2009 - summer - midterm - solutions

# 1 5 an eective factor endowment is the factor

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5. An E/ective Factor Endowment is the Factor Endowment of a country adjusted for productivity. 6. What is an E/ective Factor Endowment? Consider the following table: Land Labour T L ( effective hectares ) ( effective person ° hours ) Home 100 200 1 2 Foreign 75 225 1 3 Home has the higher land/labour ratio so the Home country is land-abundant and the Foreign country is labour scarce. Home import goods that use labour intensively. PART B: 1. Ricardian model: (a) T * PPF * 200 600 S* The opportunity cost of Steel: a ° LS a ° LT = 4 12 = 1 3 (b) a ° LS a ° LT = 1 3 a LS a LT = 1 Foreign has a comparative advantage in steel production. There will be complete specialization when 1 3 < P S P T T < 1 2
(c) w w ° should fall between the range of Relative Home Productivity Advantage a ° LS a LS = 4 2 = 2 a ° LT a LT = 12 2 = 6 so 2 < w w ° < 6 Since the wage at home is at least double the wage in foreign, the wage at home is a minimum of 100% higher than the foreign wage (50% higher is not possible). An Alternate approach to ±nd the range: with 1 3 < P S P T T < 1 and S is produced by Foreign and T is produce by Home we can consider the extremes of the relative world prices. With competitive factor markets the price of a good should re°ect the cost of pro- duction. For Steel (produced by foreign): P T S = w ° a ° LS and for Toys (produced by Home): P T T = wa LT Looking at P S P T T : P S P T T = w ° a ° LS wa LT rearranging this w w ° = P T a ° LS P S a LT ° or P T MP LT P S MP ° LS ± If P S P T T = 1 3 w w ° = 3 1 4 2 = 6 and if P S P T T = 1 w w ° = 1 1 4 2 = 2 so 2 < w w ° < 6 (d) Trade will bene±t the consumer that consumer the imported good more.

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