PEG3033 - TUTORIAL 3
1. Assume that tastes and technology are identical in China and Japan. Assume that China
is labour abundant and Japan is capital abundant. Assume that production of clothing
is labour intensive and production of automobiles is capital intensive.
a. Sketch the production possibilities frontier for China and Japan. Explain briefly
why you drew them as you did.
b. In autarky, which country has a comparative advantage in production of which
good? Why?
c. What does the Heckscher-Ohlin theorem predict would happen if trade were
opened between China and Japan?
d. Show and label the autarky and unrestricted-trade equilibria, production and
consumption points, imports and exports, autarky price ratios and term of trade.
2. Suppose that 𝑃𝑋 = 𝑎𝐿𝑋 . 𝑤 + 𝑎𝐾𝑋 . 𝑟 = 60. 𝑤 + 40. 𝑟 and that 𝑃𝑌 = 𝑎𝐿𝑌 . 𝑤 + 𝑎𝐾𝑌 . 𝑟 =
75. 𝑤 + 25. 𝑟.
a. If 𝑃𝑋 = 𝑃𝑌 = 100, what are the equilibrium values for the wage rate and the
rental rate?
b. If 𝑃𝑌 rose to 120 and the input coefficients didn't change, what would be the
new equilibrium values of 𝑤 and 𝑟.
c. After the change in part (b), would workers’ wages buy more or less good X?
More or less good Y? Would capital-owners’ rent buy more or less good X?
More or less good Y? Have real wages risen or fallen? The real rental rate?
d. Of what trade theorem is your answer to part (c) an example?
3. Assume Western Europe is capital abundant, Eastern Europe is labour abundant,
manufacturing is capital intensive, and agriculture is labour intensive. Labour is mobile
between manufacturing and agriculture within each region, but capital is immobile in
the short run (that is, there is “manufacturing capital” as well as “agricultural capital”
and each is useless in the other sector).
a. What would be the effect of opening trade on the return to capital in
manufacturing, the return to capital in agriculture, and wages in the two regions
in the short run? What is the effect on the purchasing power of the various
groups?
b. Answer part (a) for the long run.
c. Which group(s) in each region would you expect to support opening trade in the
short run? In the long run?