countries' absolute and comparative advantages?