Name: ______________________

SID: ______________________
GSI: ______________________

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UGBA 118: International Trade
Professor Steven Wood

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Spring 2016

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Exam #1 ANSWERS

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Please sign the following oath:

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The answers on this test are entirely my own work. I neither gave nor received any aid while taking this test. I
will not discuss the questions on this test until after 12:30 p.m. on February 23, 2016.
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Signature: ________________________________

Any exam turned in without a signature will be assigned a grade of zero.

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Exam Instructions
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1. When drawing diagrams, clearly and accurately label all axis, lines, curves, and equilibrium points.
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2. Explanations should be written in pencil or black. Legibility is a virtue; practice good penmanship.
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3. Explanations should be succinct and to the point; make use of bullet points and common mnemonics.
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4. If you have a question, come to the front of the class and ask me or the GSI.
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5. If you need to re-draw a diagram or need more room to write your answers, use page 2, and/or pages 11 – 14.

6. When time is called, STOP writing, immediately CLOSE your exam packet, and turn it in to me or the GSI.
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You WILL BE PENALIZED if you continue to write past the official end of the exam.
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Do NOT open this test until instructed to do so.

Exam #1 (Spring 2016) 1/9

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 A. Multiple Choice Questions (30 points). Highlight the best answer (3 points each)

1. The Mexican and South Korean economies are approximately the same size. However, in 2013, Mexico accounted
for 13.2% of U.S. international trade while South Korea accounted for just 2.7% of U.S. international trade.

a. This contradicts the predictions of the gravity model.

b. This is irrelevant to the predictions of the gravity model.

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c. This is consistent with the predictions of the gravity model.
d. This is due entirely to the North America Free Trade Agreement.

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2. According to comparative advantage, the most important benefit of trade is:

a. An increase in exports.

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b. An increase in employment.
c. An increase in the net exports.

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d. A more efficient allocation of resources.

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3.
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If a country has lower overall productivity levels than its trading partners, then:

a. The country will be unable to export.

b. The country will have a net export deficit.
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c. The country will not be able to achieve gains from trade.

d. The country will have a lower standard of living than its trading partners.
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4. If the U.S. can produce a combination of 10 shirts or 10 televisions and Mexico can produce a combination of 9
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shirts or 5 televisions, then what should the U.S. do?

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a. The U.S. should not trade with Mexico because the U.S. is self-sufficient.
b. The U.S. should export shirts to Mexico and import televisions from Mexico.
c. The U.S. should import shirts from Mexico and export televisions to Mexico.
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d. The U.S. should produce both shirts and televisions and export them to Mexico.
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5. If the terms of trade are between each country’s opportunity costs, then:
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a. Both countries would gain from trade.

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b. Only one country would gain from trade.

c. There is no basis for trade between the two countries.
d. One country would gain from trade but the other country would lose from trade.

Exam #1 (Spring 2016) 2/9

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 6. Small countries tends to benefit more from free trade than large countries because:

a. Small countries are less productive than large countries.

b. Small countries are more productive than large countries.
c. Small countries have lower incomes than large countries.
d. Small countries will have terms of trade near the opportunity costs of the large countries.

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7. When we say that steel is capital intensive with respect to wheat, this means that:

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a. Less capital is used in the production of steel than for wheat.

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b. More capital is used in the production of steel than for wheat.
c. A lower capital-to-labor ratio is used in the production of steel than of wheat.

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d. A higher capital-to-labor ratio is used in the production of steel than of wheat.

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8. A country that is capital abundant relative to another country will have which of the following advantages?

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a. A larger capital stock. Sm
b. A smaller capital stock.
c. Relatively cheaper capital.
d. Absolutely cheaper capital.
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9. In the Specific Factors Model, the owners of the specific factor:

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a. Should be in favor of trade liberalization in all cases.

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b. Should be opposed to trade liberalization in all cases.

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c. In the comparative advantage industry should be in favor of trade liberalization.

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d. In the comparative disadvantage industry should be opposed trade liberalization.

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10. If a relaxation of immigration policy were to lead to an inflow of workers, then:

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a. The return to labor would increase and the return to the owners of capital would increase.
b. The return to labor would decrease and the return to the owners of capital would decrease.
c. The return to labor would decrease while the return to the owners of capital would increase.
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d. The return to labor would increase while the return to the owners of capital would decrease.
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Exam #1 (Spring 2016) 3/9

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 B. Analytical Questions (70 points). Answer BOTH of the following questions based on the standard models developed in class. The questions are independent of
one another. The information in the various parts of the questions is sequential and cumulative.

1. Standard Trade Model (35 points). Suppose that free international trade exists between the United States and Japan with the United States exporting food,

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products, which is land intensive, and Japan exporting automobiles, which are capital intensive.

a.

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Use a Standard Trade Model diagram (on the left) to clearly and accurately show Japan’s (1) initial production and consumption choices, (2)

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exports and imports, and (3) aggregate economic welfare. Also use a World Relative Supply and World Relative Demand diagram (on the right) to

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clearly and accurately show the world equilibrium price of automobiles. These diagrams should be drawn in BLACK.

nb RSW1

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QF PA/PF

Isovalue-Budget Line Slope = -(PA/PF)0

a r RSW0

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Isovalue-Budget Line Slope = -(PA/PF)1

DF0
DF1
“B”

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(PA/PF)1
“D”

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MF0
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MF1 CIC0

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CIC1

SF0
i s “A”

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SF1
“C”

h i s XA1
RDW0

T
PPF1 PPF0

DA1 DA0 SA1 SA0 QA QA/QF

XA0

Exam #1 (Spring 2016) 4/9

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 b. Provide an economic explanation of what you have shown in your diagrams above. Be sure to
discuss (1) Japan’s production and consumption choices, (2) Japan’s exports and imports, (3)
Japan’s aggregate economic welfare, and (4) the equilibrium world relative price of automobiles.

Because Japan is exporting automobiles under free international trade, it will be relatively
more efficient in producing automobiles than the U.S. As a result, Japan’s production
possibilities curve will be “biased” toward automobiles.

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With free international trade the equilibrium world relative price of automobiles, (PA/PF)0,
will be determined by the intersection of the world relative demand curve, RDW0, and the

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world relative supply curve, RSW0.

At an equilibrium world relative price of automobiles of (PA/PF)0:

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1. Japan will produce at point “A” (the highest isovalue line that is tangent to its
production possibilities curve), supplying SA0 automobiles and SF0 food.

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2. Japan will consume at point “B” (the highest country indifference curve that is

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tangent to its budget constraint), demanding DA0 automobiles and DF0 food.

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3. Japan will export XA0 = SA0 – DA0 automobiles and import MF0 = DF0 – SF0 food.
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Exam #1 (Spring 2016) 5/9

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 c. Now suppose that because of a large earthquake Japan’s capital stock suddenly declines. On your
diagrams above, clearly and accurately show what, if anything, happens to (1) Japan’s
production and consumption choices, (2) Japan’s exports and imports, (3) Japan’s aggregate
economic welfare and (4) the equilibrium world relative price of automobiles. These changes
should be drawn in RED.

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d. Provide an economic explanation of what you have shown in your diagrams above. Discuss
what, if anything, happens to (1) Japan’s production and consumption choices, (2) Japan’s exports
and imports, (3) Japan’s aggregate economic welfare, and (4) the equilibrium world relative price

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of automobiles. Be sure to explain what causes these changes and why these takes place.

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A large earthquake that suddenly destroys some of Japan’s capital stock would shift Japan’s
production possibilities curve inward. While both food and automobile production
possibilities would be affected there would be a much greater effect on automobile

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production because automobile production is capital intensive.

At every relative price of automobiles, Japan is now able to produce fewer automobiles. This

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is represented by a leftward shift of the world relative supply curve from RSW0 to RSW1. As a
result of the reduction in the world relative supply of automobiles, the equilibrium world

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relative price of automobiles increases from (PA/PF)0 to (PA/PF)1.
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The increase in the equilibrium world relative price of automobiles from (PA/PF)0 to (PA/PF)1
causes Japan’s isovalue – budget constraint line to become steeper. Japan now maximizes
the value of its production at that point where the new, steeper isovalue – budget constraint
is tangent to the new, smaller production possibilities frontier at point “C”. Japan is now
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producing SA1 automobiles and SF1 food.

Meanwhile, Japan now maximizes its aggregate economic welfare at that point where the
new, steeper isovalue – budget constraint is tangent to the highest country indifferent curve
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at point “D” (on country indifference curve CIC1). Japan is now consuming DA1 automobiles
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and DF1 food and Japan’s aggregate economic welfare has declined.
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As a result of these changes, Japan now exports XA1 = SA1 – DA1 automobiles and imports
MF1 = DF1 – SF1 food.
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Exam #1 (Spring 2016) 6/9

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 2. The Specific Factors Model (35 points). Suppose that (1) free international trade exists between the
United States and Japan, (2) that automobiles are capital-intensive, that capital is specific to the auto
industry and that Japan is capital abundant, (3) that food is land-intensive, that land is specific to the food
industry and that the United States is land abundant, (4) that labor is a mobile factor of production used in
both the auto and food industries, and (5) the price of food is fixed.

a. Use Specific Factors Model diagrams to clearly and accurately show Japan’s (1) allocation of

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labor between the auto and food industries, (2) the nominal wage rate, (3) the return to the owners
of capital, and (4) the return to the owners of land. These diagrams should be drawn in BLACK.

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VMPLA, WA VMPLF, WF
PA0 * MPLA PF0 * MPLF0

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WA0 WF0
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WA1 WF1

PA0 * MPLA1
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0A LA1, LF1 0F
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LA0, LF0
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Exam #1 (Spring 2016) 7/9

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VMPKA, VMPTF,
RK RT

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RK1

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RT1
RK2 PA0 * MPKA0 PF0 * MPTF1

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RK0
RT0

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PA0 * MPKA1
PF0 * MPTF0

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K1 K0 K T0 T
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b. Provide an economic explanation of the results you have shown in your diagrams above.
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Labor is the mobile factor that can be used in either the automobile or food industries. In
equilibrium, the allocation of labor between the two industries is where the demand for
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labor in the automobile industry, given by the value of the marginal product of labor in the
automobile industry or PA0 * MPLA0, is exactly equal to the demand for labor in the food
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industry, given by the value of the marginal production of labor in the food industry or PF0 *
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MPLF0.
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The initial equilibrium in the labor market diagram above has 0ALA0 labor being used in the
automobile industry and 0FLF0 labor being used in the food industry. The initial equilibrium
nominal wage paid to labor is WA0 = WF0.
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Capital, which is specific to the automobile industry, is paid a nominal rent where the
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demand for capital in the automobile industry, given by the value of the marginal product of
capital in the automobile industry or PA0 * MPKA0, is exactly equal to the (fixed) supply of
capital. The initial equilibrium nominal return to the owners of capital is RK0.
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Land, which is specific to the food industry, is paid a nominal rent where the demand for
land in the food industry, given by the value of the marginal product of land in the food
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industry or PF0 * MPTF0, is exactly equal to the (fixed) supply of land. The initial equilibrium
nominal return to landowners is RT0.

Exam #1 (Spring 2016) 8/9

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 c. Now suppose that because of a large earthquake Japan’s capital stock suddenly declines. On your
diagrams above, clearly and accurately show what, if anything, happens in Japan to (1) the allocation
of labor between the auto and food industries, (2) the nominal wage rate, (3) the return to the owners of
capital, and (4) the return to the owners of land. These changes should be drawn in RED. (This part of
the question is only asking about the effects on the change in the capital stock on the allocation of
labor, the nominal wage rate, the return to the owners of capital, and the return to the owners of land. It
is NOT asking about what happens to the equilibrium world relative price of autos.)

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d. Provide an economic explanation of what you have shown in your diagrams above. Discuss what, if

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anything, happens in Japan to (1) the allocation of labor between the auto and food industries, (2) the
nominal and real wage rate, (3) the nominal and real return to the owners of capital, and (4) the
nominal and real return to the owners of land. Be sure to explain why these changes take place.

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A sudden decline in Japan’s stock of capital shifts the supply of capital curve to the left.

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Against the initial demand for capital curve (PA0 * MPKA0) the return to the owners of (the
remaining) capital will increase from RK0 to RK1.

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Because capital is specific to the automobile industry and the automobile industry is capital

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intensive, the decline in the capital stock will cause the marginal product of labor in the
automobile industry to fall. This causes a downward shift in the demand for labor curve
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in the automobile industry from PA0 * MPLA0 to PA0 * MPLA1. A decline in the (aggregate)
demand for labor with the supply of labor fixed causes the nominal was to decline from WA0 =
WF0 to WA1 = WF1.
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The decrease in the demand for labor in the automobile industry will also reduce the number of
workers in the automobile industry from 0LA0 to 0LA1 while the number of workers in the
food industry increases from 0LF0 to 0LF0.
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As the labor force in the automobile industry declines, it reduces the marginal product of capital
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because of a lower labor-to-capital ratio. In turn, this shifts the demand for capital curve down
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from PA0 * MPKA0 to PA0 * MPKA1. Because the capital stock is fixed, this reduces the return
to the owners of capital from RK1 to RK2 (although we do not know whether RK2 is greater
than, equal to, or less than RK0).
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Meanwhile, the larger labor force in the food industry increases the marginal product of land
because the labor-to-land ratio has increased. In turn, this raises the demand for land curve
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from PF0 * MPTF0 to PF0 * MPTF1. Because the supply of land is fixed, this increases the return
to the owners of land from RT0 to RT1.
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Exam #1 (Spring 2016) 9/9

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