Pontífica Universidad Javeriana Prof. R.

Sonenshine
International Economics: Week 1, Trade June 2018

Homework (Tarea) 1

a. Drawing the graph for the world market in the middle, we get the following picture:

Note: Q is measured in kg. Of coffee, while P is measured in $/kg. Of coffee. Sexport means OCE
supply of coffee exports; Simport means CCI demand for imports of coffee.

b.

In OCE, the producers gain but the consumers lose, and there is also a net gain since the gains
to producers exceed the losses to consumers:

1) Producer surplus is increased by a+b+d

2) Consumer surplus is decreased by a

3) The net gain from trade is b+d

In CCI, the producers lose but the consumers gain, and in this case there is a net gain because
the gains to consumers exceed the losses to producers:

1) Consumer surplus is increased by a'+b'+d'

2) Producer surplus is decreased by a'

3) The net gain from trade is b'+d'

c.

If bad weather in the OCE reduces the supply of coffee, then the domestic supply curve in OCE
shifts down (to the left) from S to S′, and the OCE’s autarky price increases to (say) $1.50. In the
world market, the supply of exports also falls, shifting Sexpor to S'expor (with an intercept at $1.50)
and the world price increases from $2.50 to (say) $3.
 2

THE RIGHT WAY TO DO THIS: Start with the curve that shifts in one country, then see how
that affects its autarky price (where S = D), then see how the Sexpor or Dimports curve shifts, then
determine what happens to the equilibrium world price, and then bring the new world price back
into the two countries’ S&D diagrams to see what happens to welfare in each country:

Welfare effects:
1) At the higher world price, the importing country CCI definitely loses (note how the new
triangle b′+d′ is smaller than the old one shown in part a.).

The loss in CCI is entirely borne by consumers, however, as

 producers gain x from the higher world price of $3 vs. $2.50.

 consumers lose the area x+y
 the net loss is y.

2) What happens in OCE is harder to assess because of the shift in the supply curve, but we
can say the following:

1. Consumers in OCE definitely lose the area z (due to the higher price).

2. Coffee producers in OCE may gain or lose depending on whether the rise in price is
large enough to compensate for the loss in the quantity produced.

 producers gain the area z+w (due to the higher price), but they lose (u+v+area below that)
so whether the producers gain or lose depends on which of these is bigger.
3. The net is
 w-u-v-z

2. 1Use the Ricardian model to analyze trade between two countries, Britain (B) and Egypt
(E), each of which can produce two goods, cloth (C) and steel (S), with the following
(constant) marginal products of labor:
 3

MPL (output per worker-hour)

Cloth (sq. meters) Steel (kg.) Pc/Ps

Britain 60 40 4/6
Egypt 30 10 1/3

a. First, draw production possibility frontiers (PPFs) for each country on diagrams with the
quantity of cloth (QC) on the horizontal axis and the quantity of steel (QS) on the vertical
axis. Britain has 9,000 worker-hours and Egypt has 12,000 worker-hours
i. Which country has the comparative advantage in which good? How do you know?
Britain Egypt

360,000
120,000

Qs Slope = Pc/Ps = -2/3 Slope = Pc/Ps =-1/ 3

540,000 360,000 Qc
Qc
Eygpt has a comparative advantage in cloth as shown by having a lower opportunity
cost.

ii. See above for relative price of steel (Pc/Ps)

b. Show how the equilibrium world price ratio (PC/PS)World (“terms of trade”) is determined
on a diagram showing the export supply and import demand for Cloth [assuming that
Britain and Egypt are the only two countries]. You may make up any feasible number for
the free-trade world price ratio, (PC/PS)World.

2/3

Pc/Ps
1/2

1/3

cloth

Here we see that the autarky prices of cloth are 2/3 tons of steel per yards of cloth in
Britain and 1/3 tons of steel per yards of cloth in Egypt.
 4

c. Next, draw the free trade equilibrium on your PPF diagrams and show (qualitatively,
using “community” indifference curves) how each country gains from trade compared
with autarky
i. Show where production and consumption take place with free trade, and indicate the
quantities exported and imported by each country as well as he consumption point.

Qs
Qs Britain Egypt
360,000 120,000
export
90,000 Slope = Pc/Ps = -.5
Slope = Pc/Ps = -.5
270,000 import
90,000

Qc
Cloth
Import Qc
180,000 540,000 360,000
Export
180,000

Egypt produces 360,000 yards of cloth; it consumes 180,000 and exports 180,000 yards
of cloth in exchange for imports of 90,000 kg of steel. Britain produces 360,000 kg of
steel. It consumes 270,000 kgs and exports 90,000 in exchange for 180,000 yards of
cloth.

With trade, the world price line or terms of trade enables both Britain and Egypt to
consume at a higher indifference curve that is tangent to the world price line.

d. Are equal wages even possible if the countries are to trade according to comparative
advantages? Why or why not? What does your answer have to do with absolute
advantages? What would Egypt have to do in order to be able to have wages around the
same level as Britain’s?

Britain Egypt
MPL Trade price MPL Trade price
Cloth 60 60 30*1/2 15 kg of steel
Steel 40 40 *2=80 yards 10 10
of cloth

Equal wages will not occur after trade as the MPL is considerably higher in Britain than
in Egypt. Wages in Britain for steel are the MPL (steel) of 40 times the world price of
steel of 2 yards of cloth equaling 80. Egypt produces cloth with wages being the MPL of
 5

cloth of 30 times the price of cloth being ½ ton of steel yielding a wage of 15. Wages are
not equal, because Britain has an absolute advantage in both steel and cloth.

There are many ways to answer this question. If the ratio of MPLs remains the same in
Egypt than its MPL for cloth and steel would have to increase significantly, perhaps to
150 or so for cloth and 50 for steel.

e. Britain also trades with the Netherlands, for which the marginal products are as follows:
MPL (output per worker-hour)

Cloth (sq. meters) Steel (kg.)

Pc/Ps Ps/Pc
Britain 60 40 4/6 6/4
Netherlands 40 60 6/4 4/6

Can British and Dutch (Holandeso, Netherlands) wages be equal, or close to equal? Why
is the Dutch case different from the Egyptian case? Analyze and explain.

Yes, as neither Britain nor the Netherlands have an absolute advantage in either product.

In this case, the price Britain has a comparative advantage cloth and the Netherlands has
a comparative advantage in steel. The world prices however would be roughly 1 sq.
meters of cloth/kg. of steel (assuming they would be between .67 and 1.5), suggesting
that wages would be the same as each Britain specialized in cloth and the Netherlands
specialized in steel.