ECO2ITR – International Trade Semester 2 – 2022
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ECO2ITR – International Trade
Semester 2 – 2022
Individual Assignment
Question 1 – Ricardian Model of Trade 8 marks (2+2+2+2)
Suppose two economies Home (H) and Foreign (F) produce two goods, bread and wine, with only one production factor: labour. Production technology, expressed as marginal product of labour (MPL), is given in the following table:
Technologies expressed as MPL* |
Bread |
Wine |
Home |
1/6 |
1/12 |
Foreign |
1/4 1/2 |
*Note that technologies are expressed as Marginal Products of Labour (MPL) not as unit labour requirements. To learn how these two measurements of labour productivity relate, please consult the material covered in class and the textbook.
Suppose that Home has 2400 units of labour and Foreign has 1800 units of labour.
a. (2 marks) Derive the Production Possibilities Frontier (PPF) and the Consumption Possibility Frontier (CPF) for Home and Foreign, with bread on the horizontal axis and wine on the vertical axis. What is the autarky equilibrium price of bred relative to wine in each country?
b. (2 marks) What country has the absolute advantage in producing each good? What country has the comparative advantage in producing each good? Briefly explain the difference between these two concepts.
Suppose both countries are now free to trade. The world relative price of bread is 1.
c. (2 marks) What is the pattern of specialisation and trade? Briefly explain your answer.
d. (2 marks) To the graphs you drew in point (a) add the CPF after free trade. Which country gains from free trade according to Ricardian Model. Briefly explain your answer.
Question 2 – Specific Factors Model of Trade 8 marks (2+2+2+2)
Assume Portugal can produce 2 goods Computers and timber using unskilled labour (L) that is mobile between sectors. Capital (K) is specific to producing Computers. Land (T) is specific to producing timber.
a. (2 marks) Use a single diagram to show how Portuguese labour (L) is allocated between computers and timber. This is the combined graph with the wage curves for each sector. Hint: The graph should represent both wages which are a function of MPL and prices.
Now assume Portugal engages in free trade and in the world market the price of timber is 20% higher than in Portugal, while the price of computers does not change.
b. (2 marks) Redraw the diagram in point (a) and let the price of timber increase by 20%. What happens to the labour demand curves in the computers sector and in the timber sector?
c. (2 marks) What happens to equilibrium wages and the allocation of labour. Briefly explain your answer.
d. (2 marks) Who wins and who loses in Portugal after opening to trade? Briefly explain your
answer.
Question 3 – The Heckscher-Ohlin Model of Trade 10 marks (3+3+1+3)
Assume two countries Norway (NOR) and Turkey (TUR) produce Machines (M) and Food (F) using two factors, capital (K) and labour (L), which are mobile across sectors. The production of machines is capital intensive and food production is labour intensive. Further, Norway has 250 units of labour and 250 units of capital, while Turkey has 160 units of labour and 200 units of capital. The cost of labour is w. The cost of capital is r.
a. (3 marks) Which country is capital abundant relative to the other country? Explain why.
b. (3 marks) In the diagram below, draw the relative supply of machines/food for each country in autarky (approximate positions). Explain any difference across countries and identify the relative prices and quantities in equilibrium in each country in autarky. (Hint: Remember that relative prices reflect opportunity costs).
PM/PF
RDNoR = RDTUR
QM /QF
Now, suppose Norway and Turkey are free to trade.
c. (1 mark) In the graph depicted in point (b) above mark the approximate relative price under free trade (assume the world market relative price falls in between the two countries’ relative prices when in autarky). Describe the patterns of specialisation and trade.
d. (3 marks) At free trade relative price, does Norway produce more or fewer machines relative to food in comparison to autarky? Does Turkey produce more or fewer machines relative to food in comparison to autarky? Mark these points of production at free trade price on the graph depicted in point (b).
Question 4 4 marks
Please read the article “After Covid, Services Are Where the Trade Action Is; The pandemic has showcased the digital economy, where the U.S. has enormous comparative advantages”, published in The World Street Journal on 22 March 2021. After reading the article, please answer the following true/false question. Justify your answer in no more than 300 words.
The U.S. is primarily a service economy, with comparative advantage in sectors such as construction and engineering. However, the U.S. should not promote the liberalisation of international trade in services because it would generate an overall welfare loss for the U.S. in the long run.
(1 mark) True or False?
(3 marks) Briefly explain your answer.
2022-09-08