EC205 - International Economics
Problem Set – 1
Points: 50
Submission Deadline: Wednesday, 23rd October 2024, in class
Please clearly show all the steps in your work for full credit, and explain the economic
interpretation of the equations and graphs.
Question 1: Ricardian Model
(A) Suppose that each worker in the Home country can produce three cars or two TVs. Assume
that Home has four workers. [Points 5]
a. Graph the production possibilities frontier for the Home country.
b. What is the no-trade relative price of cars at Home?
(B) Suppose that each worker in the Foreign country can produce two cars or three TVs. Assume
that Foreign also has four workers. [Points 10]
a. Graph the production possibilities frontier for the Foreign country.
b. What is the no-trade relative price of cars in Foreign?
c. Using the information provided in Part (A) regarding Home, in which good does
Foreign have a comparative advantage, and why?
(C) Now suppose the world relative price of cars is Pc/Ptv = 1. [Points 10]
a. In what good will each country specialize? Briefly explain why.
b. Does each country gain from trade? Briefly explain why or why not.
c. Instead, suppose the world relative price of cars is Pc/Ptv = 2. How will this impact the
patterns and gains from trade?
Question 2: Specific Factors Model
Suppose Indonesia and Canada trade in Good S and Good B. Use the following data for Canada
to answer the questions.
Good ‘S’
Sales revenue = 𝑃𝑠 𝑄𝑠 = $80
Payments to labour = W𝐿𝑠 = $80
Payments to capital = R𝐾𝑠 = $40
Percentage increase in the price = ∆ 𝑃𝑠 /𝑃𝑠 = 25%
Good ‘B’
Sales revenue = 𝑃𝐵 𝑄𝐵 = $80
Payments to labour = W𝐿𝐵 = $30
Payments to capital = R𝐾𝐵 = $60
Percentage increase in the price = ∆ 𝑃𝐵 /𝑃𝐵 = 0%
a) Which industry is labour-intensive? [Point 5]
b) Calculate the percentage change in the rental on capital. [Point 10]
c) Compare the magnitude of the percentage change in the rental on capital in part (b) with
that of labour. [Point 5]
d) Identify the factor that benefits from trade in real terms. Which factor loses? [Point 5]
