Homework 2 UCDavis, 160a, Prof. Farshid Mojaver Adam Smith (part 2 and 3) Read excerpts from Adam Smith’s Wealth of Nations (posted on the class web page) to answer the following questions. Gains from trade 1. What is the source of gain from trade according to Adam Smith? 2. How does Adam Smith generalize the results he draws from domestic trade between individuals to gains from trade between nations? 3. Is this generalization valid? Does everyone gain from voluntary trade (discuss in absolute and relative terms)? . 4. What enables an individual/a nation to produce something at a lower cost? 5. What are the sources of natural advantages in trade? What about the acquired ones? 6. If Britain can make good wine and lots of it, why should she import wine instead of producing it herself? 7. What is meant by specialization here? Protecting domestic industry 1. What are the two justifications for some level of protection of domestic industry according to Adam Smith? 2. What was the major function of the act of navigation in GB? 3. How did the act protect the domestic industry of GB? 4. According to Adam Smith does it matter what or with whom you trade? 5. Why Adam Smith supports the act of Navigation despite his own argument that the act reduces trade and the opulence of GB? 6. How could the defense industry benefit from this policy? 7. In addition to the defense argument name another reason for the act of navigation. Did it actually lead to a greater opulence in addition to better defense? The Ricardian Model 2 Problem 1. Consider trade between two countries, Home and Foreign. Denote values associated with Foreign using asterisks. Each country is capable of producing consumer goods X and Y. Each country is endowed with 1000 worker hours (L=1000=L*). The table below gives the unit input requirement in each country for each good: Home Foreign X aLX= 1 aLX*= 1/4 Y aLy= 1/2 aLy*= 1 a. What is the opportunity cost of producing good X in the Home country? In Foreign? b. Assume that each consumer likes to consume some of each good. What is the relative price of good X at Home in autarky? In Foreign? c. Draw Home's production possibility frontier (PPF); put output of good X on the horizontal axis and output of good Y on the vertical. Be sure to label intercepts and axes, and indicate the slope. Do the same for Foreign. Problem 2. You are given the information shown in the table about the production relationship between Wonderland and the rest of the world and use the standard Ricardian assumptions: Wonderland Rest of the World Labor Hours per Bottle of Wine 10 6 Labor Hours per Pound of Cheese 5 2 Wonderland has 40 million labor hours in total and the rest of the world has 30 million labor hours in total per year. a. Which country has absolute advantage in wine? In cheese? b. Which country has comparative advantage in wine? In cheese? c. Graph each country’s PPF. Use indifference curve to show the no-trade equilibrium (label as point A) for each country. (Suppose Wonderland consumes 4 million pounds of cheese and the rest of the world consumes 6 pounds of cheese). d. When trade is opened between Wonderland and the rest of the world, what the pattern of trade is? If the world price ratio is 0.4 bottle of wine per pound of cheese (Be careful this is not Pw/Pc but Pc/Pw), what happens to production in each country? (Label the new production point in each country as point P) e. Suppose that 2 million bottles of wine and 5 million pounds of cheese are traded. Show the consumption of each good in each country graphically using indifference curve (label the consumption point C)? Problem 3. Assume that Home and Foreign produce two goods, televisions and cars, and use the following information to answer the questions. a. What is the marginal product of labor for televisions and cars in the Home country? b. What is the no-trade relative price of televisions at Home? c. What is the marginal product of labor for televisions and cars in Foreign? What is the no-trade relative price of televisions in Foreign? d. Suppose the world relative price of televisions in the trade equilibrium is PTV/PC =1. Which good will each country export? Briefly explain why. e. In the trade equilibrium, what is the real wage at Home in terms of cars and in terms of televisions? How do these values compare with the real wage in terms of either good in the no-trade equilibrium? f. In the trade equilibrium, what is the real wage in Foreign in terms of televisions and in terms of cars? How do these values compare with the real wage in terms of either good in the no-trade equilibrium? g. In the trade equilibrium, do Foreign workers earn more or less than those at Home, measured in terms of their ability to purchase goods? Explain why. Problem 4. a. Suppose that the number of workers doubles in Home. What happens to the b. Home PPF and what happens to the no-trade relative price of wheat? c. Instead of doubling the number of workers in Home, suppose that there is technological progress in the wheat industry, so that Home can produce more wheat with the same amount of labor. What happens to the Home PPF, and what happens to the relative price of wheat? Describe what would happen if a similar change occurred in the cloth industry. Problem 5. Consider an economy that labor is not mobile between sectors in the short run. a. Show the effect of international trade on production and consumption in the short run b. Answer question in part (a) assuming domestic production prices are kept intact using appropriate tax/subsidy policies. Question 7. Make an argument to show that a domestic firm may lose out in international competition even if it is the lowest cost producer in the world. Question 8. How would you persuade people in the import-competing sector that free trade is a desirable policy? Suggest policies to soften their opposition. Question 9. Read the following excerpt from Adam Smith on division of labor and labor productivity to answer the subsequent questions 1- What is the difference between specialization in the Ricardian model and the Smithian model? 2- What does the Smithian division of labor imply on the productivity of larger economies? 3- What is the source of gains from trade and increased productivity in the Ricardian model? 4- Consider a two good economy: grain and computer. They are both produced with labor only but grain is subject to constant return to scale technology while computer production is subject to increasing return to scale technology. Draw the Production Possibility Frontier for this economy. An Inquiry into the Nature and Causes of the Wealth of Nations (Book 1, Ch 1) Of the Division of Labour THE greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour. The effects of the division of labour, in the general business of society, will be more easily understood by considering in what manner it operates in some particular manufactures. It is commonly supposed to be carried furthest in some very trifling ones; not perhaps that it really is carried further in them than in others of more importance: but in those trifling manufactures which are destined to supply the small wants of but a small number of people, the whole number of workmen must necessarily be small; and those employed in every different branch of the work can often be collected into the same workhouse, and placed at once under the view of the spectator. In those great manufactures, on the contrary, which are destined to supply the great wants of the great body of the people, every different branch of the work employs so great a number of workmen that it is impossible to collect them all into the same workhouse. We can seldom see more, at one time, than those employed in one single branch. Though in such manufactures, therefore, the work may really be divided into a much greater number of parts than in those of a more trifling nature, the division is not near so obvious, and has accordingly been much less observed. To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving, the head; to make the head requires two or three distinct operations; to put it on is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations. The division of labour, ... occasions, in every art, a proportionable increase of the productive powers of labour. The separation of different trades and employments from one another seems to have taken place in consequence of this advantage. This great increase of the quantity of work which, in consequence of the division of labour, the same number of people are capable of performing, is owing to three different circumstances; first, to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many. Questions on Discovering Data The purpose of these exercises is make you familiar with some important data basis; otherwise there is nothing magical about the questions. The questions are just a start for you to explore more if needed. 1- Go to https://www.wto.org ; click on “Documents, Data and Resources” on the top. Under “Annual Publication” on the RHS click on “World Trade Statistical Review 2019”. Click on “II. Highlights of world trade”. a. Note chart 2.1. Write what you see on the relationship of growth of trade and GDP in the last decade. b. What happened to the two during the 2008 recession? 2- Go back to “Documents, Data and Resources” and click on “STATISTICS”. Under “Tools Data” in the middle of the page click on “International Trade and market Access Data”. a. What was the World total trade in 2018? b. Which country or the group of countries were top three? c. What was China’s export of Clothing in 2017? d. Look at the trends on the top and state the two years that China experiences a dip in its exports in the last 20 years. e. Click on “tariff” on the top. Which country has the highest “Simple Average Applied MFN tariff “? How about India? Iran? 3- Go to the WTO dataset: https://data.wto.org find the China-US trade data and answer the following questions: Choose “Bilateral imports by detailed HS codes” under “Indicators”, then choose China under “Reporting Economies”, then choose US under “Partner Economies”, you can also choose a certain year and certain products here. a. As of 2016 what China imports the most from US? The product is categorized by the HS code. b. Can you draw a time series line for the total value of import for this product? How about its share as of total import? Years are from 2012 to 2017. c. As of 2016 what China exports the most to US? Now switch the reporting country to US and the partner country to China. 4- In this problem you will use the World Development Indicators (WDI) database from the World Bank to compute the comparative advantage of two countries in the major sectors of gross domestic product (GDP): agriculture, industry (which includes manufacturing, mining, construction, electricity, and gas), and services. Go to the WDI website at http://wdi.worldbank.org, and choose “Online tables,” (http://wdi.worldbank.org/table ) where you will be using the sections on “People” and on the “Economy.” a. In the “People” section, start with the table “Labor force structure.” Choose two countries that you would like to compare, and for a recent year write down their total labor force (in millions) and the percentage of the labor force that is female. Then calculate the number of the labor force (in millions) who are male and the number who are female. b. Again using the “People” section of the WDI, go to the “Employment by sector” table. For the same two countries that you chose in part (a) and for roughly the same year, write down the percent of male employment and the percent of female employment in each of the three sectors of GDP: agriculture, industry, and services. (If the data are missing in this table for the countries that you chose in part (a), choose different countries.) Use these percentages along with your answer to part (a) to calculate the number of male workers and the number of female workers in each sector. Add together the number of male and female workers to find the total labor force in each sector. c. In the “Economy” section, go to the table “Structure of output.” There you will find GDP (in $ billions) and the % of GDP in each of the three sectors: agriculture, industry, and services. For the same two countries and the same year that you chose in part (a), write down their GDP (in $ billions) and the percentage of their GDP accounted for by agriculture, by industry, and by services. Multiply GDP by the percentages to obtain the dollar amount of GDP coming from each of these sectors, which is interpreted as the value-added in each sector, that is, the dollar amount that is sold in each sector minus the cost of materials (not including the cost of labor or capital) used in production. d. Using your results from parts (b) and (c), divide the GDP from each sector by the labor force in each sector to obtain the value-added per worker in each sector. Arrange these numbers in the same way as the “Sales/Employee” and “Bushels/Worker” shown in Table 2-2. Then compute the absolute advantage of one country relative to the other in each sector, as shown on the righthand side of Table 2-2. Interpret your results. Also compute the comparative advantage of agriculture/industry and agriculture/services (as shown at the bottom of Table 2-2), and the comparative advantage of industry/services. Based on your results, what should be the trade pattern of these two countries if they were only trading with each other?