Exercise the following questions.

1. “What is needed to ensure gains from specialization is a pattern of

comparative advantage.” Explain!
2. Suppose home (H) and foreign (F) countries have difference in technology
and they both are producing products X and Y in a way that home
produces and consumes more of Y and less of X and foreign produces
and consumes more of X and less of Y before trade. Now assume that
they moved to free trade.
Graphically show and discuss the effect of trade in the case where
A) The autarky price ratio of home country is lower than world
price ratio.
B) The autarky price ratio of home country is higher than world
price ratio.
C) The autarky price ratio of home country is equal to the world
price ratio.
3. Discuss
a) Heckscher-Ohlin theorem.
b) Factor Price Equalization theorem.
c) Stolper-Samuelson Theorem.
d) Rybcznski Theorem.
4. Why is the specific-factors model referred to as a short run model?
5. Discuss the differences between internal economies of scale and external
economies of scale and indicate the implication towards trade.
6. List down the component of balance of payment accounts? What
conditions or when does country's trade balance is surplus and deficit?
Explain briefly
7. Graphically illustrate and discuss the effect of import tariff and export
subsidy.
 1. Suppose that in the United States 4 man-hours are required to produce each unit of
clothing (C) and each unit of food (F). In Canada, 1 man- hour is required for each unit of
clothing and 2 man-hours are required for a unit of food.
a) Which country has an absolute advantage in each good?
b) Which country has a comparative advantage in each good?
c) Assuming that each country has 40 man-hours of labor available for production,
draw the production possibilities frontiers for each country. (Put food on the vertical
axis.) What do the slopes of these frontiers indicate?
d) Draw the world production possibilities frontier (defined as the maximum amount of
goods that can be produced worldwide for a fixed amount of resources) . What does
its slope indicate?
2. Why is the specific-factors model referred to as a short run model?
3. An economy can produce good 1 using labor and capital and good 2 using labor and land.
The total supply of labor is 100 units. Given the supply of capital, the output of the two
goods depend on labor input as follows:
Table 1 Production function

Labor
labor Input Out put of Input to Output of
to Good I Good I Good 2 Good 2
0 0 0 0
10 25.1 10 39.8
20 38.1 20 52.5
30 48.6 30 61.8
40 57.7 40 69.3
40 66 40 75.8
60 73.6 60 81.5
70 80.7 70 86.7
80 87.4 80 91.4
90 93.9 90 95.9
100 100 100 100

a) Graph the production function for good 1 and 2.

b) Graph the production possibility frontier. Why is it curved?
4. The marginal product of labor curves corresponding to the production functions in Table
1 are as follows:

Table 2 Marginal product of labor

Workers MPL in MPL in

Employed ector 1 sector 2
10 1.51 1.59
20 1.14 1.05
30 1 0.82
40 0.87 0.69
40 0.78 0.6
60 0.74 0.54
70 0.69 0.5
80 0.66 0.46
90 0.63 0.43
100 0.6 0.4
a) Suppose the price of good 2 relative to that of good 1 is 2. Determine graphically
the wage rate and the allocation of labor between the two sectors.
b) Using the graph from question 1, determine the output for each sector. Then confirm
graphically that the slope of the production possibility frontier at that point equals
the relative price.
c) Suppose that the relative price of good 2 falls to 1.3. Repeat (a) and (b).
d) Calculate the effects of the price change from 2 and 1.3 on wages in sector 1 and 2.
e) Qualify the effects of the price change on the welfare of workers and of the specific
factors.
5. Suppose when Russia opens to trade, it imports automobiles, a capital-intensive good.
a) According to the Heckscher-Ohlin theorem, is Russia capital abundant or labor
abundant? Briefly explain.
b) What is the impact of opening trade on the real wage in Russia?
c) What is the impact of opening trade on the real rental on capital?
d) Which group (capital owner or labor) would support policies to limit free trade?
Briefly explain.
6. Consider a country that produces computers (C) and food (F) using capital (K) and labor
(L). Both industries are perfectly competitive. The techniques of production in each
industry are Leontief. As a result, unit factor requirements are fixed and given by:
, , , ,and . Note: is the number of units of
factor i required to produce a unit of good j.
a) Which industry is capital intensive? How does the capital-labor ratio in each
industry depend on the relative wage W/R?
b) Suppose that the world price of computers is $16 and the world price of food is
$12. Assume that the Home country produces both goods. What are the free trade
factor price levels W and R?
c) What is the share of revenue going to capital in each industry?
d) Suppose the world price of computers increases to $26, while the price of food
remains at $12. What are the new values of W and R? How have they changed?
What theorem could you have used to predict this result?
e) What has happened to the share of revenue going to capital in each industry as a
result of the increase in the price of computers?
f) Suppose that it has an aggregate endowment of 100 units of capital and 150
workers. How many computers and units of food will the economy produce?
g) How would your answer change if the economy’s endowment of labor increased
to 200?

7. Suppose that a new country was discovered, somewhere in the Pacific Ocean, called
Pacificus, whose people had somehow managed never to notice that the rest of the world
existed, and the world also had not noticed the country until now. In spite of all this, the
country has a well-functioning market economy.
Having now become aware of the world and persuaded by economists that it should open
to international trade, you’ve been brought in as a consultant to explain to its people what
the effects of trade are likely to be. Before doing that, however, you need information
about the country.
What information do you need in order to predict the effects that trade will have
on the country, including but not limited to which industries will expand and which will
contract, as well as who will gain and who will lose, for those reasons and others, from
opening the economy to free international trade?
 Then explain what your predictions will be, how they will depend on the
information that you get, and which of the models that we have studied so far in the
course are associated with these predictions.
8. Use a partial-equilibrium model to answer the following questions about the effects of a
tariff in a small country:
a) Show that an ad valorem tariff will cause output to increase in the import-
competing industry if that industry is perfectly competitive.
b) If the industry instead has only a single firm in the domestic country, how will its
output compare with that of an otherwise identical perfectly competitive industry
under:
i. free trade
ii. Tariff
9. Demand curves and the equality of supply to demand in countries 1 and 2 are given
by:
X1 = L1(a –P1) X2 = L2(a –P2)

There are n1 and n2 firms in each country, with constant marginal costs C1, C2 and
trade costs t1, t2.
a. Characterize the segmented market oligopoly equilibrium. (Hint: Start with
inverse demand curves and remember that each firm chooses its own output
independently: end with expressions for equilibrium pprice as a function of
parameters.
b. Country 1 imposes an import tariff, i.e., sets t 2 and collects the associated
revenue. What is the effect of a small tariff on prices and outputs? What is the
effect on country 1 welfare? What is the optimal tariff? (Hint: it simplifies to
something easy if n1 = n2 and C1 = C2 = C).
c. Country 1 imposes an export subsidy, i.e., sets t 1 (<0) and bears the revenue cost.
What is the effect of this on prices and quantities and on country 1 welfare?
Workout the answer for cases
When n1 =1 and n2 = 0
When n1 =1 and n2 = 1
When n1 > 1