chapter2 - problems

chapter2 - problems - QUIZ 1. The theory of absolute...

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Unformatted text preview: QUIZ 1. The theory of absolute advantage implied a) a small country could never gain from trading with a bigger one. b) a country had to have absolutely more labor than its trading partner for trade to be beneficial. c) the gains from trade occurred in the short run only; in the long run one country had to lose from trade. d) a country with an absolute disadvantage in both goods could never gain from trade. e) for trade to be mutually beneficial, one country had to have an absolute advantage in both goods. f) the mercantilists were right to emphasize accumulation ofspecie as a policy goal. 2. The absolute slope of a country’s production possibilities frontier (with good X on the horizontal axis and good Y on the vertical) represents a) the opportunity cost of good Y in that country. b) the opportunity cost of good X in that country. c) the autarky relative price of good Y in that country. d) the autarky relative price of good X in that country. e) (a) and (b) f) (b) and (d) 3. Under constant costs and unrestricted trade, we would expect productive specialization to be a) complete if the two countries are close in size. b) complete only if tastes are identical. c) incomplete if tastes are identical. d) complete as long as the technologies used by the countries are identical. e) incomplete if the countries are close in size. f) incomplete if one country has comparative advantage in one good and the other in the other. 4. MacDougall tested the Ricardian model of trade empirically by a) measuring which country exported more, the United Kingdom or the United States. b) measuring which country paid higher wages, the United Kingdom or the United States. c) measuring which country enjoyed higher growth rates, the United Kingdom or the United States. d) measuring how relative output per worker in various industries in the United Kingdom and the United States was related to the industries’ export performances in the two countries. e) measuring which had a larger number of successful export industries, the U.K. or the U.S. f) measuring which had the largest average market share across industries, the U.K. or the U.S. 5. Under constant cost, the equilibrium international terms of trade a) represent the rate at which good X and good Y exchange in the international market. b) must simultaneously clear the markets for goods X and Y. c) must lie between the two countries’ autarky price ratios. d) determine how the gains from trade are divided between the two countries. e) are correctly described by all of the above. f) are correctly described by (a) and (d) only. 6. In autarky under constant cost a) a country’s production opportunity set is larger than its consumption opportunity set. b) a country’s consumption opportunity set is larger than its production opportunity set. c) a country’s production and consumption opportunity sets are identical. d) a country’s production opportunity set is smaller than it would be with international trade. e) a country’s consumption opportunity set is smaller than it would be with international trade. f) both (c) and (e) are true. 7. In autarky under constant cost a) MRS = MRT = Px/Py. b) MRS = MRT > Px/Py. c) MRS = MRT < Px/Py . d) MRS > MRT = Px/Py . e) MRS < MRT = Px/Py. f) MRT > MRS = Px/Py . 8. Country A has an absolute advantage in good X if a) aLX < aLy b) aLX < bLy c) aLX < bLX d) aLX> aLY e) aLX> bLY f) aLX > bLX 9. Country A has a comparative advantage in good X if a) aLX/aLY < bLX/bLy b) aLX/aLy < bLy/bLX c) aLX < bLX d) aLX> aLY e) aLX/aLY> bLX/bLy f) aLX/aLy > bLy/bLX 10. International trade between two countries that continue to produce at their autarky production points a) cannot be beneficial. b) will always be mutually beneficial. c) will be mutually beneficial if the two countries have a pattern of comparative advantage. d) is impossible. e) will be mutually beneficial if the two countries are identical. f) requires no terms of trade. PROBLEMS 1. What are the fundamental beliefs and policy recommendations of mercantilism? What were the classical economists’ criticisms of mercantilism? 2. Explain the process by which the specie‐flow mechanism would eliminate a trade deficit in the long run. 3. Let LA = country A’s endowment of labor =200 units; LB =country B’s endowment of labor = 100 units; aLX = number of units of labor required to produce one unit of good X in country A =4; aLY =number of units of labor required to produce one unit of good Y in country A =8; bLX = number of units of labor required to produce one unit of good X in country B =5; and bLY = number of units of labor required to produce one unit of good Y in country B = 4. a) Draw the production possibilities frontier for each country. Be sure to label carefully. b) Which country has absolute advantage in which good(s)? Why? What would the theory of absolute advantage predict about the direction of trade? Why? c) If free trade according to absolute advantage were allowed, what degree of productive specialization would occur? Why? How much of each good would be produced? d) Answer the questions in parts (b) and (c) for comparative rather than absolute advantage. e) How do your answers to (b) and (c) differ from your answers to (d)? Why? 4. Now let LA = 200; LB = 300; aLX = 4; aLY = 2; bLX = 5; and bLY= 4. Answer parts (a) through (e) from question 3 using the new numbers. 5. Translate the information provided in question 4 into measures of output per unit of labor in each industry in each country (for example, how many units of good X can one unit of labor in country A produce?). Is labor in one country more productive in both industries than labor in the other country? Does this imply that trade between the two countries would fail to be mutually beneficial? Why, or why not? 6. Under autarky, what relationship holds between the production opportunity set and the consumption opportunity set? Why? How does trade affect this relationship? . 7. In a two‐country, two‐good world: a) Can one country have an absolute advantage in production of both goods? Why? b) Can one country have a comparative advantage in production of both goods? Why? 8. For two hypothetical countries producing two goods under constant costs, draw graphs showing the autarky and unrestricted trade equilibria. Draw the graphs in such a way that country B has a comparative advantage in production of good X and country A in production of good Y. Be sure to label the graphs carefully, .including the autarky price ratios, MRS, MRT, terms of trade, imports, exports, and trade triangles. 9. Comment on these statements: a) “Even if two countries have identical factor endowments and technology, there’s still a basis for mutually beneficial trade if the two have different tastes.” b) “Even if two countries have identical tastes, there’s still a basis for mutually beneficial trade if the two have different factor endowments and technology.” 10. Comment on this statement: “Trade is self‐defeating. Opening up trade equalizes the relative prices in the two countries. But once prices are equalized, there’s no longer any reason to trade. Trade will only occur when the world economy is in disequilibrium.” 11. In the chapter, we examined trade in goods X and Y under the assumption that the factor of production (labor) is completely immobile between countries. If country A has a comparative advantage in good X, this is equivalent to saying that labor in A is relatively more productive than labor in B in the X industry. Similarly, labor in B is relatively more productive than labor in A in the Y industry. Can trade in goods be viewed as a substitute for mobility of labor between countries? This question asks you to think ahead about something we’ll get to later in the book. For now, a hint: When country A exports good X to country B, good X embodies the productivity of country A’s “X‐ productive” labor. 12. Design a numerical example in which country A has: a) An absolute disadvantage in both goods and a comparative advantage in good X. b) An absolute advantage in both goods and a comparative advantage in good Y. 15. In Case One, the test of the Ricardian model is formulated in terms of output per worker in the United States and the United Kingdom in various industries. How is this related to the input coefficients used in the chapter? 16. The table below reports the units of labor required to produce 1 unit of good X and of good Y in country A and in country B for three hypothetical cases. Case I Case II Case III Country A Country B Country A Country B Country A Country B Good X 1 3 1 2 1 2 Good Y 2 4 2 4 2 1 a) For each case, in which good(s) does each country have an absolute advantage? b) For each case, in which good(s) does each country have a comparative advantage? c) In which case(s) would trade be mutually beneficial? Why? 17. Dismalia is a country with an unproductive labor force. It requires more units of labor to produce a unit of any good in Dismalia than in other countries. Dismalia’s leaders have decided that the country cannot gain from international trade because the country’s labor is so unproductive. Are they correct or incorrect? Explain. ANSWERS QUIZ 1. d. 2. f. 3. a. 4. d. 5. e. 6. f. 7. a. 8. c. 9. a. 10. c. ANSWERS TO PROBLEMS AND QUESTIONS FOR REVIEW 1. Mercantilism viewed trade as a zero‐sum game, the goal of which is to export as much as possible and import as little as possible. The resulting surplus (excess of the value of exports over the value of imports) leads to an accumulation of specie, or gold and silver. Classical economists questioned the desirability of mercantilists’ goals by pointing out that individuals derive satisfaction from goods and services, not from the accumulation of specie. The same economists also questioned the long‐run viability of mercantilist policies since the specie flow mechanism implies that a balance‐of‐trade surplus leads to monetary growth, rising prices, a decline in exports, and a rise in imports. 2. A country runs a trade deficit when the value of its imports exceeds the value of its exports.The excess of imports is paid for with gold. The deficit country’s money stock falls and the trading partner’s money stock rises with the flow of gold. Prices fall in the deficit country and rise in the trading partner. The change in relative prices increases the deficit country’s exports and lowers its imports, reducing the deficit. 3. a) Country A’s production possibilities frontier has a vertical intercept of 25, a horizontal intercept of 50, and a slope of ‐1/2. Country B’s has a vertical intercept of 25, a horizontal intercept of 20, and a slope of ‐5/4. b) c) d) e) Country A has an absolute advantage in production of good X because 4 < 5 (aLX < bLX), and country B has an absolute advantage in production of good Y because 4 < 8 (bLY < aLy). Trade according to absolute advantage would result in country A specializing in good X and exporting some of it to B, while B would specialize in Y and export some of it to A. Specialization according to absolute advantage would be complete; each country would produce only its good of absolute advantage. This occurs because the pattern of absolute advantage doesn’t change with the degree of specialization. Country A could produce 200/4 = 50 units of X, and country B 100/4 = 25 units of good Y. Country A has a comparative advantage in production of X because the opportunity cost of producing X in A (aLX/aLY= 4/8 = 1/2 units of Y) is lower than that in B (bLX/bLY= 5/4 units of Y). Country B has a comparative advantage in production of Y because the opportunity cost of producing good Y in B (4/5 units of X) is lower than that in A (8/4 units of X). Trade according to comparative advantage would result in A specializing in producing good X and exporting some of it to country B which would specialize in producing good Y and export some of it to country A. Specialization would be complete because the pattern of comparative advantage doesn’t change with the degree of productive specialization. Country A would produce 200/4 = 50 units of X, and country B 100/4 = 25 units of Y. The answers differ only in terms of the definitions of absolute and comparative advantage. Since country A has both an absolute and a comparative advantage in good X and country B in good Y, the outcomes are the same. 4. a) Country A’s production possibilities frontier has a vertical intercept of 100, a horizontal intercept of 50, and a slope of ‐2. Country B’s has a vertical intercept of 75, a horizontal intercept of 60, and a slope of ‐5/4. b) c) d) e) Country A has an absolute advantage in production of both good X (because 4 < 5) and good Y (because 2 < 4). According to absolute advantage, trade wouldn’t be mutually beneficial and would, therefore, not occur. There would be no trade; each country would continue to produce at the point on its production possibilities frontier tangent to the highest attainable indifference curve, that is, at the country’s autarky equilibrium. Country A has a comparative advantage in production of good Y, because the opportunity cost of producing a unit of Y in A (2/4 = 1/2 units of X) is lower than that in B (4/5 units of X). Country B has a comparative advantage in production of good X because the opportunity cost of producing a unit of good X in country B (5/4 units of Y) is lower than that in country A (4/2 units of Y). Under trade based on comparative advantage, country A would specialize completely in producing good Y, producing 200/2 = 100 units. Country B would specialize completely in good X, producing 300/5 =60 units. According to absolute advantage, trade wouldn’t be mutually beneficial and wouldn’t occur because country A has an absolute advantage in production of both goods. According to comparative advantage, trade would be mutually beneficial and would occur. 5. One unit of labor can produce 1/4 units of X or 1/2 units of Y in country A. One unit of labor can produce 1/5 units of X or 1/4 units of Y in country B. Labor in country A is more productive than labor in country B in the sense that one unit of labor can produce more of either good in A than in B. This does not imply that trade can’t be mutually beneficial (as demonstrated in question 4). More can be produced by having labor in each country produce the good in which that labor is relatively more productive. 6. Under autarky, the production and consumption opportunity sets are identical. Graphically, they’re represented by the triangles formed by the X and Y axes and the production possibilities frontiers. The two opportunity sets must be identical in autarky because, with no trade, the only source of goods for consumption is domestic production. Trade expands the consumption opportunity set beyond the production opportunity set by allocating the world’s labor more efficiently between production of the two goods. Countries then trade at terms of trade that differ from the autarky prices, expanding the consumption opportunity sets beyond the production opportunity sets. 7. a) Yes, see the numerical example in question 4. b) No, for one country (say, A) to have a comparative advantage in production of both good X and good Y would require that aLX/aLY < bLX/bLY and aLy/aLX < bLy/bLX Both statements can’t be true (try plugging in some numbers). 8. 9. a) This statement is false in a model that assumes a constant‐cost production technology. Mutually beneficial trade requires that the countries exhibit a pattern of comparative advantage. If the two countries have identical factor endowments and technology, their production possibilities frontiers will be identical and the opportunity cost of producing each good will be the same across countries. Because the production possibilities frontiers are straight lines under constant costs, tastes are irrelevant in determining the pattern of comparative advantage. b) This statement generally is true under constant costs. If the two countries have different factor endowments and technologies, then the slopes of the production possibilities frontiers will differ, reflecting comparative advantage. Again, tastes are irrelevant. An exception to this answer could arise if the differences in technology were of the following special type: aLX = αbLX and aLY = αbLy (α > 0). 10. Opening trade does equalize relative prices in the two countries. This means that there’s no incentive for further expansion of trade, not that the incentive to engage in the current level oftrade disappears. 11. We’ll see in Chapter Four that trade in goods can be viewed as a substitute for international factor mobility. When a country exports its good of comparative advantage, the economic effects are very similar to the effects of exporting the resources used in producing the good. 12. a) There are many possible correct answers. One example is aLX = 10; aLY = 8; bLX = 8; bLy = 4. b) Again, there are many possible correct answers; one is aLX = 6; aLY= 3; bLX = 10; bLy = 8. 15. Output per worker in an industry is equal to the reciprocal of the industry’s input coefficient, which measures labor per unit of output. For example, if aLX = 5, each worker produces one‐fifth units of output. All the results in the chapter can be derived using output per worker in place of our input coefficients. 16. a) Case I: Country A has an absolute advantage in both goods and country B in neither good. Case II: Country A has an absolute advantage in both goods and country B in neither good. Case III: Country A has an absolute advantage in good X and country B in good Y. b) Case I: Country A has a comparative advantage in good X and country B in good Y. Case II: Neither country has a comparative advantage in either good. Case III: Country A has a comparative advantage in good X and country B in good Y. c) Trade would be mutually beneficial in Cases I and III because of the existence of comparative advantage. 17. Dismalia’s leaders are not correct. They assert that trade cannot be beneficial to Dismalia because it has an absolute disadvantage in all goods. Nonetheless, Dismalia must have a good or goods of comparative advantage, and specialization in such goods would be beneficial regardless of the absolute disadvantage. ...
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