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Set04a-SFGov

# Set04a-SFGov - Econ 441 Problem Set 4 Answers Alan...

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Econ 441 Alan Deardorff Problem Set 4 - Answers Specific Factors, Government Policies Page 1 of 9 Problem Set 4 - Answers Specific Factors and Government Policies 1. In the Extreme Specific Factors Model, a. What does a country’s excess demand curve look like? The PPF in the Extreme Specific Factors Model is just a point Y X , in goods space (X,Y space). Excess demand and supply are just the difference between this point and the tangencies of indifference curves with various price lines: b. What determines the relative price at which the excess demand curve crosses the vertical axis? This is the autarky price, of course, and it is given by the slope of the indifference curve passing through Y X , . c. Suppose a world of two countries that are trading freely, with the home country importing good X , and exporting good Y to Foreign. Suppose now that Home (only) experiences an improvement in its technology so that the factors employed in its X industry become more productive by, say, 10%. What will this do to i) its excess demand or supply curve, ii) the world equilibrium relative price of X , iii) the real wage of labor in Home’s X industry iv) the real rental price of capital in Foreign’s Y industry? This will increase X by 10% without changing Y . For any given price, this will increase income, causing consumption of both goods to increase (assuming they are normal goods). In order for consumption of Y to increase, however, consumption of X cannot rise by as much as X . Therefore, for any price, the country’s excess supply of X increases and its excess demand decreases, shifting X Y X p=p X /p Y p A p 1 p 2 X 1 X 2 X 1 X 2 p 1 p 2 p A ED Y X

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Econ 441 Alan Deardorff Problem Set 4 - Answers Specific Factors, Government Policies Page 2 of 9 its ED curve to the left throughout its length, as shown below. This, in turn, causes the world equilibrium relative price of X to fall, as also shown. In the Home X industry, labor is paid the value of its marginal product. That marginal product has increased by 10% due to the improved technology, so labor’s wage in units of X has gone up by that amount. However, the price of X has fallen, and we don’t know by how much. If the price falls by less than 10%, then this is necessarily an improvement in its real wage. But if it falls by more than 10%, which it may (depending on the elasticities of the various curves), then workers in the Home X industry can buy less of Y, and may be made worse off if their demand for Y is a large enough part of their budgets. Thus the effect on the wage in the Home X industry is ambiguous. As for capital in the Foreign Y industry, its marginal product has not changed, so it is paid the same in terms of Y. But that payment is worth more in terms of X, due to the price change, so its real payment has increased.
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