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(10 points) The production possibilities frontier for a country is depicted below. Food



a) (8 points) On the diagram above, show a trading equilibrium when the international price of clothing relative to food is greater than the autarky price. Make sure you depict the consumption and production points, and draw the community indifference curve and the relative price both under autarky and with trade. b) (2 points) Which good does this country export?


This question is not covered in the midterm in Spring 2009.

2. (28 points) The graph below shows production possibilities frontier for two countries, Home and Foreign, producing two goods, Toys (T) and Garlic (G). Assume that Home is endowed with 100 workers and Foreign is endowed with 800 workers. G G

400 200







a) (4 points) In the table below fill in the unit labor requirements for each good and country. Garlic Home Foreign b) (4 points) Which country has comparative advantage in producing Garlic? Which country has comparative advantage in producing Toys? Why? Toys

c) (4 points) Find the interval in which the relative price of Garlic must fall in order for trade to be mutually beneficial.

d) Now the country opens up to trade. Assume relative world price for Toys is 4 and that the preferences of the consumers at Home are described by the following utility function: U=G.

a. (4 points) Depict the consumption possibilities after trade for each country on the graph above. Please make sure to label the slope and the intercepts. b. (4 points) Carefully label Pa, (production point in autarky); Ca (consumption point in autarky), Pt (production point with trade) and Ct (consumption point with trade) for Home. c. (8 points) Home is ______________ (exporting/importing) __________ units of toys if the relative price of toys is 4. For this price ratio to be an equilibrium price ratio, Foreign should ___________ (export/import) ______________ units of garlic.

3. (13 points) Assume that all the assumptions of the Hecksher-Ohlin model are valid. Apparel (A) is a labor intensive good and Electronics (E) is a capital intensive good; Country 1 is capital (K) abundant and Country 2 is labor (L) abundant. After these two countries start trading, in Country 2: a) (2 points) Relative price of Electronics _________________ (increase/decrease). b) (2 points) Relative output of Electronics ________________ (increase/decrease). c) (2 points) Relative demand for L ______________ (increase/decrease). d) (2 points) Relative wages (w/r) _______________ (increase/decrease). e) (5 points) Graph:



4. (15 points) Home is producing two goods X and Y, using labor (L) and capital (K). Initially, Home is endowed with 30 L and 80 K. Assume the production functions in two industries are: X=LK and Y=min{4L, K}. a. (7 points) Assume w/r=2. Draw the Edgeworth box for this economy and determine the labor allocation.

b. (8 points) What is the relationship between w/r and K/L? Please show your answer in the graph below and provide a brief explanation. w/r w/r



5. (18 points) Germany and Turkey produce two goods each, home appliances (H) and agricultural products (A), and use three factors of production. Home appliances (H) are produced using only capital (K) and skilled labor (S) and agricultural products (A) are produced using only capital (K) and unskilled labor (U). Capital is completely mobile between the two sectors ( K = K A + K H ), while unskilled labor is only used in sector A and skilled labor is only used in sector H. Assume that the relative world price for agriculture is given and constant at p A / p H . a) (10 points) Draw a diagram that shows the demand for capital, the nominal return to capital (r), and the allocation of capital between the two sectors in Germany. Please carefully label all axes, origins and (equations and names of the) curves.

b) (8 points) Suppose sometime in the future, Turkey enters the EU. Some predict that this will lead to a migration of unskilled workers from Turkey to Germany. If this is true, what will happen to the allocation of capital in Germany between sector A and sector H? Please depict your answer in the above graph and discuss your result clearly.

6. (8 points) Assume American workers are more productive in both the agriculture and the electronics sectors, compared to China. Assume also that US has comparative advantage in electronics. Discuss whether the following argument is true or false/ “Wages are higher in the US because US specializes in the production of electronics which is a “high value sector”. Therefore wages in China will increase if China emulated US’s pattern of specialization.”

7. (8 points) What would have to be true for the observed increase in inequality in Mexico to conform to the standard predictions of the Hecksher-Ohlin model? Could you propose two explanations that could explain the increase in inequality in Mexico?