International Economics
Econ 4401
Homework 1 Answer Key
Tim Uy
Question 1. Exchange Economy.
This question studies the trading patterns between two countries with different endowments and
different preferences. Suppose there are two countries, Home and Foreign. They are endowed
with different amounts of two goods, Wheat (W) and Corn (C). The countries have the following
preferences. Home has utility function of the form
U (W, C) =
1
1
log W + log C
2
2
The Foreign country, on the other hand, has the utility function
U (W ∗ , C ∗ ) =
2
1
log W ∗ + log C ∗
3
3
Endowments are as follows: Home has 100 units of wheat and 70 units of corn, while Foreign
has 50 units of wheat and 80 units of corn. Normalize the price of corn to one. We will only be
interested in the relative price of wheat to corn, which we will denote p.
(a) [5] Find the autarky price of wheat relative to corn in the Home country.
p=
7
10
(b) [5] Find the autarky price of wheat relative to corn in the Foreign country.
p=
8
10
(c) [5] Compare autarky prices in the two countries. In which country is the price of wheat
higher relative to the price of corn? Explain why that is (cite the factors that determine these
autarky prices).
1
The price of wheat is higher in the foreign country. There are two reasons for this. First,
wheat is scarcer in the foreign country; hence it can command a higher price if both goods are
demanded equally. This is however, not the case, and the fact that the second country spends
twice as much on corn than wheat lowers the price of what relative to corn in that country. In
equilibrium the supply effect is stronger than the demand effect and the price is higher in the
foreign country.
(d) [5] Find the price of wheat relative to corn when countries open up to trade.
p = 0.74
(e) [5] What is the pattern of trade between the two countries? Which country exports wheat?
Which country exports corn?
Home exports wheat and imports corn. The opposite is true of foreign, which exports
corn and imports wheat. This can be seen by comparing the countries’ endowments with what
they eventually consume under free trade.
(f) [5] Show that if there is no redistribution of income, winners and losers both exist in each
country.
Wheat owners in home gain, corn owners in home lose. Foreign owners of wheat
lose while foreign corn owners gain. This can be seen by comparing the autarky prices
with the price after trade and noting that the price of wheat went up in home while it went
down in foreign.
Question 2. Comparative Advantage.
Two countries, Home and Foreign, use one factor, labor, to produce two goods, Shirts (S) and
Notebooks (N). The Home country can produce Shirts with one unit of labor and Notebooks
with two units of labor. The Foreign country can produce Shirts with 3 units of labor and
Notebooks with 4 units of labor. Home country is endowed with a labor force of 200 units,
while the endowment for the foreign country is 100 units. Preferences in each country can be
described by the following utility function:
U (N, S) = log N + log S
(a) [5] Which country has an absolute advantage in producing Shirts? Which country has an
absolute advantage in producing Notebooks?
2
Home in both cases. It is more efficient at producing both goods.
(b) [5] Which country has a comparative advantage in producing Shirts? How is this relevant in determining the pattern of production in a world where the countries can trade? Explain.
Home. This is because the opportunity cost of a shirt at home is half a notebook while
that in foreign is three-quarters of a notebook; hence, it is better to produce shirts at home.
(c) [5] What is the pattern of production and consumption in the Home country in autarky?
Ln = Ls = 100
N = 50, S = 100
(d) [5] What is the pattern of production and consumption in the Foreign country in autarky?
L∗n = L∗s = 50
50
50 ∗
,S =
N∗ =
4
3
(e) [10] Now consider the case where the two countries are allowed to trade. Find the world
equilibrium price. Do both countries specialize? What is the pattern of trade?
p=2
Foreign specializes in notebooks; home diversifies and produces both. Foreign exports notebooks
and imports shirts; the opposite is true of home.
Question 3. Autobiography.
Write a short (100-150 word-) autobiography detailing your background and interests, highlighting any experiences you may have had overseas. Think about how international events
have helped to shape your own life experiences and explain how international economic activity
impact what you do today [10].
3
Question 4. Trade Data.
For each of the following countries: the US, South Korea, China, Mexico, Canada, Germany,
Brazil, Australia, Spain, and South Africa, compute the following statistics (and present them in
a table) using data gathered from the online sources listed on the class website: (1) net exportsto-GDP ratio, (2) GDP per capita, and (3) population, both in 1990 and in 2005. Given these
statistics, what can you say about the volume of trade for these countries? Has trade grown
over time? Do richer (i.e. higher GDP per capita) countries trade more? Do bigger countries
(i.e. those with larger population) trade more? Explain [30].
See background reading for HW1 posted on the class website.
4