PS01a-Ricardo - Econ 441 Problem Set 1 - Answers Alan...

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Econ 441 Alan Deardorff Problem Set 1 - Answers Ricardian Model Page 1 of 9 Problem Set 1 - Answers The Ricardian Model 1. Which of the following characterize the Ricardian Model? a. Perfect mobility of factors across industries Yes b. Perfect mobility of factors across countries No c. Constant returns to scale Yes (Almost trivially, since, with only one factor, a proportional increase in all factors is just an increase in labor. Since output is proportional to the labor input, this satisfies the definition of constant returns to scale: that a proportional increase in all inputs leads to an equal proportional increase in output.) d. The law of diminishing returns No (Or one could say that it does not apply. That is, an increase in one factor input does not lead to a fall in its marginal product, as the law of diminishing returns would predict. But in this case there is no other factor input to be held fixed, as required for that law to apply.) e. Identical technologies across industries No f. Identical technologies across countries No g. Cournot competition No h. Perfect competition Yes 2. Suppose that a small open economy has 200 workers and that its technology requires 1 worker-hour per unit of food and 3 worker-hours per unit of cloth. In autarky, it employs 100 workers in each of the two industries. With free trade, it faces world prices of $10 per unit of food and $20 per unit of cloth. a. Suppose that in autarky, workers in both industries are paid $8 per hour. What are the autarky prices of food and cloth? Prices of the goods are just their costs of production: p F = 8 · 1 = $8 per unit of Food; p C = 8 · 3 = $24 per unit of Cloth. b. When the country opens to free trade, under the normal assumptions of the Ricardian model, what will it produce, import, and export? From the information given, can you determine the quantities of any of these? What is the country’s national income with trade, measured in dollars? The country has a comparative advantage in Food, since a LF /a LC = 1/3 while p F /p C = 10/20 = 1/2, and thus a LF /a LC < p F /p C . It will therefore specialize completely in producing Food, moving all of its 200 workers there. Its output of food (per hour) will be 200 units, while its output of Cloth will be zero.
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Econ 441 Alan Deardorff Problem Set 1 - Answers Ricardian Model Page 2 of 9 Producing only Food, but demanding both goods, it will export Food and import Cloth. We cannot determine the quantities of exports and imports without more information about the structure of demand. National income is 10 · 200 = $2000 per hour. (If we follow Mikic in assuming Cobb-Douglas preferences – which she assumes implicitly on page 16 – then we can say more. Since in autarky 100 workers were employed in both industries, paid the same wages, consumers must have been spending half of their incomes on each good. With an income of $2000 with trade, they will spend $1000 on Food, buying 1000/10 = 100 units, and thus exporting 100 units also. They will spend $1000 on Cloth,
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This note was uploaded on 04/15/2009 for the course ACCOUNTING BUSI0027 taught by Professor Guan during the Spring '09 term at HKU.

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PS01a-Ricardo - Econ 441 Problem Set 1 - Answers Alan...

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