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International Economics Dr.

McGahagan Pugel -- Chapter 4 Problems
Problem 4.1. Heckscher-Ohlin and Production technologies According to Heckscher-Ohlin (in contrast with Ricardo) all countries have the same set of production technologies available to them. You can buy a backhoe to dig a ditch in Nanking or in Nanty Glo. The reason countries may make different choices from the same set of production technologies is that they have different factor prices, which in turn reflects the fact that they have different factor endowments. Differences in factor endowments are the basis for trade in the HO model. Problem 4.2. Zero sum game? Trade in the HO model, like trade in the Ricardian model, is a positive sum game. The welfare of the "representative consumer" in both countries increases as a result of trade. Problem 4.3. Factor abundance and factor intensity. Note that factor abundance relates to national endowments and factor intensity to industries. We compare factor abundances by comparing the ratios of two factors across countries: in this problem, the labor/land ratio in Pugelovia is 20 / 3 = 6.67 the labor/land ratio in ROW is 80 / 7 = 11.43 ROW is labor abundant and Pugelovia is land-abundant (since 3 / 20 is greater than 7 / 80) Since the labor-abundant country is expected to have a comparative advantage in the labor-intensive industry, we would expect the ROW to export cloth and Pugelovia to export wheat. Problem 4.4. Deriving a supply curve from a production possibility frontier. Consider an example similar to that in problem 9. Assume there are only 3 states in the US, namely Pennsylvania (PA), Iowa (IA) and South Dakota(SD). With the factor endowments present in these states, they can produce at a maximum: Maximum production of wheat PA IA SD 50 200 250 Maximum production of corn 150 200 100 Opportunity cost of corn 1/3 unit of wheat 1 unit of wheat 2.5 units of wheat

The supply curve can actually be drawn without drawing the PPF. Note that Pennsylvania is the low opportunity cost producer for corn, and therefore has a comparative advantage in corn. It will therefore be the first of the three states to produce corn. Suppose the price of wheat is one dollar a bushel (we will assume this remains constant). What will Pennsylvania do if the price of corn is 33 cents a bushel? 34 cents a bushel? (at 33 cents a bushel, it would make 0.33 * 150 = $ 49.50 from corn production and $ 1 * 50 = $ 50 from wheat production, so it would produce wheat; at 34 cents a bushel, it would make 0.34 * 150 = $ 51 from corn production, so it would produce corn). At a price of 33.33 cents or greater, PA produces 150 units of corn -- our first point on the supply curve for corn. What price for corn gets Iowa to switch to corn production? What is total US corn production when PA and IA both produce corn? (answer: $ 1 and 350, so we have a second point on our supply curve for corn). What price for corn gets South Dakota to switch to wheat production? What is total US production? (answer: $ 2.5 and 450, so we have a third point on our supply curve for corn).

wheat / P.corn / P.wheat/P. for a US total of 500 wheat and zero corn [Note that this means that P.00 but less than $ 3.P.142 counties (the number of counties in the US).40.00 but more than 0.00 a bushel. so Pennsylvania drops corn production] -. You should see that if --P.P. not just on its dollar price. so that (for example) some farmer in Pennsylvania has land which cannot be used to grow wheat.00. If we construct an example with 3.P. and can be justified if we assume that production conditions differ WITHIN each of the states. so he will grow corn at any positive price. The 3-state PPF example is reproduced on the next page. .corn more than $ 1.wheat / P.corn is less than 1.Problem 4 (continued) Hence our supply curve for corn is (if we connect the points directly) or. -. for a US total of zero wheat and 450 corn These points ARE the points of the production possibility frontier of the country taken as a whole. it will look very curved indeed. -. for 250 wheat and 350 corn.wheat is less than 1 / 3. the rising price of corn will drive farmers out of wheat and into corn. If we construct an example with 50 states. the PPF would look even more curved. even SD switches to corn. all producers produce wheat. only SD produces wheat. for 450 wheat and 150 corn (only PA produces corn). SD and IA produce wheat.40. What about the supply of wheat? Note that even if the price of wheat stays at $ 1.corn = $ 3.00 or more.wheat / P. so the PPF graph (on the next page) looks more like a Heckscher-Ohlin PPF rather than a Ricardo PPF. if we use a step function (which more literally translates our numbers into a graph): The graph on the left looks more like what we are used to seeing as a supply curve. The supply of wheat depends on its price RELATIVE TO corn.corn is less than 0.

pasta / P.0.togas = 3. the quantity of cloth demanded increases. so that P.5 in the back of the book (p. Problem 4.6.togas = 4.pasta / P.wheat = 2. Again remember that the prices shown by the price lines are P.cloth / P.4 (continued) The three-state Production Possibility Frontier (PA in red. For problem 4.cloth / P. as the price line becomes flatter.5 and 4. or more generally will show the relative price of the good on the horizontal axis. Pasta and Togas.cloth / P.7. 680 and see if you can answer the questions without reading the provided answer. which may be misread as saying that the welfare of everyone in the country improves]. and production shifts out of cloth and into wheat.togas. When the text labels a line Price = 0. When P. Therefore. SD in magenta): Problem 4. . 679).5. the representative consumer moves to a higher indifference curve. [The text language expects the answer that the country's welfare improves. P. the country would export cloth. The text notation is a bit confusing. it takes 4 togas to buy a unit of pasta. the county is at its autarky point S0.pasta / P. the country will be importing cloth. Puglia.5 W/C. the relative price of cloth drops. As the relative price of cloth drops. so the representative consumer's welfare improves. Add the trade triangle to the graph when P.0.wheat. IA in blue. note that at P. Make sure you understand that the (absolute value of the) slope of the price line shows the relative price of cloth.Problem 4. 679 that as the terms of trade improve. they mean that it takes only half a unit of wheat to buy a unit of cloth. Note that in the graph on p. and since the production of cloth is decreasing. Look at the graph on p.6 See the very thorough answer to problem 4. If the relative price of cloth increased to more than 2.wheat is 0. Be sure to be able to translate the text notation into relative prices accurately.

5 and 1 Between 1 and 1. ROW will expand its production of cloth and will move to a higher indifference curve as the price line becomes steeper (try to add a S2 and a C2 to the PPF graph of the rest of the world.5 cloth 2 cloth Color on graph blue magenta green red Note that B is the LOW OPPORTUNITY COST producer of wheat.wheat / P.C. higher indifference curve). Terms of trade.D None .8. Note that you can use the supply and demand graphs in Part B of figure 4.5 and 2 Above 2. The autarky price P. 55.0. 680. B.3.D B. C.Problem 4.4 to see what is happening to producer and consumer surplus in the US and in ROW when price rises to 1. Person A is the HIGH OPPORTUNITY COST PRODUCER of wheat.5 cloth 1 cloth 1.cloth Less than 0.5 Between 1.9. and will be the first to enter into wheat production. and sketch in the price line and the new.67. See the text explanation on p. The text presentation assumed that the world price after trade was 1. portraying international equilibrium. Problems 4. D B only A. and in the rest of the world (ROW) was 0. Multi-person Production Possibility Frontier. and will be the last to enter into wheat production.D B.wheat in the US was 2.cloth / P.5 Between 0. output of cloth 1 1 3 2 Opportunity cost of wheat 0.0.D A only A.C A. Supposing that the relative price of cloth rises to 1.0 Wheat production 0 2 3 5 6 Cloth Production 7 6 5 2 0 Producers of Wheat Cloth None A.3.C. so that the ROW would export cloth to the US.C. this is a terms-of-trade improvement for ROW. and a terms of trade deterioration for the US. Refer to the graph on p.B. The production pattern will therefore be: P. Maximum output of wheat Person B Person C Person D Person A 2 1 2 1 Max. See problem 4 for a detailed example.