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1)
Tutorial 1 Solutions
ECON 341
Answer the following questions in NOT MORE THAN TWO sentences
a)
What determines the pattern of international trade in the Ricardian Model?
The patter of trade is determined by comparative advantage arising from differences in labor
productivity. The country with the comparative advantage in producing a good exports it.
b)
Why is the PPF a straight line in the Ricardian Model?
This is because the Ricardian model ignores the role of capital and land (there is only one factor,
labor) and hence, there are no diminishing returns to labor. The marginal product of labor is a
constant in this model.
c)
In the Ricardian model with two sectors, labor is mobile between the two sectors. What
does this mean about wages in the two sectors?
Wages in the two sectors have to be equal.
d)
In the Ricardian model with two goods and two countries (Home and Foreign), can it be
that Home gains from trade but Foreign does not? What does the world price have to be for this to
occur?
Yes, when the world price equals Foreign’s autarky price, Home gains from trade but foreign is no
better off.
2)
Adapted from Questions 2, 3, 4 and 5 from the Textbook, Chapter 2.
Consider the Ricardian model. Suppose that each worker in the Home country can produce three
cars or two TVs. Assume that Home has 4 workers.
a)
Graph the production possibilities frontier for the Home country.
b)
What is the autarky relative price of cars at home.
Autarky equilibrium occurs when PC/PTV = MPLTV/MPLC . Hence, the autarky relative price of cars
at home is 2/3
Suppose that each worker in the Foreign country can produce two cars or three TVs. Assume that
Foreign also has four workers.
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University of Auckland
c)
Tutorial 1 Solutions
ECON 341
Graph the production possibilities frontier for the Foreign country.
d)
What is the autarky relative price of cars in Foreign?
By the same argument in b) above, the autarky relative price of cars in foreign is given by 3/2.
e)
In which good does Foreign have a comparative advantage and why?
Foreign has a lower autarky price of TVs relative to Home (2/3 versus 3/2). Hence, Foreign has a
comparative advantage in TVs.
Suppose that in the absence of trade, Home consumes nine cars and two TVs, while Foreign
consumes two cars and nine TVs.
f)
Add the indifference curve for each country to the figures in Problem 2 and 3. Label the
PPF, indifference curve U1 and the no-trade equilibrium consumption and production for each
country.
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University of Auckland
Tutorial 1 Solutions
ECON 341
Suppose that the world relative price of cars (to TVs) is equal to 1.
g)
In what good will each country specialize? Explain.
Home will specialize in cars and Foreign in TVs because Home has a comparative advantage in cars
and Foreign in TVs.
Suppose that the consumption under trade at Home is 8 cars and 4 TVs, while at Foreign,
consumption is 4 cars and 8 TVs.
h)
Graph the new world price line for each country in the figures and add a new indifference
curve U2 for each country in the trade equilibrium.
See below.
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University of Auckland
Tutorial 1 Solutions
ECON 341
i)
Label the exports and imports for each country. How does the amount of exports compare
with Foreign imports?
As seen from the diagram below, the amount of car exports from Home and the amount of imports
of cars by Foreign equals the same (4 units). Similarly, the export of TVs from Foreign equals the
import of TVs from Home (4 units).
j)
Does each country gain from trade? Why or why not?
Yes, each country benefits because both Home and Foreign are now on a higher indifference curve,
indicating higher utility for consumers.
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University of Auckland
Tutorial 1 Solutions
ECON 341
k)
Calculate the real wage at Home under autarky and free trade. Have workers gained in real
terms? What about in the Foreign country?
In autarky, Home produces both products. The wage rate has to be equal to the value of the
marginal product of labor in both sectors. Hence, w = 𝑃𝑃𝐶𝐶 3. Dividing both sides by 𝑃𝑃𝑇𝑇𝑇𝑇 , w/𝑃𝑃𝑇𝑇𝑇𝑇 =
(𝑃𝑃𝐶𝐶 /𝑃𝑃𝑇𝑇𝑇𝑇 ) ∗3 =( 2/3)*3 = 2 TVs. Under trade, Home specializes in cars. Hence, in the car sector, w
𝑤𝑤
𝑤𝑤
𝑤𝑤
= 𝑃𝑃𝑐𝑐𝑤𝑤 3 still holds. Again, dividing by 𝑃𝑃𝑇𝑇𝑇𝑇
, w/𝑃𝑃𝑇𝑇𝑇𝑇
= (𝑃𝑃𝑐𝑐𝑤𝑤 /𝑃𝑃𝑇𝑇𝑇𝑇
) ∗3 = 1*3 = 3 TVs. This is because
the world relative price of cars under trade is 1. Hence, Home workers see an increase in the real
wage with trade.
We can similar calculate the real wage in autarky and free trade for Foreign. Foreign produces both
∗
goods in autarky. Hence, in the TV sector, 𝑤𝑤 ∗ = 𝑃𝑃𝑇𝑇𝑇𝑇
3. Dividing by 𝑃𝑃𝐶𝐶∗ , we find that 𝑤𝑤 ∗ /𝑃𝑃𝐶𝐶∗ =
𝑃𝑃∗
2
𝑤𝑤
∗
� 𝑇𝑇𝑇𝑇
∗ � ∗ 3 = � � ∗ 3 = 2 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐. Under trade, Foreign produces TVs and so 𝑤𝑤 = 𝑃𝑃𝑇𝑇𝑇𝑇 3 still holds.
𝑃𝑃𝐶𝐶
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𝑤𝑤
Diving by 𝑃𝑃𝑐𝑐𝑤𝑤 , 𝑤𝑤 ∗ /𝑃𝑃𝐶𝐶𝑤𝑤 = (𝑃𝑃𝑇𝑇𝑇𝑇
/𝑃𝑃𝐶𝐶𝑤𝑤 ) ∗3=1*3 = 3 cars. Foreign workers also see an increase in their
real wage with trade.
3)
This question pertains to the Specific Factors Model with two sectors – Agriculture (with
fixed factor Land) and Manufacturing (with fixed factor Capital). Assume that the price of
Agriculture falls due to trade. Answer the following questions:
a)
With the help of a diagram, show what happens to the wage W.
Show the Value of Marginal Product of Agriculture curve shifting down by the amount of the price
decrease. The wage falls.
b)
What happens to the allocation of labor between Agriculture and Manufacturing? In other
words, does labor employed in Agriculture increase or decrease? What about labor employed in
Manufacturing? Show this in the diagram.
Labor employed in Agriculture falls while labor employed in manufacturing increases.
c)
What happens to the marginal product of land? What happens to the marginal product of
capital? Explain.
The marginal product of land decreases because there is less labor now employed in Agriculture.
Conversely, since there is more labor employed in Manufacturing, the marginal product of capital
rises.
d)
Are capital owners better off or worse off in real terms? What about land owners? Are any
of your results ambiguous? (To see this examine what happens to the real return to capital and land
in terms of the prices of both Agriculture and Manufacturing).
Since the marginal product of capital rises, and since under perfect competition RK=MPK*PM,
RK/PM rises. Since PM is unchanged, this means that RK rises. This implies that RK/PA rises because
the numerator rises and the denominator falls. So capital owners are unambiguously better off.
The marginal product of land falls. This means that RT/PA falls. This means that the fall in RT is
greater than the fall in PA. Since PM is unchanged, RT/PM also falls. Land owners are unambiguously
worse off.
There is no ambiguity in any of the above results.
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