2009 - fall - midterm - solutions

The ricardian model predicts wages will vary across

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The Ricardian model predicts wages will vary across countries to re°ect di/erences in productivity. Wages will be higher in countreis with higher productivity. Relative to autarky, free trade increases wages in all countries so workers are better o/. The Heckscher-Ohlin model predicts that relative factor prices will be equal across countries. This is based on the assumption of identical technologies across coun- tries. The predictions of the the Ricardian model are supported by the data. Looking at both cross-section and time-series data we observe higher wages paid when productivity is higher. (b) Consider a 2 country Ricardian world with 5 goods. The unit labour requirements for the production of each good in Home and Foreign are presented in the following table: unit labour requirements Industry A B C D E Home 7 10 10 2 6 Foreign 3 3 4 2 4 The equilibrium relative wage is w w ° = 1 2 . Determine the pattern of trade in the absence of transport costs. Discuss how the range of traded goods may be altered with the inclusion of transport costs, such as those that might arise due to extra security and insurance costs as mentioned in the article. Consider as an example, transport costs as a percentage of production costs, with z = 50% so that transport costs increase the cost of an export good (in the importing country) by a factor of 1 : 5 . Ranking the goods by Home±s Relative Productivity Advantage ° a ° Li aLi ± D 1 E 2 3 A 3 7 C 2 5 B 3 10 Home will export D and E: Foreign will export A; C; and B: With tranport costs, z = 0 : 5 ; compare P i P ° i for each good to see if it is still traded. E is usually exported from home to foreign. With transport costs: P E P ° E = 1 2 6 4 1 : 5 1 = 9 8 > 1 5
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E is no longer traded. P A P ° A = 1 2 7 3 1 1 : 5 = 7 9 < 1 A is no longer traded P D P ° D = 1 2 2 2 1 : 5 1 = 3 4 < 1 D is still exported from home to foreign. P C P ° C = 1 2 10 4 1 1 : 5 = 10 12 < 1 C is no longer traded P B P ° B = 1 2 10 3 1 1 : 5 = 10 9 > 1 B is still exported from foreign to home. 6
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