ps3ans - ECON 450: INTERNATIONAL TRADE MARK MOORE FALL 2011...

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ECON 450: INTERNATIONAL TRADE MARK MOORE FALL 2011 PROBLEM SET 3 SOLUTIONS A. Do problems 1-4 at the end of chapter 4 in the Krugman-Obstfeld text. 1. Texas and Louisiana are both oil-producing states. A decrease in the price of oil will reduce output in these two states, hurting owners of capital and workers in the oil industry. While some capital will be able to migrate to other sectors (for example, those that use oil as a factor of production), a significant fraction of capital is specific to the oil industry. By the same token, some workers in the oil industry have skills that transfer to other sectors, and this transition will take time and is not costless. 2. a. b.
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2 3. a. Draw the marginal product of labor times the price for each sector given that the total labor allocated between these sectors must sum to 100. Thus, if there are 10 workers employed in Sector 1, then there are 90 workers employed in Sector 2. If there are 50 workers employed in Sector 1, then there are 50 workers employed in Sector 2. For simplicity, define P 1 = 1 and P 2 = 2 (it does not matter what the actual prices are in determining the allocation of labor, only that the relative price P 2 / P 1 = 2). In competitive labor markets, the wage is equal to price times the marginal product of labor. With mobile labor between sectors, the wage rate must be equal between sectors. Thus, the equilibrium wage is determined by the intersection of the two P × MPL curves. Looking at the diagram above, it appears that this occurs at a wage rate of 10 and a labor supply of 30 workers in Sector 1 (70 workers in Sector 2). b. From part (a), we know that 30 units of labor are employed in Sector 1 and 70 units of labor are employed in Sector 2. Looking at the table in Question 2, we see that these labor allocations will produce 48.6 units of good 1 and 86.7 units of good 2. At this production point ( Q 1 = 48.6, Q 2 = 86.7), the slope of the PPF must be equal to - P 1 / P 2 , which is - ½. Looking at the PPF in Question 2a, we see that it is roughly equal to - ½.
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3 c. If the relative price of good 2 falls to 1.3, we simply need to redraw the P × MPL diagram with P 1 = 1 and P 2 = 1.3. The decrease in the price of good 2 leads to an increase in the share of labor accruing to Sector 1. Now, the two sectors have equal wages ( P × MPL ) when there are 50 workers employed in both sectors. Looking at the table in Question 2, we see that with 50 workers employed in both Sectors
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ps3ans - ECON 450: INTERNATIONAL TRADE MARK MOORE FALL 2011...

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