Economics 433: Advanced International Trade
Prof. Andrés Rodríguez-Clare
Spring, 2006
Problem Set 1
Due January 24 , 2006
Please print this problem set out and work directly on it. If necessary, you may attach
extra sheets. Be sure to show your work on all questions that require a numerical
response.
Name __________________________________________________________________
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Answer the following problems 1-3 using the chapter information for Home and Foreign:
Problem 1
(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) 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.
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Problem 2
(a) Using Figure 2.5, show that an increase in the relative price of wheat from its
international equilibrium of 2/3 will raise Home’s utility.
(b) Using Figure 2.6, show that an increase in the relative price of wheat from its
international equilibrium of 2/3 will lower Foreign’s utility. What is the Foreign’s utility
when the international price reaches 1, and what happens in Foreign when the relative
price of wheat rise above that level?
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Problem 3
Suppose that the Home country is much larger than the Foreign country. For example,
suppose we double the number of workers at Home from 25 to 50. Then Home it is
willing to export up to 100 bushels of wheat at its no-trade price of PW/PC = 1/2, rather
than 50 bushels of wheat as shown in Figure 2.11. Below we draw a new version of
Figure 2.11, with the larger home country.
(a) What is the new international equilibrium relative price of wheat?
(b) Draw a new version of the trade equilibrium in Home and in Foreign, and show
the production point and consumption point in each country.
(c) Are there gains from trade in both countries? Explain why or why not.
PW/PC
Foreign Imports
Home Exports
1
D
1/2
0
50
80
100
Figure 2.11-new: With Larger Home Country
Wheat
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Problem 4
There are two countries: US and Mexico. There are two goods: computers and
apparel. There is one factor of production: labor. The MPL for computers and apparel is
as follows:
MPLc
MPLa
Opp cost of c
Opp cost of a
US
2
3
Mexico
1/4
1
a) What is the opportunity cost of c and a in the two countries? Fill in the table above.
b) Who has absolute advantage in computers? Who in apparel?
c) Who has comparative advantage in computers? Who in apparel?
c) What is the autarky relative price of computers in the US and Mexico?
d) Imagine that the US-Mexico border is closed, so that there is no trade, but you find a
little hole in the wall. What is the “roundabout” way of obtaining apparel in the US? Is
this cheaper than the direct way?
f) Assume that total labor units in Mexico are 30, whereas in the US there are 200. Draw
the PPF for both countries with apparel on the horizontal axis. Now imagine that
consumers in Mexico and the US are identical, and that they have extreme preferences:
no matter what price, they always want to consume two units of apparel per computer.
(Note: in this case the social indifference curves can be depicted as L shaped, with the
corner of the L lying always on a ray given by Qc = (1/2)Qa). What is the equilibrium
production and consumption point in autarky for both countries?
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h) Now imagine that trade is established. What is the possible range for the wage in
Mexico relative to the wage in the US? What would happen if the wage were to fall
outside this range?
i) Show that the international relative price of apparel must be 2/3. At this international
price, draw the CPF of both countries and determine the new equilibrium consumption
and production point for both countries. Describe the pattern of specialization and trade.
Draw the trade triangles. Talk about the gains from trade for both countries. What
happened to the wage in Mexico in terms of apparel, and in terms of computers?