International Trade Theory
Exercise 1
Mercantilists and Absolute Advantage
1. What were the pillars of the Mercantilists thought and why did the mercantilists
consider the holding of precious metal important to nation-state
2. What are the critical assumptions of the price-species flow mechanism? What
happens to the trade balance in a surplus country if the demand for the traded
goods is price elastic? Why
3. Briefly explain why the ideas of Smith and Hume were so devastating to
Mercantilist thinking and policy
4. The following table shows the hours of labour required to produce I unit of each
commodity in each country
United states
United Kingdom
Wheat
3hrs
4hrs
Clothing
9hrs
4hrs
Which country has an absolute advantage in wheat and why? In clothing? Why? If
trade takes place between the two countries at a barter price of 1 clothing for 2
wheat (or 1 wheat for ½ clothing,) why does each country gain from trade?
5. Using the above table suppose that the United Kingdom has 500hrs of labour
available to it. Prior to trade, the country is using 300 of those labour hours to
produce clothing and the remaining 200 labour hours to produce wheat. How
much wheat and how much clothing will the United Kingdom be producing in
Autarky (pre-trade situation)
6. Assume a trading situation were the exchange rate is at the barter price of 1
clothing for 2 wheat (or 1 wheat for ½ clothing). If the United Kingdom devotes all
of its resources into cloth production, given the above exchange rate it produces
125 units of cloth and 0 units of wheat. Why is this so?
Now suppose the United Kingdom exports 40C (and therefore receives 80W in
exchange) and keeps the remaining 85 for its own consumption. What would be
the United Kingdom consumption of wheat and clothing in the trading situation?
By how much has the UK, because of trade, been able to increase its
consumption of wheat and its consumption of clothing?
Comparative Advantage
7. Given the following table:
France
Germany
Computers
100days
60days
wheat
4days
3days
a. Calculate the autarky price ratios for both Computers and Wheat.
b. Which country has a comparative advantage in computers? Explain why?
Which has a comparative advantage in wheat? Explain why?
c. If the terms of trade is 1 computer : 22 wheat, how many days of labour does
France save per unit of its imported good by engaging in trade? How many
days does Germany save per unit of it’s import good?
8. In light of the Ricardian model, how might you evaluate the claim by developing
countries that they are at a disadvantage in trade with powerful industrialized
countries?
9. Using the following table please answer the following questions
Bread
VCRs
Lamps
Rugs
Books
United Kingdom
2 days
8 days
4 days
3 days
2 days
United States
2 days
6 days
2 days
2 days
3 days
a. Assume the wage rate in the United Kingdom ( Wuk ) is £8 per day, the wage rate
in the United States ( Wus ) is $20 per day, and the exchange rate (e) is $2/£1. With
this information, determine the goods that will be U.K. exports and the goods that will
be U.S. imports
b. Using the above example as in (a), calculate the upper and lower limits (in pounds
per day) to the UK wage rate that are consistent with a two-way trade between the
countries.
c. Using the information as in (a) calculate the upper and lower limits (in $/£) to the
exchange that are consistent with two-way trade between the countries.
10. a. What happens to the pattern of trade if the level of wages in one country
increases, other things being equal?
b. Similarly what happens to the patterns of trade of the domestic country if the price
of foreign currency rises (i.e., it’s currency depreciates in value)
11. Monetizing the Ricardian model by the introduction of wages, is there a paradox
in the Ricardian model similar to that of the mercantilist model. If yes please explain.
If no, why not.