Chapt004EndofChapterproblems - Chapter 04 Extensions and...

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Chapter 04 - Extensions and Tests of the Classical Model of Trade CHAPTER 4 EXTENSIONS AND TESTS OF THE CLASSICAL MODEL OF TRADE Answers to End-of-Chapter Questions and Problems 1. As a result of the trade surplus, France experiences, under a fixed exchange rate, a net gold inflow and the United Kingdom experiences a net gold outflow. Assuming that the price- specie-flow mechanism is in operation, these gold movements will result in an increase in prices and wages in France and a decrease in prices and wages in the United Kingdom. Because the demand for traded goods is assumed to be price-elastic, this will cause the expenditures for U.K. goods by France to rise and the expenditures for French goods by the United Kingdom to fall. These adjustments will take place until trade is balanced. The changes in prices in the two countries will lead to a change in the terms of trade that will move them closer to those of the United Kingdom in autarky, i.e., the terms of trade will deteriorate for the United Kingdom and improve for France. 2. (a) There is a basis for trade here because the relative labor costs for the two commodities are different in autarky, i.e., 6/8 is not the same as 4/4. From another perspective, the individual price ratios in autarky are different between the two countries, i.e., they are 1 wine:0.67 shoes (or 1S:1.5W) in Italy and 1 wine:0.5 shoes (or 1S:2W) in Switzerland. (b) Italy should export shoes and Switzerland should export wine because the relative labor cost of shoes is less in Italy relative to wine. From Switzerland’s point of view, its absolute disadvantage is less in wine compared to shoes. (c) The international terms of trade must lie between 1 wine:0.67 shoes and 1 wine:0.5 shoes (or 1S:1.5W and 1S:2W). (d) The commodity terms of trade = 1 wine:(P wine /P shoes ) shoes [or 1 shoe:(P shoes /P wine ) wine], which results in 1 wine:(14/24) shoes, i.e., 1 wine:0.583 shoes [or 1 shoe:(24/14) wine, i.e., 1 shoe:1.714 wine].
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This note was uploaded on 10/24/2010 for the course ECON 460 taught by Professor Staff during the Fall '08 term at UNC.

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Chapt004EndofChapterproblems - Chapter 04 Extensions and...

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