Part I:
1. Chapter 5 (6th edition), question 1 & 3
1. An increase in the terms of trade increases welfare when the PPF is rightangled. The production point is the corner of the PPF. The consumption point is
the tangency of the relative price line and the highest indifference curve. An
improvement in the terms of trade rotates the relative price line about its intercept
with the PPF rectangle (since there is no substitution of immobile factors, the
production point stays fixed). The economy can then reach a higher indifference
curve. Intuitively, although there is no supply response, the economy receives
more for the exports it supplies and pays less for the imports it purchases.
3. 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.
2. Chapter 7 (6th edition), question 2.
2. There is no incentive to migrate when there is factor price equalization. This
occurs when both countries produce both goods and when there are no barriers to
trade (the problem assumes technology is the same in the two countries). A tariff
by country A increases the relative price of the protected good in that country and
lowers its relative price in the country B. If the protected good uses labor
relatively intensively, the demand for labor in country A rises, as does the return
to labor, and the return to labor in the country B falls. These results follow from
the Stolper-Samuelson theory, which states that an increase in the price of a good
raises the return to the factor used intensively in the production of that good by
more than the price increase. These international wage differentials induce
migration from country B to country A.
Part II:
1 If, beginning from a free trade equilibrium, the (net barter) terms of trade improve for a
country, then it will
(a) increase production of its import competing good.
(b) increase consumption of its export good.
(c) increase the quantity of its imports.
(d) experience an export-biased shift in its production possibility frontier.
(e) None of the above.
Answer: C
2.
If a country lent money to another, this must
(a) lower the terms of trade of the recipient country.
(b) lower the terms of trade of both countries.
(c) improve the terms of trade of the recipient country.
(d) improve the terms of trade of the donor country
(e) None of the above.
Answer: E
3.
If the United States exports skilled-labor intensive products and services, then we should
expect unions representing skilled labor to
(a) lobby in favor of tariffs.
(b) lobby against the imposition of tariffs.
(c) be indifferent to the issue of tariffs.
(d) lobby in favor of improved terms of trade.
(e) Not enough information.
Answer: E
4
If a there are no international loans or capital flows, then if a country’s terms of trade
improve, we would find that
(a) the value of its exports exceeds the value of its imports.
(b) the value of its exports becomes less than that of its imports.
(c) the value of its exports exactly equals that of its imports.
(d) the quantity of its exports equals that of its imports.
(e) None of the above.
Answer: C
5 If PC/PF were to increase in the international marketplace, then
(a) all countries would be better off.
(b) the terms of trade of cloth exporters improve.
(c) the terms of trade of food exporters improve.
(d) the terms of trade of all countries improve.
(e) None of the above
Answer: B
6. .
Multinational corporations may provide benefits to their home countries for the following
reasons except which one?
(a) Secure raw materials for the source country
(b) Allow for exports of products, which involve company-specific trade secrets
(c) Allow domestic firms to secure timely deliveries of commodities or products, which do
not enjoy a stable or deep market internationally
(d) Shift home country technology overseas via licensing
(e) None of the above.
Answer: D
7.
American labor unions have recently maintained that U.S. multinational corporations have
been
(a) exporting American jobs by investing overseas.
(b) exporting American jobs by keeping investment in the United States.
(c) importing cheap foreign labor by shifting U.S. investment overseas.
(d) importing cheap foreign workers by keeping U.S. investment at home.
(e) None of the above.
Answer: A
8.
In theory, labor mobility is
(a) a complete complement to trade flows.
(b) a partial complement to trade flows.
(c) a complete substitute for trade flows.
(d) a partial substitute for trade flows.
(e) None of the above.
Answer: C
Essay question:
1.
Factor-intensity reversals describe a situation in which the production of a product may be
land-intensive in one country, and relatively labor intensive in another (at given relative
wage levels). For example, cotton may be land intensive in the U.S., and labor intensive in
Egypt where land is relatively scarce and expensive. Suppose factor-intensity reversals
were common. How would that affect the conclusion that a country in which land is
relatively scarce will not be the country with
a comparative advantage in the land-intensive product?
Answer: The answer here is straightforward (though it has various interesting
implications). In this case we cannot define or identify a product in terms of its
relative factor intensity (at all or any relative wage level). Therefore, the
Heckscher-Ohlin Theorem is ipso-facto inapplicable.
2. One of the commonly used assumptions in deriving the Heckscher-Ohlin model is that tastes
are homothetic, or that if the per capita incomes were the same in two countries, the
proportions of their expenditures allocated to each product would be the same as it is in the
other country. Imagine that this assumption is false, and that in fact, the tastes in each
country are strongly biased in favor of the product in which it has a comparative advantage.
How would this affect the relationship between relative factor abundance between the two
countries, and the nature (factor-intensity) of the product each exports? What if the taste
bias favored the imported good?
Answer: If in fact national tastes were strongly biased in favor of the product in which the
country enjoyed a comparative advantage, then we would expect a bias in favor
of rejecting the Heckscher-Ohlin Theorem in actual trade data. The engine
driving the H-O model is that a country should be expected to have a relatively
low cost of producing the good in which it has a comparative advantage.
However, the respective demand forces would tend to raise the price of this good,
so that the expected pattern would not generally be observed. However, if the
tastes were biased in favor of the imported good, then the predictions of the
Heckscher-Ohlin Theorem would be expected to be generally observed.
3.
Suppose, as a result of various dynamic factors associated with exposure to international
competition, Albania’s economy grew, and is now represented by the rightmost production
possibility frontier in the Figure above. If its point of production with trade was point c,
would you consider this growth to be export-biased or import biased? If Albania were a
large country with respect to the world trade of A and B, how would this growth affect
Albania’s terms of trade? Its real income?
Answer: If point c is the production point with trade, then Albania has a comparative
advantage in good B. Therefore, from the shape of the new production possibility
frontier (as compared to the original one), this is clearly an export-biased growth.
This ceteris paribus would tend to worsen Albania’s terms of trade. The terms of
trade effect would, again ceteris paribus, worsen its real income. However, the
growth itself acts in the opposite direction.