Assume a Ricardian model with two countries, Home and Foreign, that both produce textiles and coffee.

economics

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International trade theory questions:

 

Problem 1. (6 points)

Assume a Ricardian model with two countries, Home and Foreign, that both produce textiles and coffee. Home has 2000 units of labor available. Home’s unit labor requirement in the production of textiles is aLT = 4, while in the production of coffee it is aLC = 2. Foreign has 1000 units of labor available. Foreign’s unit labor requirement in the production of textiles is aLT = 1, while in the production of coffee it is aLC = 2.

 

a) What is the main reason for trade in the Ricardian model? (1 pt)

b) Assume that there is no trade and both countries produce textiles and coffee.

1.      b1)  Without trade, the relative price of textiles in terms of coffee equals the opportunity cost (again textiles in terms of coffee). Explain why this is the case. (0.5 pts)

2.      b2)  What are the prices of textiles in terms of coffee in both countries? (0.5 pts)

c) Assume that both countries open for trade. In equilibrium, the price of textiles is denoted by PTt , while the price of coffee is denoted by PCt .

 

1.      c1)  Graph the relative supply curve (RS). Label the axes and all relevant points. (1.5 pts)

2.      c2)  Assume that, with free trade, the price of textiles in terms of coffee is PTt /PCt = 1. Calculate the output that is produced by both countries and describe the pattern of trade. (1.5 pts)

3.      c3)  Now assume that, with free trade, the price of textiles in terms of coffee is PTt /PCt = 0.5. Determine the output that is produced by both countries. (1 pt)

 

Problem 2. (4 points)

 

Assume that the US and China both produce cars and steel using labor and capital as input factors in the production. The car industry is capital intensive, while the steel industry is labor intensive. The US imports steel from China and exports cars to China. China imports cars from the US and exports steel to the US.

 

a) What is the main difference between the specific factors model and the Heckscher-Ohlin model? (1 pt)

b) Assume that the US trade policy leads to an increase in the price of steel but does not affect the price of cars.

1.      b1)  Base your argumentation on the specific factors model and assume that labor is mobile, while capital is industry specific. What are the effects of the trade policy on the Chinese workers? Explain your result. (1.5 pts)

2.      b2)  Base you argumentation on the Heckscher-Ohlin model. What are the effects of the trade policy on the Chinese workers? Explain your result. (1.5 pts) 

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