Homework 2
UCDavis, 160a, Fall 2010
The Ricardian Model 3
Prof. Farshid Mojaver
Problem 1
You are given the information shown in the table about the production relationship between
Wonderland and the rest of the world and use the standard Ricardian assumptions:
Wonderland
Rest of the World
Labor Hours per
Bottle of Wine
10
6
Labor Hours per
Pound of Cheese
5
2
Wonderland has 40 million labor hours in total and the rest of the world has 30 million
labor hours in total per year.
a. Which country has absolute advantage in wine? In cheese?
b. Which country has comparative advantage in wine? In cheese?
c. Graph each country’s PPF. Use indifference curve to show the no-trade
equilibrium (label as point A) for each country. (Suppose Wonderland consumes
4 million pounds of cheese and the rest of the world consumes 6 pounds of
cheese).
d. When trade is opened between Wonderland and the rest of the world, what the
pattern of trade is? If the world price ratio is 0.4 bottle of wine per pound of
cheese (Be careful this is not Pw/Pc but Pc/Pw), what happens to production in
each country? (Label the new production point in each country as point P)
e. Suppose that 2 million bottles of wine and 5 million pounds of cheese are traded.
Show the consumption of each good in each country graphically using
indifference curve (label the consumption point C)?
Problem 2
Assume that Home and Foreign produce two goods, televisions and cars, and use the
following information to answer the questions.
a. What is the marginal product of labor for televisions and cars in the Home country?
What is the no-trade relative price of televisions at Home?
b. What is the marginal product of labor for televisions and cars in Foreign? What is the
no-trade relative price of televisions in Foreign?
c. Suppose the world relative price of televisions in the trade equilibrium is PTV/PC =1.
Which good will each country export? Briefly explain why.
d. In the trade equilibrium, what is the real wage at Home in terms of cars and in terms of
televisions? How do these values compare with the real wage in terms of either good in
the no-trade equilibrium?
e. In the trade equilibrium, what is the real wage in Foreign in terms of televisions and in
terms of cars? How do these values compare with the real wage in terms of either good in
the no-trade equilibrium?
f. In the trade equilibrium, do Foreign workers earn more or less than those at Home,
measured in terms of their ability to purchase goods? Explain why.
Problem 3
This question is based on the chapter information for Home and Foreign.
a. Suppose that the number of workers doubles in Home. What happens to the
Home PPF and what happens to the no-trade relative price of wheat?
b. Instead of doubling the number of workers in Home, suppose that there is
technological progress in the wheat industry, so that Home can produce more wheat with
the same amount of labor. What happens to the Home PPF, and what happens to the
relative price of wheat? Describe what would happen if a similar change occurred in the
cloth industry.
Problem 4
Consider an economy that labor is not mobile between sectors in the short run.
a. Show the effect of international trade on production and consumption in the short run
b. Answer question in part a assuming the keeps its domestic production prices intact using
appropriate tax and subsides.
Question 5
Make an argument to show that a domestic firm may lose out in international competition
even if it is the lowest cost producer in the world.
Question 6
Read the following excerpt from Adam Smith on division of labor and labor productivity
to answer the subsequent questions
An Inquiry into the Nature and Causes of the Wealth of Nations (Book 1, Ch 1)
Of the Division of Labour
To take an example, therefore, from a very trifling manufacture; but one in which the division of
labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to
this business (which the division of labour has rendered a distinct trade), nor acquainted with the
use of the machinery employed in it (to the invention of which the same division of labour has
probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day,
and certainly could not make twenty. But in the way in which this business is now carried on, not
only the whole work is a peculiar trade, but it is divided into a number of branches, of which the
greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third
cuts it, a fourth points it, a fifth grinds it at the top for receiving, the head; to make the head
requires two or three distinct operations; to put it on is a peculiar business, to whiten the pins is
another; it is even a trade by itself to put them into the paper; and the important business of
making a pin is, in this manner, divided into about eighteen distinct operations, which, in some
manufactories, are all performed by distinct hands, though in others the same man will sometimes
perform two or three of them. I have seen a small manufactory of this kind where ten men only
were employed, and where some of them consequently performed two or three distinct
operations. But though they were very poor, and therefore but indifferently accommodated with
the necessary machinery, they could, when they exerted themselves, make among them about
twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling
size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins
in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be
considered as making four thousand eight hundred pins in a day. But if they had all wrought
separately and independently, and without any of them having been educated to this peculiar
business, they certainly could not each of them have made twenty, perhaps not one pin in a day;
that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth
part of what they are at present capable of performing, in consequence of a proper division and
combination of their different operations.
The division of labour, ... occasions, in every art, a proportionable increase of the productive
powers of labour. The separation of different trades and employments from one another seems to
have taken place in consequence of this advantage. This great increase of the quantity of work
which, in consequence of the division of labour, the same number of people are capable of
performing, is owing to three different circumstances; first, to the increase of dexterity in every
particular workman; secondly, to the saving of the time which is commonly lost in passing from
one species of work to another; and lastly, to the invention of a great number of machines which
facilitate and abridge labour, and enable one man to do the work of many.
1- What is the difference between specialization in the Ricardian model and the
Smithian model?
2- What does the Smithian division of labor imply on the productivity of larger
economies?
3- What is the source of gains from trade and increased productivity in the Ricardian
model?
4- Consider a two good economy: grain and computer. They are both produced with
labor only but grain is subject to constant return to scale technology while
computer production is subject to increasing return to scale technology. Draw the
Production Possibility Frontier for this economy.
Heckshcer-Ohlin Model
Jeopardy Answers
DIRECTIONS: As in the popular TV game show, you are given an answer to a question and you
must respond with the question. For example, if the answer is, "a tax on imports", then the correct
question is, "What is a tariff?"
1. term used to describe Argentina if Argentina has more land per unit of capital than Brazil.
2. term used to describe aluminum production when aluminum production requires more
energy per unit of capital than steel production.
3. general term used to describe the amount of a factor needed to produce one unit of a
good.
4. the two key terms used in the Heckscher-Ohlin model; one to compare industries, the
other to compare countries.
5. term used to describe when the capital-labor ratio in an industry varies with changes in
market wages and rents
6. term describing the ratio of the unit-capital requirement and the unit-labor requirement in
production of a good.
7. the assumption in the Heckscher-Ohlin model about unemployment of capital and labor.
8. interpretation given for the slope of the production possibility frontier.
9. the H-O model theorem that would be applied to identify the effects of a tariff on the
prices of goods and factors.
Multiple Choice Questions
1. In the 2-factor, 2 good Heckscher-Ohlin model, the two countries differ in:
A. tastes.
D. relative availabilities of factors of production.
B. military capabilities.
E. labor productivities.
C. size.
2. In the 2-factor, 2 good Heckscher-Ohlin model, a change from autarky (no trade) to trade will
benefit the owners of:
A. capital.
B. the relatively abundant factor of production.
C. the relatively scarce factor of production.
D. the relatively inelastic factor of production
E. the factor of production with the largest elasticity of substitution.
3. One way in which the Heckscher-Ohlin model differs from the Ricardo model of comparative
advantage is by assuming that __________ is (are) identical in all countries.
A. factor of production endowments
D. technology
B. scale economies
E. opportunity costs
C. factor of production intensities
4. According to the Hecksher-Ohlin model,
A. everyone automatically gains from trade
B. the scarce factor necessarily gains from trade
C. the gainers could compensate the losers and still retain gains.
D. a country gains if its exports have a high value added.
E. None of the above.
5. Starting from an autarky (no-trade) situation with Heckscher-Ohlin model, if Country H is
relatively labor abundant, then once trade begins:
A. wages and rents should rise in H.
B. wages and rents should fall in H.
C. wages should rise and rents should fall in H.
D. wages should fall and rents should rise in H.
E. None of the above.
6. Suppose that there are two factors, capital and land, and that the United States is relatively land
endowed while the European Union is relatively capital-endowed. According to the HeckscherOhlin model,
A. European landowners should support US-European free trade.
B. European capitalists should support US-European free trade.
C. all capitalists in both countries should support free trade.
D. all landowners should support free trade.
E. None of the above.
7. Assume that only two countries, A and B, exist.
Consider the following data:
Countries
Factor Endowments
A
B
Labor Force
45
20
Capital Stock
15
10
If good S is capital intensive, then following the Heckscher-Ohlin Theory,
A. country A will export good S.
B. country B will export good S.
C. both countries will export good S.
D. trade will not occur between these two countries.
E. Insufficient information is given.
False, True, Or Uncertain, Explain Why (Questions in Heckscher-Ohlin Theory)
Question 1
“Opening up free trade does hurt people in import-competing industries in the short run. But in
the long run, when people and resources can move between industries, everybody ends up gaining
from free trade.”
Question 2
“American workers gain from free trade with China because free trade lowers prices of clothing
in the United States and American workers spent very large portion of their income on clothing”