hw1solutions1

hw1solutions1 - Econ/EEP 181 International Trade Assignment...

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Econ/EEP 181: International Trade Assignment # 1 Solutions Luosha Du, Shanthi Nataraj, and Robert Santillano University of California, Berkeley Due: September 15, 2008 1. We are given the following labor input requirements: Cloth Wheat UK 4 hours 12 hours USA 6 hours 4 hours (a) What is the relative price of cloth in terms of wheat in the UK? In the USA? In autarky, relative prices are equal to the opportunity cost of production. This is because, if a positive amount of both goods are demanded, in equilibrium, the cost of purchasing a good must equal the cost to produce the good. Letting the USA be home and UK be foreign, we have : P c P w = a c a w = 3 2 wheat cloth P * c P * w = a * c a * w = 1 3 wheat cloth Notice, we wrote in the units for the relative price and opportunity cost. (b) Where will the free trade price settle post trade? Who will export which good? If positive amounts of both goods are demanded in each country, then the post trade price must either be equal to, or rest in between the two autarkic relative prices. This gives : ± P c P w ² w ³ 1 3 , 3 2 ´ A country will export whichever good for which they have a comparative advantage. From the above calculations, since the UK has a lower opportunity cost for cloth in terms of wheat, they will export cloth and the US will export wheat. (c) If the post-trade relative price of cloth in terms of wheat is equal to 1/3, show what happens to consumption of cloth and wheat in the US and UK pre- and post-trade. Use this information to calculate the wage in the USA relative to the UK post-trade. We answer this question by asking: “How much can we consume with one unit of labor pre- and post-trade?” Before trade, a country can only consume what it can produce itself, so it depends on technology (i.e. ULRs). With trade, however, a country will produce the good for which it has a comparative advantage and can then either consume it, or trade it at world prices for the other good. We therefore, get the following : 1
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Table 1: Consumption with 1 Unit of Labor Before Trade After Trade with ± P c P w ² w = 1 3 wheat cloth Cloth Wheat Cloth Wheat UK 1/4 1/12 1/4 1/12 USA 1/6 1/4 3/4 1/4 In the table above, boxes are used to denote the goods for which a country has a comparative advantage in the “Before Trade” columns. We know those amounts are produced post trade in each of the countries after trade, and then we convert them into the other good using the relative price of 1/3. This is easily done when we notice the units on the relative price of cloth in terms of wheat. For example, if the US produces 1/4 units of wheat, we perform the following calculation to determine how much cloth they can consume : 1 4 wheat × 3 1 cloth wheat = 3 4 cloth
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hw1solutions1 - Econ/EEP 181 International Trade Assignment...

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