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Problem Set 2 Econ 355 - Introduction to International Trade 2013-2014 Term 2

Due Tuesday February 4th 2014 by 6:30pm in class or on Connect

True/False/Uncertain

For each of the following statements, say whether it is true, false, or uncertain and explain why using a couple of sentences, graphs or equations. 1. In the specic factors model model, a simultaneous 10% increase in the price of Manufacturing and 10% increase in the price of Agriculture would make owners of both capital and land better o. 2. In the Heckscher-Ohlin model, if the share of countrys capital used in Computers is higher C C than the share of countrys labor used in Computers (i.e. K > L ), then Computers must K L be the capital-intensive sector. 3. An individual worker might be better o as a result of trade in the short run, but worse o in the long run.

Specic factor model

In this question you will need to do some numerical calculations. Please report the numbers up to one decimal place. Home produces two goods, Manufacturing and Agriculture. Manufacturing is produced using capital K (immobile factor used in Manufacturing) and labor LM (mobile factor) according to the following production function
2 QM = 2K 2 LM , 1 1

which implies that the marginal products of K and L are respectively:


1

M P KM M P LM

= =

2 LM

K2 1 K2
1 2 LM

Agriculture is produced using land T (immobile factor used in Agriculture) and labor LA (mobile factor) according to the following production function:
2 QA = T 2 LA , 1 1

which implies that the marginal products of T and L are respectively:


1

M P TA = M P LA = 1. Properties of the production function.

2 1 LA 1 2T2 1 2 1 TT 1 . 2 L2

(a) Suppose that K = 16. What is the M P L in Manufacturing when L = 1, 2, 4, 6, 8? (b) Suppose that K = 49. What is the M P L in Manufacturing when L = 1, 2, 4, 6, 8? (c) Plot the M P L you calculated in parts 1a and 1b against L (plot both cases in the same graph). What principle is illustrated by the shape of the M P L curves seen in this graph? From now on suppose that the Home country is endowed with K = 100 capital, T = 64 land, and L = 41 labor. 2. Autarky equilibrium. Assume for now that the country is in autarky. You are given the autarky prices of Manufacturing and Agriculture, PM = 1 and PS = 2. (a) What is the allocation of labor across the two sectors? In other words, what is LM and what is LA ? (b) What is the (nominal) wage of workers? What is the wage in terms of Manufactures W W PM ? What is the wage in terms of Agriculture PA ? (c) What is the rental rate on capital RK ? What is the real rental on capital in terms of RK K Manufactures P and in terms of Agriculture R PA ? M (d) What is the rental rate on land RT ? What is the real rental on land in terms of ManuRT T and in terms of Agriculture R factures P PA ? M 3. Trade equilibrium. Now imagine Home can trade with a Foreign country that is better at Agriculture. After opening to trade with the Foreign country the price of Agriculture declines T = 1, while the price of Manufacturing stays at 1. to the world price PA (e) What happens to the allocation of labor across sectors? Recalculate LM and LA after the price change and compare them to autarky values. (f) What happens to the real wage? Recalculate values.
W PM

and

W PA

and compare them to autarky


RK PM

(g) What happens to the real rental on capital? Recalculate to autarky values. (h) What happens to the real rental on land? Recalculate autarky values.

and
RT PA

RK PA

and compare them

RT PM

and

and compare them to

(i) Summarize your results about the impact of trade on income distribution: are the workers winners or losers? What about the owners of capital and land? 2

Problems from the Textbook

Please solve problems 1 and 5 from Chapter 4 of International Trade textbook by Feenstra and Taylor.