14 - Economics 181: International Trade Answer Key ‐...

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Unformatted text preview: Economics 181: International Trade Answer Key ‐ Assignment #1, Spring 2011 Question 1: (a) (b) (c) (d) The autarky relative price of lumber in terms of fish in Iceland is 1/5 Since the autarky relative price in Canada is the same, there is no incentive to trade. Canada now has an absolute advantage in both industries Canada now has a comparative advantage in the production of lumber, Iceland has a comparative advantage in fish. (e) The relative supply schedule is shown in the figure below: Pl/Pf 10.7 (Ql/Qf)w = (Ql+Ql*)/(Qf+Qf*) (f) The figure above also shows a relative demand schedule that implies a world equilibrium price which equals Iceland’s autarky price. Therefore Iceland is incompletely specialized (g) In this scenario, the world relative price of lumber in terms of fish is given by . Since 1/4 1/5 Iceland produces both commodities, and Canada only lumber, we can link the prices to the wages using the perfect competition assumption (zero profits) as follows (w refers to the wage in Iceland, w* to the wage in Canada): 8 ∗∗ ∗ Therefore the relative wage of Iceland is given by ∗ 1 8 1 2 (h) The increase in Iceland’s labor force does not have an effect on the autarky relative prices. The only thing it does is that it moves the vertical part of the relative supply schedule to the left, from 10.7 to 6.7. Question 2: In Kenya, producing a unit of oil necessitates three times as much labor as producing one unit of shirts. Hence, as labor is the only factor, and as we assume perfect factor market and perfect mobility across industries (which implies that the wages in both industries are equal), a unit of oil costs in Kenya three times as much as a unit of shirt: 1 oil = 3 shirts. (a) is WRONG. In Nigeria, producing oil requires twice as much labor per unit as producing shirts. For the same reason as above, a unit of oil costs twice as much as a unit of shirts: 1 oil = 2 shirts in Nigeria. (b) is WRONG. In Nigeria, producing one unit of shirts requires 6 units of labor while it requires only 4 units in Kenya. Hence, Kenya (and not Nigeria) has an absolute advantage in producing shirts. (c) is WRONG. Note that when it takes exactly the same amount of labor to produce the same good in both countries, it is hard to talk of absolute advantage: both countries have the absolute advantage, which also means that no country really has an absolute advantage… So this would depend on your convention. As detailed in question (a) and (b), the relative price of oil in terms of shirts is higher for Kenya than for Nigeria. Hence, Nigeria has a comparative advantage in producing oil, and thus Kenya has a comparative advantage in… Shirts! (d) is TRUE D is the only true answer Question 3: If P(y)/P(x) is higher in the home country than in the rest of the world, then this means that y is relatively more expensive to produce in the home country than in the rest of the world (or reciprocally, that x is cheaper to produce in the home country). The home country thus has a comparative advantage in good x. In open trade system, the home country would specialize in x, export x and import y. (b) is correct. Note that you could (and should) have eliminated (a) and (d) at first sight, as you always export what you are good at producing. If you have a comparative advantage in producing cheese, you do not import cheese, you export it!!! Question 4: a) L*/alw* = 200/6 = 33.3 WINE L*/alc* = 200/6 = 33.3 CHEESE FOREIGN: ‐ No absolute advantage ‐ Autarchy: 1 cheese = 1 wine ‐ Comparative advantage in cheese L/alw = 100/2 = 50 WINE L/alc = 100/5 = 20 CHEESE HOME: ‐ Absolute advantage for both wine and cheese ‐ Autarchy: 1 cheese = 5/2 wine ‐ Comparative advantage in wine b) L*/alw* = 200/6 = 33.3 WINE L*/alc* = 200/6 = 33.3 CHEESE L/alw = 100/2 = 50 WINE L/alc = 100/5 = 20 Indifference curve HOME: ‐ Slope = ‐2/5 ‐ price of wine in terms of cheese = 2/5 ‐ price of cheese in terms of wine = 5/2 CHEESE Indifference curve FOREIGN: ‐ Slope = ‐1 ‐ price of wine in terms of cheese = 1 ‐ price of cheese in terms of wine = 1 Due to the perfect mobility of labor assumption in the Ricardian Model, wages are equalized between the two sectors. We have: Pc/aic = Pw/aiw and Pc*/aic* = Pw*/aiw*. Therefore, in autarky, we also get Pc/Pw = aic/aiw = 5/2 and Pc*/Pw* = aic*/aiw* = 1. c) aic/ aiw= 5/2 Pc/Pw We get (Qc/Qw)w = 2/3 when each country specializes in producing one good (Domestic in wine and foreign in cheese). aic*/ aiw* = 6/6 = 1 d) aic/ aiw= 5/2 6/5 Pc/Pw (0+200/6)/ (0+100/2) = 2/3 (Qc/Qw)w = (Qc+Qc*)/(Qw+Qw*) aic*/ aiw* = 6/6 = 1 2/3 6 (Qc/Qw)w = (Qc+Qc*)/(Qw+Qw*) 6 Here, we are faced with a linear relative demand function and homothetic preferences. In equilibrium: (Qc + Qc*)/(Qw + Qw*) = 6 – 5(Pc/Pw) = 2/3 Pc/Pw = 16/15 Also, in equilibrium, since the relative demand curves passes through the vertical part of the relative supply curve, we know that both countries specialize. While the foreign country specializes in the production of cheese, the home country specializes in the production of wine. So, Qc = 0; Qw = 100/2 = 50; Qc* = 200/6 = 33.3; Qw* = 0. Finally, we calculate the equilibrium wage rates. w = Pw/aiw = Pw/2 and w* = Pc/aic* = Pc/6 where Pw and Pc are world prices of wine and cheese, respectively. And, the relative wages are as follows: w/w* = (Pw/aiw)/( Pc/aic*) = (Pw/Pc)( aic*/ aiw) = (15/16)(6/2) = 2.81 ...
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This note was uploaded on 03/18/2011 for the course ECON 162 taught by Professor Hanemann during the Spring '07 term at University of California, Berkeley.

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