midterm4%20solutions - Prof. Harrison, Econ 181, Fall 05 1...

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Prof. Harrison, Econ 181, Fall ’05 1 Economics 181: International Trade Midterm Solutions 1 Short Answer (20 points) Please give a full answer. If you need to indicate whether the answer is true or false, please explain your answer. You must give an explanation to get full credit for the answer (1 point for correct answer; 1 point for the explanation). 1. (Ricardian framework). Assume that country X produces two goods, cloth and steel. Country X has an absolute advantage in the production of both goods, but only has a comparative advantage in producing steel. Assume that the free trade price is in between the two country autarky prices. With trade, consumers will have to pay a higher price for steel, but wages in country X will rise when it opens up to trade. True or False? TRUE . We know that ± a s a c ² X < ± a s a c ² W , which implies that both the autarky opportunity cost and relative price of steel in terms of cloth is lower in country X . Therefore, with trade, the relative world price for steel is higher for consumers in X than it was in autarky. Even still, since world prices differ from autarky prices, there are gains from trade, which implies that consumption in X increases. Since consumption = income = wages, wages unambiguously increase. 2. The Theorem of Factor Price Equalization (FPE) states that with trade, returns to factors should equalize throughout the world. This implies that wages should become equal across all countries. One important assumption underlying this theorem is differences in technology across countries. True or False? FALSE . The FPE theorem is derived under the assumptions of the H-O model, which assumes technology is identical across countries. 3. Home and Foreign can produce cheese, wine, and tools with the following unit labor requirements: Table 1: Unit Labor Requirements Home Foreign Cheese 4 2 Wine 2 4 Tools 2 3 In world trade equilibrium, wages are the same in home and foreign, w = w * . What good(s) will Home produce? What good(s) will Foreign produce? Each country’s production is determined by comparing the unit production costs, or a i × w vs. a * i × w * , for each good i . Whichever country has the lower unit production costs will produce the good. Since w = w * , comparative advantage is determined by directly comparing the ULR’s of each country. Therefore, Home will produce wine and tools and Foreign will produce cheese.
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Prof. Harrison, Econ 181, Fall ’05 2 4. Answer and Explain. If P c /P f were to increase in the international marketplace, then: (a) All countries would be better off (b) The terms of trade of cloth exporters improve (c) The terms of trade of food exporters improve (d) The terms of trade of all countries improve (e) None of the above Answer: B. In the standard trade model, terms of trade are defined by: TOT = P X P M . Therefore, for countries with P X P M = P c P f , an increase in the international price will increase the TOT . This is true for cloth exporters. 5. If the USA is abundant in skilled labor relative to unskilled labor, then the Stolper-Samuelson theorem
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midterm4%20solutions - Prof. Harrison, Econ 181, Fall 05 1...

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