Name:_____________
SSII 2010, 160A Midterm
Professor Farshid Mojaver
There are 153 points in the exam. Please answer all the questions in the space provided
General Questions
1) [8 pts] Questions pertaining to excerpts from Adam Smith’s Wealth of Nations
a) Why Adam Smith supports the act of Navigation despite his own argument that the act reduces trade
and the opulence of Great Britain (at least in the short run)?
b) In addition to the defense argument made by Adam Smith do you see any other reason for the act of
navigation? Did the act actually lead to greater opulence in addition to better defense?
2) [4 pts] How can a developed country compete against some low foreign wage industries?
3) [4 pts] Why is the PPF a straight line in the Ricardian model and bowed out in Hecksher-Ohlin
model?
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4) [25 pts] Economic Consultant in Poorestan
Poorestan is a poor country with income per capita and poor natural resources. At the present Poorestan
lives in isolation and does not trade with any country. Policy makers in Poorestan are debating whether
they should open up to international trade but they are several concerns and questions and they turn to
you for advice.
a) Make an argument in support of international trade. Why trade is “good’ for Poorestan.
b) Policy makers in Poorsetan are concerned that they have nothing to export, that technologically
they are far behind any other country in every sector. What would you address this concern.
c) Policy makers in Poorestan want to know if they open up trade what would be their exports.
Make some educated guesses as the types of goods that Poorestan could export.
d) Policy makers in Poorestan want to know who gains and who loses from trade if they open up to
international trade. Please make sure you address the questions both in the (i) short run and (ii)
long run. [10 pts]
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Question on the Ricardian Model of Trade
1) [24 pts] Answer the following questions given the information in the following table.
Unit Labor Requirements
Malaysia
Indonesia
Shirts
20
20
Cameras
10
40
a) Which country has absolute advantage in shirt production and why? What about camera production?
b) In absence of trade, what is the opportunity cost of Shirts (in terms of Cameras) in Indonesia and
Malaysia?
c) For which product does Indonesia have comparative advantage?
d) What is the relative domestic price of Shirts in each country before trade?
e) Suppose there are 200 units of labor in Malaysia and 400 in Indonesia. Draw a graph showing production
possibility frontier of Malaysia and Indonesia. Have Shirt production of the horizontal axis and Camera on
the Vertical axis.
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f) If world price of shirts to cameras were 1 what would be the world production of Camera and Shirts?
Which country would produce each?
g) Use a hypothetical indifference curve in a graph showing gains from trade for each country (when
international PS/PC =1).
h) What constitutes the basis of trade in the Ricardian Model? (in other words who exports what)
2) [9 pts] Consider the following information about production in the United States and China
a. Which country has absolute advantage in apparel and why?
b. Which country has comparative advantage in apparel and why?
c. What will US export to China and why?
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Heckscher-Ohlin Model
1)[24 pts] Questions on HO theory
a) What constitutes the basis of trade in the HO theory of trade?
b) What is the prediction of HO theory regarding trade patterns?
c) Based on HO theory what would be the impact of free trade on the existing international wage gaps?
d) Has this prediction come true to any degree? Why international wage rates are still so different?
e) What does "Leontieff Paradox" refer to?
f) Did the Paradox ever get resolved? And if so how? What is the final verdict on the Leontief paradox
and the HO theory?
2) [10 pts] State and prove Solper-Samuelson Theorem
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[8 pts] On Factor Movement
What is the impact of a massive influx of foreign capital on the (a) production and (b) factor prices of a small
open economy like Vietnam (labor abundant)?
[12 pts] Questions on Sector-Specific Model
Suppose two countries, Canada and Mexico, produce two goods, timber and televisions.
Assume that land is specific to timber, capital is specific to televisions, and labor is free to move
between the two industries. When Canada and Mexico engage in free trade, the relative price of
televisions falls in Canada and the relative price of timber falls in Mexico.
a) In a graph, show how the wage changes in Canada because of a fall in the price of televisions, holding
constant the price of timber. Can we predict that change in the real wage?
b) What is the impact of opening trade on the rentals on capital and land in Canada?
Can we predict that change in the real rentals on capital and land?
c) What is the impact of opening trade on the rentals on capital and land in Mexico? Can we predict that
change in the real rentals on capital and land?
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d) In each country, has the specific factor in the export industry gained or lost, and has the specific
factor in the import industry gained or lost?
Outsourcing: [20 points]
1) Using an outsourcing model show that all countries can gain from trade in intermediate goods (say
components and R&D products). Clearly state your assumptions.
2) Explain the increase in relative wage of skilled to unskilled labor in US and China using an
outsourcing model.
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