Problem Set 2_Answers

Problem Set 2_Answers - UNIVERSITY OF SOUTHERN CALIFORNIA...

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UNIVERSITY OF SOUTHERN CALIFORNIA Marshall School of Business FBE 462 – International Trade & Commercial Policy Answers to Problem Set #2 1. If production of firm involves a fixed cost, then a. there exists internal economies of scale. b. there exists external economies of scale. c. there exists constant returns to scale. d. there exists decreasing returns to scale. 2. With increasing returns to scale and transaction costs, a. a firm will likely locate its production in a smaller market. b. a firm will likely locate its production in a bigger market. c. a firm will be indifferent in locating its production between the smaller or bigger markets. d. a country with a higher demand for a good will likely be an importer of this good. 1. A. The numbers presented indicate the productivity of labor (output per labor year) in each product for each country. They can be used as direct indicators of absolute advantage— for each product, which country’s labor is more productive? Pretzelvania has the absolute advantage in both products. B. There are a number of (mathematically equivalent) ways to examine comparative advantage, which involves relative comparisons between products and countries. (In the rest of the answers, we drop “thousands” from all numbers.) If we use the labor-productivity numbers as presented, then we can examine the country- to-country ratio of productivities for the two products. Pretzelvania’s advantage (relative to Toblerenia) in chocolate is 6/4 = 1.5, while its relative advantage in beer is 15/8 = 1.875. Thus Pretzelvania has a comparative advantage in beer (its relative advantage in beer is larger). Another way to look at this is to use relative cost or price numbers to determine comparative advantage (this is closer to our concept of trade based on arbitrage). The indicator of cost is labor years per unit of output, so we need to use the inverses of the numbers given in the problem. Here we usually look at the product-to-product ratio of price (or cost) for each country (with no trade), and then compare the two countries. The relative price (or cost) of chocolate in Pretzelvania is (1/6)/(1/15) = 2.5 (with no trade, chocolate is 2.5 times as expensive as is beer in Pretzelvania). The relative price (or cost) of chocolate in Toblerenia is (1/4)/1/8) = 2 (with no trade). With no trade, Toblerenia has the comparative advantage in chocolate, because chocolate is relatively inexpensive in Toblerenia. Looked at the other, with no trade the relative price of beer is 1/2.5 = 0.4 in
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FBE 462 Problem Set #2 Answers 2 Pretzelvania, and it is 1/2 = 0.5 in Toblerenia, so Pretzelvania has the comparative advantage in beer.
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