Carefully analyze and answer the questions.
1. Consider the numerical examples of exercise 1 and 2 on page 52 in Krugman and Obstfeld (8th Edition).
Draw the production possibility frontier for each country.
Which country has a comparative advantage in apples, which one in bananas?
Which country has an absolute advantage?
Indicate the range of the international prices within which there will be gains from trade for both countries.
Now imagine that Home's technology is different. It turns out that one unit of Home labor can produce 0.2 apples or 1 banana. What would the pattern of production/trade be in this case? Explain the reason why the trade pattern is the way it is.
2.Take the numerical example we used in class to discuss the Ricardo model.
Draw the world production possibility frontier. (Hint: To do so, ask yourself what world output would be for all possible international prices (Pc/Pw)t). Now assume that both countries consume wine and clothing in equal proportions (i.e., their utility function is of the form U(c,w) = min {c,w}. Wine (w) and clothing (c ) are perfect complements) Now indicate on the graph the exact point on the world production possibility frontier at which the world consumes. Compare that point to the world consumption point before trade and before specialization.
As you notice, there are indeed gains from trade.
The question left is whether a world with free trade is the best of all possible worlds. Convince yourself that it is actually not always the best case. Allow for international mobility of labor. In other words, workers are free to decide where they want to work (at home or abroad). Show us how the production possibility frontier will look like in this case. Convince yourself that indeed, under this scenario, the world is better off than in the case of free trade. Now when you consider the international division of production (i.e., where goods will be produced) with internationally mobile labor, would you say that it is in line with the principle of comparative advantage? Discuss
You should realize while doing this exercise how essential the assumption of the international immobility of labor is for international trade and the theory of comparative advantage.
3.Discuss problems 6 and 9 in Krugman and Obstfeld, p. 52.
4.Your country imports high tech products and exports agricultural products.
Suppose you had any control over future technological developments (You have none, but anyway), would you prefer scenario (a), (b) or (c) and why? (Where necessary, illustrate with a graph using the Ricardo analysis of comparative advantage.)
a. There is a technological revolution abroad in the high tech industry. In other words, productivity increases significantly in the technology sector.
b. There is a productivity increase abroad in the agricultural sector.
c. No technological revolution at all abroad.
5.Answer the problem 7 in Feenstra and Taylor, p. 57....
A life office is planning to issue a new series of 3-year unit linked endowment policies. Two designs of policy are under consideration, both having level annual premiums of f1,000. Type A: 85% of the first year's premium and 101% of each subsequent premium is invested in units. On surrender the bid value of the units allocated is paid. Type B: 95% of each premium is invested in units. On surrender the bid value of the units allocated is paid less a penalty of 10% of the total premiums outstanding under the policy. There is a bid/offer spread in unit values, the bid price being 95% of the offer price. A fund management charge of 1% of the value of the policyholder's fund is deducted at the end of each policy year. The death benefit, which is payable at the end of the year of death, and the maturity value are equal to the bid value of the units allocated. Surrenders are assumed to take place at the end of the year. The office's expenses in respect of the policy are f100 at the start of the first year and (30 at the start of the second and third years. The office holds unit reserves equal to the bid value of the units and zero non-unit reserves. The dependent rate of mortality at each age is assumed to be 1% and the dependent rate of surrender at each duration is 5%. The non-unit fund is assumed to grow at the rate of 71/1% pa. (i) Calculate the unit fund values at the end of each year assuming that the growth in unit value is 71%% pa and hence calculate the estimated maturity proceeds for each policy type. [6] (ii) Calculate the net present value of the profit that is expected to arise under each policy type, using a discount rate of 10% pa. [8] [Total 14]1. (24 points) Suppose the graph below represents an economy that is initially in long-run equilibrium. Note: The price level is being measured by the GDP Deflator divided by 100 so that it takes on values such as 1.20 instead of 120. This doesn't change the substance of our work, but it makes the math a little easier. LRAS P SRAS P = 1.20. . . . . . . . . . . . . . . . . . A B P = 1.10 C P = 0.95... AD2 AD1 14.2 Y a. Suppose the economy is in long-run equilibrium at a current price level of 1.20. If nominal GDP is $18 trillion, what is real GDP? Real GDP = Nominal GDP/price level 18 trillion/1.2= $15 trillion b. Suppose that a pandemic causes a sharp and sudden decrease in consumption spending. Spending rebounds in the following quarter but remains significantly below it's level prior to the pandemic. Which curve shifts on the graph above? If the economy was originally in long-run equilibrium at point, A, which is the new short-run equilibrium following the decrease in consumption spending, A, B, or C? Briefly explain your answers. A decrease in consumption spending means decreased aggregate demand. So it shifts the AD curve to the left from AD1 to AD2, which crosses SRAS curve at point B. C. What happens to nominal wages when this shift occurs to the new short-run equilibrium? What happens to real wages? Are they above, below, or the same as at the original long-run equilibrium at point A? At point B the nominal wage doesn't change but since price level is lower, real wage increases. Therefore, real wage is higher than its level at point A. d. Assuming the government takes no action, how will market forces drive the economy back to the long-run equilibrium (which curve will shift and why)? Will the new long-run equilibrium be the original one at point A, or a new one at point C? In the long run, lower price level will reduce production cost, therefore, firms increase output. Aggregate supply rises so the SRAS curve shifts to the right. New SRAS will cross AD2 at point C. e. When the economy once again reaches its long-run equilibrium, are nominal wages higher, lower or the same as they were at point A? Are real wages higher, lower, or the same as they were at point A?. Nominal wage is lower at point C and real wage is lower than it is at point A. 2. (8 points) Elmer Fudd believes increasing the money supply will have no short-run effect during a recession because money is neutral. Briefly explain the error in Elmer's reasoning.CHAPTER 2 0 TRADE AND TECHNOLOGY: THE RIDARDIAN MODEL 57 b. Which country has an absolute advantage in f. In the trade equilibrium, do Foreign work- the production of bicycles? Which country ers earn more or less than those at Home, has an absolute advantage in the production measured in terms of their ability to pur- of snowboards? chase goods? Explain why. c. What is the opportunity cost of bicycles in terms of snowboards at Home? What is the 8. Why do some low-wage countries, such as opportunity cost of bicycles in terms of China, pose a threat to manufacturers in indus- snowboards in Foreign? trial countries, such as the United States, d. Which product will Home export, and whereas other low-wage countries, such as Haiti, do not? which product does Foreign export? Briefly explain why. Answer Problems 9 to 1 1 using the chapter information 7. Assume that Home and Foreign produce two for Home and Foreign. goods, TV's and cars, and use the information 9. a. Suppose that the number of workers dou- below to answer the following questions: bles in Home. What happens to the Home PPF and what happens to the no-trade rela- In the No-Trade Equilibrium tive price of wheat? Home Country Foreign Country b. Suppose that there is technological progress in the wheat industry such that Home can produce more wheat with the same amount MPL P of labor. What happens to the Home PPF, Pir = 3 and what happens to the relative price of wheat? Describe what would happen if a. What is the marginal product of labor a similar change occurred in the cloth for TV's and cars in the Home country? industry. What is the no-trade relative price of TV's at Home? 10. a. Using Figure 2-5, show that an increase in b. What is the marginal product of labor for the relative price of wheat from its world TVs and cars in the Foreign country? What relative price of f will raise Home's utility. is the no-trade relative price of TV's in b. Using Figure 2-6, show that an increase in Foreign? the relative price of wheat from its world c. Suppose the world relative price of TV's in relative price of f will lower Foreign's utili- the trade equilibrium is Pre-/Pc = 1. Which ty. What is Foreign's utility when the world good will each country export? Briefly relative price reaches 1, and what happens in explain why. Foreign when the world relative price of d. In the trade equilibrium, what is the real wheat rises above that level? wage at Home in terms of cars and in terms 11. (This is a barder question.) Suppose that the of TVs? How do these values compare with Home country is much larger than the Foreign the real wage in terms of either good in the country. For example, suppose we double the no-trade equilibrium? number of workers at Home from 25 to 50. c. In the trade equilibrium, what is the real Then Home is willing to export up to 100 wage in Foreign in terms of TV's and in bushels of wheat at its no-trade price of terms of cars? How do these values compare Pur/Pc= + rather than 50 bushels of wheat as with the real wage in terms of either good shown in Figure 2-11. In the following, we in the no-trade equilibrium? draw a new version of Figure 2-11, with the larger Home country.1/1 ONE International Trade Theory PROBLEMS Weconlab I. Home has 2,400 units of labor available. It can produce two goods, oranges and point. The unit labor requirement in orange production is 6, while in poor production it is 4 L. Graph Home's production possibility frontier. h. What is the opportunity cost of orampes in terms of pears? c. In the absence of trade, what would be the price of oranges in terms of pears? Why? 1. Home is as described in problem 1. There is now also another country, Foreign, with a labor force of 1600. Foreign's unit labor requirement in orange production is 10, while in pear production it is 2. a. Graph Foreign's production possibilities frontier. b. Contract the world relative supply curve. 3. Now suppose world relative demand takes the following form: Demand for oranges/ demand for pears = price of pears/price of oranges. a. Graph the relative demand curve along with the relative supply curve. h. What is the equilibrium relative price of oranges? C. Describe the pattern of trade. d. Show that both Home and Foreign gain from trade. 4. Suppose that instead of 2,400 workers, Home had 4,800. Find the equilibrium relative price. What can you say about the efficiency of world production and the division of the gains from trade between Home and Foreign In this case? 5. Suppose that Home has 4,800 workers but is only half as productive in both industrie as we have been assurming. Construct the world relative supply curve and drama the equilibrium relative price. How do the gales from trade compare with there in the case described in problem 4? 6. "Chinese workers cars only $.75 per hour, If we allow China to export as much as it likes, our workers will be forced down to the same level. You can't import a $12 shirt without importing the 5.75 wage that goes with it"Discuss 7. Japanese labor productivity is roughly the same as that of the United States in the manufacturing sector (higher in some industries, lower In other), while the United States is still considerably more productive in the service sector But most services are nontraded. Some analysts have argued that this poses a problem for the United States, because our comparative advantage lies in things we cannot sell on world markets. What is wrong with this argument? 8. Anyone who has visited Japan knows it is an Incredibly expensive place, although Japanese workers earn about the same as their U.S. counterparts, the purchasing power of their incomes is about one-third less. Extend your discus ion 7 10 explain this observation. (Hint: Think about wages and the implied prices of no goods.) ". How does the fact that many goods are nontraded affect the extent of possible gains from trade? 10. We have focused on the case of trade involving only two countries. Support that there are many countries capable of producing two goods, and that each country has only one factor of production, Isbor. What could we say about the pattern of production and trade In this case? (Hint: Try constructing the world relative supply curve.)
