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Unformatted text preview: Prof. Harrison, Econ 181, Fall ’06 1 Economics 181: International Trade Midterm Solutions Please answer all parts. Please show your work as much as possible. 1 Short Answer (40 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. One shortcoming of the Heckscher-Ohlin framework is that it predicts that wages everywhere in the world are equal, yet the empirical evidence suggests that wages in fact vary with country productivity levels. True or False? TRUE . One of the results of the H-O framework is the Factor Price Equalization theorem, which states that the returns to factors will equalize with trade around the world. One of the necessary assumptions for this is that technology is identical across countries. However, empirically, neither wages nor productivity levels are equalized around the world. We can therefore point to this evidence as a shortcoming of the H-O framework. 2. Theories of foreign direct investment predict which of the following should attract foreign investment to a host country? (a) High tariffs (b) Large markets (c) Firm-specific assets (internalization) (d) Low factor prices (e) All of the Above Answer: e. High tariffs block companies from selling goods to a country. By producing goods in these countries directly, they sidestep these tariffs. Producing goods in a large market increases access to sell goods in the large market. Firm-specific assets in another country ease the production process. Finally, low factor prices lower the cost of production. 3. Home and Foreign can produce cheese, wine, and tools with the following unit labor requirements: Home Foreign Cheese 12 2 Wine 4 4 Tools 9 3 In world trade equilibrium, wages at home are half of foreign, with w = 1 2 w * . What good(s) will Home produce? What good(s) will Foreign produce? Prof. Harrison, Econ 181, Fall ’06 2 The production of goods will depend on which country has the lower unit factor costs. For good i , we have to compare a i × w with a * i × w * . Rearranging this expression, home is more efficient at the production of good i if w/w * < a * i /a i . Therefore, looking at the ratio of unit labor requirements for each good, we get: a * c /a c = 1 / 6 , a * w /a w = 1 , and a * t /a t = 1 / 3 . Since w/w * = 1 / 2 home will produce wine and foreign will produce cheese and tools. 4. True or False? (please explain your answer using a diagram) In the standard trade model, an improvement in the terms of trade for a country will lead the country to export less and import more, placing the country on a lower indifference curve. FALSE . Although an improvement in the terms of trade may lead a country to export less and import more, the country will necessarily be on a higher indifference curve....
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This note was uploaded on 09/24/2008 for the course ECON c181 taught by Professor Harrison during the Fall '06 term at Berkeley.
- Fall '06