Eco364 International Trade Theory Midterm Fall 2021
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Eco364 International Trade Theory Midterm
Fall 2021
1. Consider the Ricardian model where the economies produce C and W with the following parameters: aC = 6, aW = 8, aC(*) = 9, aW(*) = 7, L = 30 and L* = 45
Let the RD curve be as follows. RD: =1.2-0.4Qr .
(5) a. Find the range of prices where complete specialization holds.
(5) b. Determine whether complete specialization hold and state equilib- rium .
solution: a. = , = = 1.28 so the range is ( , )
b. = =5; = =6.4 so the critical point for specialization= = 0.78. at Qr = 0.78, using RD becomes =1.2-.4(0.78) = 0.888 so complete specialization happens. =0.888
2. Consider the Specific Factors Model. Let RSd , RS* and RS be the domestic, foreign and world relative supply curves. M is capital specific and F is land specific. The foreign economy is K abundant and the domestic economy T abundant.
let the curves be as follows:
RSd : =500+0.8Qr
RS* : =300+1.3Qr
RD: =1200-0.6Qr
(5) a. Find RS.
(5) b. Find equilibrium Qr .
(5) c. Find equilibrium .
Solution: RS is found by averaging and at any Qr so = ( + ) = (500 + .6Qr + 300 + 1.3Qr ) = 400 + 1.05Qr
equilibrium requires RS=RD so 400 + 1.05Qr = 1200 - 0.6Qr hence Qr = = 484.8. substituting this into RS gives : = 400 + 1.05Qr = 400 + 1.05(484.8) = 901.9
3. Consider the standard trade model with goods C and F . The PPC
1 1
curve given by QF(2) + QC(2) = 12. the utility of the agent is U(qC , qF ) = qF(2) + qC(2) . let pC = 4 and pF = 9.
(5) a. determine the amount of C and F produced in equilibrium.
(5) b. find the optimal consumption bundle.
(5) c. Find whether trade occurs.
Solution:
a. we use F for QF and C for QC . productive equilibrium implies = so = . hence C = F . now use the PPC to solve for F . this means we have F2 + ( )2 F2 = 12 implying F2 = 10.02 or F = 3.16 so C = 1.41
b. use C for qC and F for qF . first we need income I which is the value of production V . using the quantities produced from (1) we have I = PF F + PC C = 4(1.41) + 9(3.16) = 34.08. now for the Lagrangian L(C, F, λ).
L(C, F, λ) = F + C + λ(34.08 - 4C - 9F)
the first order conditions give
(1) 0.5C = 4λ, (2) 0.5F = 9λ, (3) 34.08 = 4C + 9F
solve for F in terms of C using (1) and (2). this gives F = ( )2 C = 0.198C. substitute this into the constraint to yield (4 + 9 x 0.198)C = 34.08, implying C = 5.89. now F = ( )2 C = 1.17
c. so trade occurs since C consumption is higher than C production. likewise F consumption is lower than F production. the domestic economy imports C and exports F .
Part B: Theoretical Problems. 60 marks
1. In the Ricardian model RD-RS diagram analyze the effects of following
independent shocks on . Assume < and that the initial equilibrium
supports specialization. Let C be cloth and W wine.
(5) a. Foreign schools insist their students wear uniforms.
(5) b. Covid strikes domestic labour force but not the foreign labour force..
2. In the Specific Factors Model RD-RS diagram analyze the effects of following independent shocks on . The domestic economy is land abun- dant, the foreign economy capital abundant, F is the land specific good and M the capital specific good. Let M be manufactured goods and F food.
(5) a. Technological changes raise marginal product of capital in the domestic economy.
(5) b. Suppose consumers become aware M production creates more pollution than previously thought. All consumers are concerned about the environment.
(5) c. An earthquake destroys part of the capital stock in the foreign economy.
(5) d. For the shock in (a) explain the effect on world trade of M in a sentence.
solution: the domestic economy imports M but can now produce more M so trade in M falls.
(5) e. For the shock in (b) explain the effect on world trade of F in a sentence.
solution: the domestic economy imports less M so exports less F implying trade in F falls.
3. Consider the Heckscher-Ohlin model. Let the domestic economy be labour abundant and the foreign economy capital abundant.
(5) a. Assume plague wipes out part of the domestic population. In the box diagram show the effect on allocation of L to the domestic C sector. Assume initial prices of C and F are unchanged.
(5) b. Independent of (a) suppose productivity of labour in C production rises in the foreign economy. In the RD-RS diagram show the resulting effect on . Assume world RS is halfway between domestic and foreign RS.
(5) c. For the shock in (b) explain the effect on world trade of C in a sentence.
(5) d. For the shock in (b) analyze the impact on the nominal wage rate worldwide under Factor Price Equalization.
solution: c. trade in C rises since its relative price falls.
solution: d. wages may rise, fall or be unchanged. higher MPL pushes the wage up but lower pC pushes it down.
(5) 4. In the Specific Factors labour market model show the effect on the domestic wage and labour allocation to M production when floods remove significant parts of land from cultivation.
2022-04-09