International Trade
Homework #2
(Chapters 5&6)
Ch 5: 2, 3, 5
Ch 6: 1, 2, 5
Ch 5:
2.
The definition of cattle growing as land intensive depends on the ratio of land to labor used in
production, not on the ratio of land or labor to output. The ratio of land to labor in cattle exceeds the
ratio in wheat in the United States, implying that cattle is land intensive in the United States. Cattle is
land intensive in other countries as well if the ratio of land to labor in cattle production exceeds the ratio
in wheat production in that country. Comparisons between another country and the United States is less
relevant for this purpose.
3. “The world’s poorest countries cannot find anything to export. There is no resource that is
abundant – certainly not capital nor land, and in small poor nations not even labor is abundant.”
Discuss
This question is similar to an issue discussed in Chapter 4. What matters is not the absolute
abundance of factors, but their relative abundance. Poor countries have an abundance of labor
relative to capital when compared to more developed countries. For example, consider a large, rich
country like the United States and a small, poor country like Guatemala. Though the United States
has more land, natural resources, capital, and labor than Guatemala, what matters for trade is the
relative abundance of these factors. The ratio of labor to capital is likely to be much higher in
Guatemala than in the United States, reflecting a relative scarcity of capital in Guatemala and
abundance in the United States. This makes labor relatively cheaper and capital more expensive in
Guatemala than in the United States. Notice that this difference in factor prices is not driven by how
much labor Guatemala has compared to the United States, but by the proportion of labor to other
factors.
5. Recently, computer programmers in developing countries such as India have begun doing work
formerly done in the US. This shift has undoubtedly led to substantial pay cuts for some
programmers in the US. How is this possible when the wages of skilled labor are rising in the
US as a whole? What argument would trade economists make against seeing these wage cuts as
a reason to block outsourcing of computer programming?
Specific programmers may face wage cuts due to the competition from India, but this is not inconsistent with
skilled labor wages rising. By making programming more efficient in general, this development may have
increased wages for others in the software industry or lowered the prices of the goods overall. In the short
run, though, it has clearly hurt those with sector specific skills who will face transition costs. There are many
reasons to not block the imports of computer programming services (or outsourcing of these jobs). First, by
allowing programming to be done more cheaply, it expands the production possibilities frontier of the US,
making the entire country better off on average. Necessary redistribution can be done, but we should not stop
trade which is making the nation as a whole better off. In addition, no one trade policy action exists in a
vacuum and if the US blocked the programming imports, it could lead to broader trade restrictions in other
countries.
Ch 6:
1. Assume that Norway and Sweden trade with each other, with Norway exporting fish to Sweden
and Sweden exporting Volvos (cars) to Norway. Illustrate the gains from trade between the two
countries using the standard trade model, assuming first that tastes for the goods are the same in
both countries, but the production possibilities frontiers differ: Norway has a long coast that
borders on the north Atlantic, making it relatively more producing in fishing. Sweden has a
greater endowment of capital, making it relatively more productive in cars.
Note how welfare in both countries increases as the two countries move from production patterns governed
by domestic prices (dashed line) to production patterns governed by world prices (straight line).
2. In the trade scenario in Problem 1, due to overfishing, Norway becomes unable to catch the
quantity of fish that it could in previous years. This change causes both a reduction in the
potential quantity of fish that can be produced in Norway, and an increase in the relative world
price for fish, Pf/Pa.
A. Show how the overfishing problem can result in a decline in welfare for Norway.
B.
Also show how it is possible that the overfishing problem could result in an increase in
welfare for Norway.
In panel a, the reduction of Norway’s production possibilities away from fish cause the production of
fish relative to automobiles to fall. Thus, despite the higher relative price of fish exports, Norway moves
down to a lower indifference curve representing a drop in welfare.
In panel b, the increase in the relative price of fish shifts causes Norway’s relative production of fish to
rise (despite the reduction in fish productivity). Thus, the increase in the relative price of fish exports
allows Norway to move to a higher indifference curve and higher welfare.
5. Japan primarily exports manufactured goods, while importing raw materials such as food and oil.
Analyze the impact of Japan’s terms of trade of the following events: (no graphs needed, just
write what happens)
A. A war in the Middle East disrupts oil supply.
B.
Korea develops the ability to produce automobiles that it can sell in Canada and the US.
C.
US engineers develop a fusion reactor that replaces fossil fuel electricity plants.
D. A harvest failure in Russia.
E.
A reduction in Japan’s tariffs on imported beef and citrus fruit.
The terms of trade of Japan, a manufactures (M) exporter and a raw materials (R) importer, is the world
relative price of manufactures in terms of raw materials (pM/pR). The terms of trade change can be determined
by the shifts in the world relative supply and demand (manufactures relative to raw materials) curves. Note
that in the following answers, world relative supply (RS) and relative demand (RD) are always M relative to
R. We consider all countries to be large, such that changes affect the world relative price.
(a) Oil supply disruption from the Middle East decreases the supply of raw materials, which increases the
world relative supply. The world relative supply curve shifts out, decreasing the world relative price of
manufactured goods and deteriorating Japan’s terms of trade.
(b) Korea’s increased automobile production increases the supply of manufactures, which increases the
world RS. The world relative supply curve shifts out, decreasing the world relative price of manufactured
goods and deteriorating Japan’s terms of trade.
(c) U.S. development of a substitute for fossil fuel decreases the demand for raw materials. This increases
world RD and the world relative demand curve shifts out, increasing the world relative price of manufactured
goods and improving Japan’s terms of trade. This occurs even if no fusion reactors are installed in Japan
since world demand for raw materials falls.
(d) A harvest failure in Russia decreases the supply of raw materials, which increases the world RS. The
world relative supply curve shifts out. Also, Russia’s demand for manufactures decreases, which reduces
world demand so that the world relative demand curve shifts in. These forces decrease the world relative
price of manufactured goods and deteriorate Japan’s terms of trade.
(e) A reduction in Japan’s tariff on raw materials will raise its internal relative price of manufactures. This
price change will increase Japan’s RS and decrease Japan’s RD, which increases the world RS and decreases
the world RD (i.e., world RS shifts out and world RD shifts in). The world relative price of manufactures
declines and Japan’s terms of trade deteriorate.