Econ101PS1Solutions

Econ101PS1Solutions - Economics 101 | Fall 2009...

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Economics 101 | Fall 2009 International Trade Problem Set 1-Answer Key-. Instructor: Marc-Andreas Muendler E-mail: muendler@ucsd.edu 1 . Ricardian Trade Theory and Specialization We have: ܮ ൌ ͳͲͲ Ǣ ܮ כ ൌ ʹͲͲ PPF. Labor in Home is allocated to cheese and wine production, ܮ ൌ ͳͲͲ ൌ ܮ ൅ ܮ . Substituting: ܮ ൌ ͷܳ and ܮ ൌ ʹܳ , we find PPF: ͳͲͲ ൌ ͷܳ ܥ ൅ ʹܳ ܹ Labor in Foreign is allocated to cheese and wine production, ܮ כ ൌ ʹͲͲ ൌ ܮ כ ൅ ܮ כ . Substituting: ܮ כ ൌ ͸ܳ ܥ כ and ܮ כ Ǥ ൌ ͸ܳ ܹ כ , we find PPF: ʹͲͲ ൌ ͸ܳ ܹ כ ൅ ͸ܳ ܥ כ Opportunity cost of cheese: Home: ಽ಴ ಽೈ ൌ ʹǤͷ Foreign: ಽ಴ כ ಽೈ כ ൌ ͳ Home has absolute adavantage in both and comparative adavantage in the production of wine.
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Autarky. The autarky consumption possibilities are the PPFs. The relative price of cheese in terms of wine in autarky is 2.5 in Home and 1 in Foreign. Free Trade. World equilibrium requires that relative supply of goods equals their relative demand at world equilibrium prices. If the relative price of cheese ܥ ܹ exceeds a country's opportunity cost in cheese production, its firms will specialize in cheese. If ܥ ܹ is less than opportunity cos W± WKHQ WKH FRXQWU\¶V ILU ms will specialize in wine. If the relative price happens to equal opportunity cost, the country's firms have the same earnings when making cheese or wine. The country's firms will be willing to supply any relative amount of the two, resulting in a flat section to the relative supply curve. Therefore, ܫ݂ ௉஼ ௉ௐ ൏ ͳǡ ݐ݄݁݊ ାொ כ כ ାொ ൌ Ͳ ; Both countries produce wine. ܫ݂ ͳ ൏ ௉஼ ௉ௐ ൏ ʹǤͷǡ ݐ݄݁݊ ାொ כ כ ାொ ଴ା כ ା଴ ; Home specializes in wine and Foreign in Cheese. ܫ݂ ௉஼ ௉ௐ ൐ ʹǤͷǡ ݐ݄݁݊ ାொ כ כ ାொ ௬௜௘௟ௗ௦ ሱۛۛሮ λ ; Both countries produce cheese. This relative supply is depicted in Figure 2. We are given 3 different demand functions. Case 1. ܳ ൅ ܳ כ ܳ כ ൅ ܳ ൌ ͸ െ ͷሺ ܲܥ ܹܲ
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As you can see in Figure 2, the relative quantity of cheese in equilibrium is ; Home specializes in wine and Foreign in cheese production. The world equilibrium price is ଵ଺ ଵହ . Using this price in Figure 1, we see that the world trade line expands both countries' consumption. Case 3. ܳ ൅ ܳ כ ܳ כ ൅ ܳ ൌ Ͷ െ ͷሺ ܲܥ ܹܲ As you can see in Figure 2, there is not any price for which the relative demand for cheese is greater than the relative supply; this means, the relative quantity is 0 in equilibrium, and then the relative price is ; both countries produce wine. No cheese is produced. No international trade occurs.
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Econ101PS1Solutions - Economics 101 | Fall 2009...

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