Exercises 2
Hechscher- Ohlin (H-O) Model
1. Suppose that the K/L ratio is higher in France than in Spain. What would you expect to be
the wages in France as trade takes place between the two countries? Why?
2. Graphically illustrate the gains from trade in the H-O model
3. In the H-O model which factor of production would advocate for free trade and which would
oppose it ? (Hint:Stolper-Samuelson theorem)
4. What do we mean by the factor-price-equalization theory
5. Briefly discuss why answering the question ‘is trade beneficial in the H-O model’ a bit
complicated
Growth and Trade
6. What do you understand by immiserizing growth?
7. Briefly explain the Rybczynski Theorem in a small country setting
8. Can growth in the abundant factor ever lead to an expansion of the trade triangle if the
Rybczynski Theorem holds in the case of a small country?
Krugman Theory
9. While the recognition of the economics of scale may make trade theory more ‘realistic’, what
does this recognition do to the ability of trade theory to predict the commodity trade pattern
of countries? Explain
10. Ignoring the mathematics, explain the operation of the krugman model in economic terms
and indicate the principal lessons of it.
11. Why is an increase in the number of varieties of a good regarded as a gain from trade? Can
you think of economic disadvantages associated with greater product variety? Explain.
12. Is the existence of product differentiation a necessary condition for the existence of intraindustry trade?
13. Is the distinction between ‘intra-industry trade’ and ‘inter-industry trade’ a useful distinction?
Why or why not?
Trade Policy
14. Analyze using a graph the economic impact of the following policies in a partial equilibrium
setting:
a. Quotas
b. Tariffs
c. Subsidies.
Given the above instruments, who are the winner and losers from these policies? And which is the
most efficient instrument to achieve the aim of the policy
15. How would the analysis in question 14 change if the country is a large country? In particular,
use partial equilibrium analysis to discuss the impact of tariff in a two country-world
16. Briefly explain the infant industry argument for protection. What are its strengths and
weaknesses?
Gravity Model
17. The gravity model predicts that the volume of trade is directly related to the GDP of each
trading partner and is inversely related to the distance between them. Is this true or false?
Please provide explanation to back up your answer.
18. Does size and distance matter in the Gravity model? Justify your answer.
Product Cycle Model
19. What is the link between (dynamic) comparative advantage and the product life theory?
20. What are the stages involved in the Product life cycle theory?
Labor Mobility
21. If labor move from Sweden to Finland, what do you think would happen to the following:
a. wages in both Finland and Sweden
b. price of goods in Finland and Sweden.
c. Which country gains from the labor migration and why?
Free trade
22. If tariffs are supposed to generate income for the government and improve domestic
production of the good, why would you call for free trade?
Exchange Rate
23. Suppose Brazil’s inflation rate is 100% over one year but the inflation rate in Holland is only 5
percent. According to the PPP, what should happen over the year to the Dutch guilder’s exchange
rate against the Brazilian real?
24. Discuss why it is often asserted that exporters suffer when their home currencies appreciate in
real terms against foreign currencies and prosper when their home currencies depreciate in real
terms.
25. A country imposes a tariff on imports from abroad. How does its action change the exchange
rate between the home and foreign currency through the PPP?
26. What is the effect of an increase of the domestic interest rate on the exchange rate via the
PPP? How about increases in money supply and the output?
27. What are the shortcomings of the PPP
Balance of Payments
28. Can you think of a reason why a government might be concerned about a large current
account deficit or surplus?
29. Is it possible for a country to have a current account deficit at the same time it has a surplus in
its balance of payments?